There isn’t a better time to invest than today. The way to build real wealth is by living well below your means and then saving and investing the difference. The poor buy things; their homes are cluttered with them. The middle class buys liabilities like second homes and boats, and then they are obliged to make payments and upkeep on them for years. In contrast, the rich buy investments that appreciate and pay them dividends and interest for decades.
Despite recent market turmoil, historic long-term returns still average 10% to 12%. At a 10% rate of return, your investments should double every seven years. So $100 invested today becomes $200 in 7 years, $400 in 14 years and $800 in 21 years. Even at a modest 7% rate of return, your investments should double every 10 years.
Getting started may seem as daunting as embarking on any new hobby, but on average this kind of hobby pays you money rather than costing you. Every hour you spend learning about investments is an hour of free entertainment. It is an hour you are not spending money at the mall or on a more expensive pastime. And ultimately investing will be your engine of income and appreciation. It will subsidize what might otherwise be a subsistence lifestyle based solely on Social Security checks during retirement.
The first step is getting some money together. In the beginning, the amount you save is most important. Later, after you have amassed a significant multiple of your annual spending, the amount you make on your investments becomes much more significant. At that point (at age 40 or when you have five times your annual spending to invest), it’s time to seek a personal fee-only financial planner in your area. Visit the website of the National Association of Personal Financial Advisors at www.napfa.org. for information.
In step 2, open an account where you can do your investing. E*Trade is a discount firm. Account minimums are $2,000 with less than $50,000 in combined assets, and stock trades cost $12.99. TD Ameritrade offers accounts with a $2,000 minimum and trades of $9.99 each. Scottrade offers $7.00 per trade with a minimum of just $500. Charles Schwab offers trades at $12.95 with a $1,000 minimum account size. Fidelity charges $19.95 per trade with a $2,500 minimum.
Competition continues to force brokerage companies to adjust their charges on a regular basis, so verify the fees before signing up. Be sure to ask about any monthly inactivity charges. Avoid any account with monthly or annual fees. You plan on investing in a balanced portfolio and then going fishing. You don’t want to be charged for the 11 months between now and your annual rebalancing. Make sure you know what the account minimums are too. They should never be more than a few thousand dollars. Although you don’t plan on transferring your account, ask what the charges are to do so, and make sure they are reasonable, typically about $75.
Each broker has special promotions that may offer free trades, cash or electronic goods. Taking the best promotion is tempting, but evaluate brokers without considering the promotion.
Setting up an account is easy, and you may be able to do it online. If you need to sign account agreements, read them carefully. Not only should you understand what you signing, but this is the first step in your financial education, and your goal is to gain wisdom and experience.
Half of any area of expertise is learning the vocabulary, which gives you both a shorthand for discussing finance and possibly a new a way of thinking about the world of investments. If you don’t understand something, check it out at Investopedia or call your broker’s toll-free number.
In step 3, get money into your investment account. Many brokers allow you to link your checking account to your investment account electronically so you can transfer money at any time. Better yet is setting up a monthly automatic transfer. A day or two after your paycheck is deposited into your checking account, an amount you have designated is automatically transferred into your brokerage account.
The principle is to pay yourself first. You deserve to build wealth, and wealth is what you save and invest, not what you spend. Think of a rich person simply as a poor person who has saved a lot of money. Save and invest as little as $100 a month for 46 years earning 10%, and you can retire with a million dollars. And $500 a month grows to an astounding $5 million.
Those 46 years of saving ideally take place between ages 20 and 66. If you are beginning later in life, you may have to invest more to save the same amount. In fact, for every seven years you delay saving and investing, you cut your retirement lifestyle in half.
Today is the day to decide if you want to be financially free. I can’t emphasize enough that time in the markets is more crucial than timing the markets. Who among us doesn’t wish we had invested as much as possible in the markets at the prices 46 years ago?
Push yourself to save as much as you can automatically each month. No one should save less than $100 a month in their taxable savings, and this taxable savings is in addition to any work-related retirement accounts.
After you have begun adding money into your taxable savings account, it’s time for step 4, actual investing. Knowing the best mix of investments requires a great deal of research and analysis. Investment advisors can add significant value for large portfolios. But for small amounts when you are just getting going, how much you save each month is more critical than the asset allocation you select.
To pick a fund, go to www.maxfunds.com. This is an excellent layman’s site for fund analysis. In the drop-down box “Show me these funds” select the category you want to purchase. I will tell you which categories to purchase later, but for now assume you know. Next, in the drop-down box “That are sorted by,” select “Highest MAXFunds Rating.” Finally, click “Go.”
The tool lists many investment choices, ranked from their highest score downward. If you can invest at least $2,000, buy an exchange-traded fund. These funds are purchased with a transaction fee ($8 to $20). The amount you are purchasing should be significant enough so the transaction costs to purchase the fund are well under 1% of your initial investment. For amounts less than $2,000, consider waiting and accumulating more to invest or else purchase a no-load mutual fund without any transaction fee.
The site puts a yellow star next to their favorite fund, which is a good place to begin. If you are evaluating funds on your own, look for a fund where the TYPE is ETF and the expense ratio (EXP) is as low as possible. That is often the best choice of a fund. The lower the costs, the more you will keep of the return.
Finally, let’s talk about investment categories. Start with a fund that follows U.S. large-cap stocks, and then as you gather additional investment money add funds in the order in which they are least correlated with each other. Here is the order for your first five investments.
Launch your investment portfolio with a “Large Cap Value” fund or better yet a “Blend” fund such as Vanguard Total Stock Market ETF (VTI) or iShares Russell 1000 Index Fund (IWB). Make your first investment in this fund at least $3,000. This should cover all the stocks in the S&P 500 and more.
Second, add an “Intl. Diversified” fund like iShares MSCI EAFE (EFA) or Vanguard Europe Pacific ETF (VEA). Third, add a “Natural Resources” fund like iShares Natural Resources (IGE). Fourth, add a “Small-Cap Value” fund like iShares Russell 2000 Value Index Fund (IWN) or Vanguard Small Cap Value ETF (VBR). Fifth and finally, add an “Emerging Market” fund like iShares MSCI Emerging Markets Index (EEM) or Vanguard Emerging Markets ETF (VWO).
After investing in these five funds, you will probably know enough to evaluate your asset allocation with more sophistication than this simple allocation. If you want, go back and add another share to the “Blend” and “Intl. Diversified” allocations. By then you should have over $20,000 and be on your way to growing rich. Getting started can be intimidating, but these simple steps will help you through your first few years of investing.