Building a valuable asset for the future
Mutual Funds for the Little Guy
by Gary Foreman
Compound Interest for Poor People
4 Beginner Investment Mistakes
I read your article on financial advisors, and was wondering what your thoughts were for someone who wanted to invest in a few mutual funds and didn't have enough business to excite most financial advisors but still felt uncomfortable doing it solo.
Anita asks a good question. Most of us don't have large amounts of money to invest, which limits our attractiveness to financial planners. And with investments becoming more complicated, it's harder for the average guy to know what to do.
Let's break this into three parts. First, we'll look at the eight basic rules of investing. Second, we'll look at the three things that a do-it-yourselfer must learn. And, finally we'll see if we can't show Anita how to select funds that are right for her.
These basic rules are the foundation of any successful investing program. Fortunately, they're easy to understand.
There is no risk-free investment, even if you put your money in the bank. They'll guarantee that you'll get it all back, but no one will guarantee how much you'll be able to buy with it.
Time reduces risk. History has shown that in any given 10-year period, you would have made money if you owned all of the stocks on the NY Stock Exchange. Even including the years of the crash of '29 and the depression.
You must consider inflation. Your investment must grow faster than inflation or you're really losing money. Being too cautious in your investment selection can actually increase your risk.
You must consider taxes. Even at a 15% tax rate, your growth will be significantly affected. Suppose you invest $1,000 and it grew 8% per year for 50 years. If your growth were taxed each year at 15%, you'd end up with $28,650 at the end. But, if you didn't have to pay taxes along the way, that same $1,000 would have grown to $50,653.
Invest early. Money invested in your twenties has more time to grow than dollars invested in your forties.
Invest often. Don't wait until you have a big bunch of money to invest. Get in the habit of adding to your account on a monthly or quarterly basis. You'll be amazed at how those smaller amounts add up over the years.
Compounding is a wonderful thing. Having your money make more money sure beats working for it. All you have to do is to let your earnings stay in the account and wait for time to pass. Any newby investor can do that.
Doing average is ok. You don't need to be a stock picking genius. Very few people are. All you need to do is to get average returns over a number of years and you'll do quite well.
OK, now let's see if we can help Anita grow more comfortable with a do-it-yourself investment project. Like any DIY project, she's going to have to be willing to learn and to try new things.
She'll want to learn about three main topics, how commissions and fees will be charged, how to determine what a fund invests in, and how to evaluate past fund performance statistics. These are simple concepts that anyone can understand.
By now Anita should know the basic truths of investing and some idea of how mutual funds work. Next, let's learn something about a concept that greatly simplifies investing. That's the "index fund."
Earlier we mentioned owning all of the stocks on the NY Stock Exchange. An index fund does just that. An index fund is not really managed. There's no one trying to outguess the market. The fund is managed to be a reflection of the index that it represents.
Studies have shown that index funds will generally outperform all but a few managed mutual funds. That makes Anita's job easier. Instead of picking a fund, all she has to do is to pick an index that represents her level of aggressiveness. If she's cautious, she'll want a fund that indexes the NYSE, American Stock Exchange or S&P 500. If she's braver, she might want to index the NASDAQ. Or if she's aggressive, she might want to check out one of the technology index funds. Then she'll choose a quality mutual fund company that offers a fund for the index she's selected.
Should Anita be careful as she begins investing? Sure! But, if she starts small, adds money regularly and continues to learn, she'll be able to build a valuable asset for her future.
Updated November 2013
Gary Foreman is a former financial planner and purchasing manager who founded The Dollar Stretcher.com website and newsletters in 1996. He's been featured in MSN Money, Yahoo Finance, Fox Business, The Nightly Business Report, US News Money, Credit.com and CreditCards.com. Gary shares his philosophy of money here. You can follow Gary on Twitter. Gary is also available for audio, video or print interviews. For more info see his media page.
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