Sure, it’s important to start investing young, but are bonds, stocks or mutual funds the best investment for us? And what the hell does liquid have to do with it?
You’re sitting in a big sterile lecture hall Monday morning listening to your professor’s droning yet all you can think about is how you’re going to make it through the week with $5. Your ever-dwindling savings account is down to a measly $30. Yet you’ve still got an ominous stack of credit card, phone, cable and electric bills collecting dust on the corner of your desk, and it’ll be weeks before your next paycheck arrives.
How nice would it be if you just won a million dollars in the lottery and didn’t have any financial worries. Unfortunately, the chances of this are almost zero. Solving your financial woes may take a little more initiative than buying tonight’s winning ticket.
Sooner or later everyone needs to think about how to secure their financial future. Maybe you’re a lucky graduate who’s already got a job lined up. Or you’ve been working hard at school and managed to save a little extra money. Or maybe an awesome paid internship will cover your expenses. Whatever your situation, choosing to invest early is the best way for you to guarantee your financial security. In investing, time is your best friend.
You’ve probably heard some well-established middle-aged acquaintance mention their investments from time to time — a certain mutual fund, an IRA plan, a hot stock. If the words are just words to you, read on. But considering the possible rewards, taking time to look at things now will pay off later on. Once you know some basic info, stashing away hard-earned money doesn’t have to be hard.
Investing is putting your money to work to make more money. There are tons of ways to do this, all with different payoffs.
There are three basic ways that you can invest your money: stocks, bonds or cash (like a savings account). You can invest in each of these directly. Or you can invest in them indirectly by buying mutual funds, which pool people’s money together before investing it en masse.
Doug May, a financial advisor for Merrill Lynch in Indianapolis, IN, describes three things to consider before investing that will help you decide which route(s) to take:
1. Why am I investing? What is the end goal? Is it for a new car, or is it for retirement?
2. What is the time frame? How long do I have to come up with the money? This varies largely on your goal. If it is for retirement, most students have 40+ years to work with.
3. How much will I need to reach my goal? It’s hard to figure out the logistics of how much and where to put your money if you don’t know how much you’ll need in the end.
Once you answer these questions, you’ll then want to consider three other determining factors: liquidity, safety and return.
Liquidity refers to the accessibility of your money and how easily it’s converted to cash. If immediate financial security isn’t a big issue, you don’t need to worry about investments with short maturity dates, or those that have an expected return in a fairly short amount of time (two years versus 10 or more years). Determining the liquidity of your investments really depends on whether your goals are long or short-term. If you’re investing for long-term goals, you want something that will grow and short maturity investments won’t really do this for you.
One suggestion from experienced investor Brad Huges, managing director of an Internet service in Australia, Includes, “Build a stash of cash; at least three months of living expenses, preferably six months.” (If you’re wondering where you’ll get three months of living expenses, read Invest For Success). This should be money that you set aside early on (you could split the money you are saving the first couple of months between this and your other investments), as well as money that you can have easy access to, like in a separate savings account. While it may not be necessary for a student to put aside that much money for emergencies, it may not be a bad idea to set aside this money in case you’re ever in a jam (all those crumpled-up bills and quarters in your Mickey Mouse bank from third grade probably won’t cut it, either).
Safety refers to the risk involved. Investing always involves risk, but the amount varies a lot depending on where you put your money.
Many people afraid of losing money choose safer investments. Putting your money only in safe investments may not get you to your final goal though, especially after factors such as inflation and increased cost of living. Also, while some investments may fluctuate more on the short term, over time, things often even out, yielding a decent average return. So it may still be worth it to consider those investments that may have a moderate amount of short-term risk, but have a fairly consistent long-term growth. This is where it is important to do your research. One great way to look at the growth and development of different investments is at the Web sites listed above.
An aggressive investment includes newer and smaller companies’ stocks. They carry greater risks, but have the possibility for greater returns, too. Sara Canon, a financial advisor and broker services representative for Irwin Union Securities in Columbus, Ind., describes how more aggressive companies tend to “go down further and go up higher typically. You may see a gain of 40 or 50 percent at a time.”
Return is how much you can expect to get back from your initial investment. Sometimes it’s a fixed rate, like in money market accounts which have a set interest rate (according to May, something like 4.5-4.8 percent), and other times the potential to make or lose a lot of money varies widely, like in stocks. Keep in mind the only way to get a higher average return is to lower your safety.
With these things in mind, it’s time to look at the different investing options in more detail.
Stock buys you a piece of a company. When a company is doing well, you may receive some of their profits through dividends (which are typically paid quarterly), and the price per share will also increase. Unfortunately, this works both ways and the loss can be great, too.
There are many different stocks with a wide range of prices and dividends. While it may be tempting to use your $200 to buy a couple of shares of your favorite fast food chain, investing in individual stocks involves a pretty high risk, and with only three or four shares, your dividends, at an average of 2-3 percent, won’t be paying you much either (maybe only a dollar or two per share).
Normally, investors purchase one round lot, or 100 shares, of a certain company at a time. In addition, diversifying the stocks you pick helps even out some of the risk. Knowing this, it often takes a decent sum of money to begin investing purely in stocks.
John Arnold, a stock-only investor from Bloomington, Ind., offers one other tidbit of advice: “It pays to buy in larger quantities.” You pay a commission fee to the broker when you buy stock. As Arnold explains, the commission is usually a flat fee plus a small percentage of the amount you’re investing (around 25 percent). The fee and percentage vary, based on the range your investment amount falls in. So you’ll get more for your commission money if you’re investing $5,000 instead of only $1,500.
One of the benefits of online trading is the elimination of broker fees. While it’s not free, many times you simply pay a flat fee. While Arnold may pay a minimum of $40-50 commission for his purchases, online trading sites, such as etrade.com, quote commission rates from $6.99 to $8.99. There are also many other sites that also offer low-cost commission/transaction fees.
Penny stocks are another temptation for students. These stocks are usually less than $5 a share, and upon first glance seem more appealing than the more expensive blue-chip stocks (stocks of stable and predictable companies like Coca-Cola, which has been averaging around $46 a share). Jennifer Harkins, a recent graduate of University of Virginia now working at a regional brokerage firm, offers one lesson she’s learned: “Penny stocks are extremely risky — so if you plan on investing in those, plan on not needing the money, period.”
The growth of many Internet and Internet-related companies has many people buying stock for the the first time, too. The first day a private company becomes public and allows the general public to buy stock is their Initial Public Offer, or IPO.
Many young Internet technology companies, as well as other Internet-related service companies have had their IPO’s recently. Because of the expected continual growth of the Internet, many people have been anxious to purchase stock in these companies. While share prices of many of these companies may start at about $10-15, they often skyrocket within the day because the demand is so high. The possible growth of these companies is high enough that people are willing to keep bidding to buy shares. (One example is the online company Priceline.com, whose IPO on March 30, 1999 had the price of $16 a share. During the next two months, prices fluctuated between $55 and $165 per share. Also who can forget Google which started out at $85 for its IPO in 2004 and is now trading at $485.
While many of these companies may continue to have huge surges in growth, they are for the most part still young companies whose long-term future is hard to predict.
Bonds, or loans you make to the government or corporations, are another, often safer, option. Bonds usually pay a specific amount or interest rate (around 5-7 percent) on a regular basis. Normally, corporate bonds have higher yields than government bonds and the time span of bonds vary depending on the source. Be wary of junk bonds, though. The higher interest rates (9-10 percent) may be appealing, but these companies are at a greater risk than other companies, due to debt. They have to pay higher rates to borrow money.
For students, the main drawback to bonds is that there are few selling for less than $1,000, and often you can’t buy just one. If you can’t afford bonds, but still want to invest in them, they are included in some mutual funds.
Invest For Success
Wondering where you’d get the cash to invest now, when you can barely scrounge up enough beer money for a decent Friday night party? Not sure how many companies to invest in? Get the wisdom on these and other topics of investing basics.
Why have mutual funds become so popular? They offer simplicity, variety and built-in diversification that is appealing to many investors. Investors can limit options by choosing a certain type of fund (i.e. money-market funds, bond funds, balanced funds, growth funds, etc.); this is much simpler than choosing from thousands of stocks. Fund managers direct these funds with regard to expected results, making different investments that give investors the automatic advantage of diversification.
Most mutual funds require an initial investment, usually around $500, but after that you can make additional purchases whenever and for whatever amount you like. Mutual fund purchases can be made monthly or quarterly through automatic deductions from your savings account, making them a convenient way to invest on a consistent basis.
Online investing may even enable you to get started for even less. Also, you can begin looking at the different types of funds available at these sites. These sites have complete lists of all the funds available on the market and price quotes, but they also allow you to look at funds by different groupings or rankings (top 10 most viewed individual funds or top 10 funds based on returns).
Andy Tacs, a junior at Penn State, has already invested in a money-market account. “At age 16, I took my life savings — $2,000 at that point — and dumped it into a money market account. I invest in medium-range, non-utility/transportation businesses. It’s nice; the money is just on cruise control. They make all my specific choices for me, so that I don’t ride the ups and downs of a few companies, but see the trends of the entire segment of the economy. They [Janus] do a decent job. I think I’ve got somewhere around $3,000 now, since I have the profit reinvested.”
How To Do It
How do I go about making these investments? There are a lot of options: financial advisors, stock brokers, fund managers as well as transactions via the Internet.
While some students feel intimidated visiting a financial advisor, others have found consulting an advisor to be beneficial. Steven Ronald, a student at Concordia University in Montreal, said “I recently went to see a financial advisor and the experience was a positive one. He took the time to explain the different mutual funds available … he pretty much stuck to basic information and showed me how time is the most important factor in the long term-growth of wealth.”
Banks have expanded into the brokerage business so your local bank may even be able to help you make purchases. There are numerous larger brokerages, such as Vanguard, Charles Schwab and Merrill Lynch. They are either, or both, full-service (those that will help you make your investment choices) or discount (those that buy and sell stocks/funds that you decide on) brokers.
As for online possibilities, there are many. It may be the answer you’re looking for, depending on your investment strategy. For Harkins, who chooses to buy and hold for long-term growth, “The cheapest route is through the Internet, like using e-trade.”
While the Internet is a great place to make trades and begin your investment planning, there are dangers to online investing, too. The Securities and Exchange Commission offers some tips for investing in this very fast-paced market. Some of these include setting price limits on fast-moving stocks and making sure cancelled orders were actually not executed.
Investing wisely can also lead to a fulfilling retirement. Johnnie Godwin of Gallatin, Tenn., had a successful career climbing the corporate ladder to Vice President before facing early retirement due to new administration. But he was financially prepared; he had a company pension, personal IRA investments through Merill-Lynch, a 401k plan, had purchased a home and had also invested in cheap land that ended up being worth a lot more over time. As he says, “I had a rich career. But retirement is in many ways even richer. I’m sitting in shorts, a T-shirt, training shoes after playing hard racquetball earlier this morning. I’ve got a chapter on a book I need to get finished. And I’ll do that at my own pace … you wouldn’t believe how much my life and career and retirement are so wonderfully rich.”
Although retirement may seem ages away, it’s never too early to start working towards a comfortable one. Once you are employed, one great way to begin saving for retirement is through Individual Retirement Accounts, or an IRA. IRA’s were set up by the government to help encourage people to save for their retirement. Basically an IRA plan is a self-directed plan (which means you choose how the money is invested) that allows you to deposit up to 10 percent of your earnings, up to a maximum of $2,000 a year, into a special account set up by a bank, brokerage, or mutual fund. The benefit of this account is that the IRA’s allow you to defer paying taxes on these earnings until you begin taking money out of this account. While you can’t begin taking withdrawals out until you reach 59-and-a-half years old, it still allows you to save a lot more because it is tax free income.
Even though most of us aren’t rolling in the dough, yet, it’s never too early to begin thinking about your financial future. With so many options it really can seem overwhelming, so taking the first step may just be figuring out the basics. While all this may not be as fun as living it up with your buddies, one day you might just be surprised to find that it was worth your time — when that luxury car and brand new home are more than just a dream!If you liked this article, click here to buy me a beer!