I know, I know: The idea of investing was scary and overwhelming before the stock market started going berserk, so now the thought has you downright petrified. Yes, the circus we call the Stock Exchange has been particularly wild in recent years, but investing can still have a place (an important place, even!) in your financial life.
Here’s how to look at it: The market has always fluctuated and it always will, but for money that you won’t need to touch for the next 20 or 30 years, it can actually be riskier to keep it in a savings account that doesn’t keep up with inflation.
Before buying your first share, make sure other important ducks are in a row (that includes getting rid of credit card debt, contributing to retirement plans and socking away nine months’ worth of living expenses for emergencies). Feel better? Now you’re primed for an investing how-to:
Or, in English: Don’t put all your investment eggs in one company’s basket. You’ll avoid being at the mercy of one stock’s performance by going with mutual funds, which pool your money with that of other investors into a large basket of stocks and/or bonds.
To thine own risk tolerance be true.
Putting money in the stock market always carries risk, but how much risk depends on what you’re comfortable with and how long you plan to let your investments grow. Stocks tend to be more volatile than bonds, which are the more conservative choice, but they also have the potential to yield greater returns. Vanguard has an Investor Questionnaire that helps you allocate based on the answers you provide to questions such as how sad, upbeat, or indifferent you’d be if your investments lost 31% of their value (that’s what happened in the fall of 2008!). Generally speaking, the further away you are from needing your money, the more risks you can afford to take; as you get closer to that deadline, it’s wise to become more cautious.
Cozy up to the index.
Indexes you hear of, like the S&P 500 or the Wilshire 5000, track the performance of certain sets of stocks. Why should you care? Because these indexes have given rise to your cheapest (and therefore most effective) investment prospect. There are two types of mutual funds: “active” and “passive.” Active funds employ managers who actively pick and choose the securities you’ll invest in—but paying those managers means less money for you! Index mutual funds are passive in that no one’s constantly picking and choosing. The fund is set up to track the performance of the index at a low cost to you. (According to Morningstar, S&P 500 funds returned more than active funds over the last 30 years, but, of course, past performance doesn’t predict the future.) When researching funds, direct your attention to “expense ratios”—the lower the ratio, the less you pay to invest—and read Burton Malkiel’s book (he’s my hero!) and Charles Ellis’s “The Elements of Investing”, which makes quite the case for choosing index funds over active funds. You could also call Vanguard (800-937-5544) or Charles Schwab (866-232-9890) to get started.
Learn the ABCs of ETFs.
There’s a new index tracker on the block that’s been getting a lot of buzz lately: exchange-traded funds, or ETFs. ETF expense ratios are often even lower than those of index mutual funds. The difference is that ETF shares are traded on the Exchange throughout the day, just like stocks, offering the flexibility to take advantage of fluctuating prices. Traditionally, each ETF trade incurred a commission, dampening ETFs’ low-cost advantage. But now, Vanguard and Charles Schwab both offer commission-free ETFs, making these funds friendlier to the average investor.