CONSIDER INVESTING IN STOCK AND BOND FUNDS
5. Consider Investing in Stock and Bond Funds
Once you have your three-month savings cushion in place, you can continue putting money into low-risk bank accounts and money market funds, or you can choose to get more aggressive with your investments. The advantage of stocks and bonds is that they’ve historically tended to earn more for investors over long periods of time, allowing them higher returns to stay ahead of inflation.
The downside of stocks and bonds is that they’re riskier than money market funds. Translation: You can lose money by investing in them. Only you can decide how much risk you’re willing to take for the chance to earn higher returns over time, but one common approach has been to put about half of the holdings you don’t plan to touch for many years into stocks, one-third into bonds, and the rest in money market funds. This is a mix you may want to consider for your retirement savings plans, although some experts recommend putting somewhat more into stocks for IRAs and 401(k)s.
If you do decide to put some of your money in stocks and bonds, do so by investing in stock mutual funds and bond mutual funds. A mutual fund is a type of investment that pools together the money of thousands of people. It’s headed by a fund manager, who invests the entire sum in a variety of stocks, bonds, and/or money market instruments. Avoid investing in funds with a load, which is the commission that some mutual fund companies charge each time you put money in or take money out of a fund. They don’t perform any better on average than no-load funds, so there’s no point in paying extra for them. I recommend that you consider only no-load mutual funds with low expenses. Expenses are the annual fees charged by the fund and can take a huge bite out of your investment returns if you’re not careful.
Although stock funds are considered somewhat riskier than bond funds, they have also performed somewhat better over long periods of time. If you decide to invest in a stock fund, I recommend you consider a type known as an index fund. “Index” means it tracks the performance of a recognized basket of stocks, such as the Standard & Poor’s 500 Index.
Two companies that offer index funds with no loads are Vanguard (www.vanguard.com; 800-662-7447) and T. Rowe Price (www.troweprice.com; 800-541-6066). Vanguard has some of the lowest fees and the largest selection of index funds, but you’ll generally need at least $3,000 to open an account there if you want to invest in its index funds. (It also has a special fund that only requires $1,000 to start; see p. 132 for more details.) T. Rowe Price has higher fees (still lower than the industry average) but allows investors to get started with a minimum of $50 a month automatically siphoned out of a checking account.
Bonds are generally less risky than stocks but riskier than money market funds and you can still lose money with them. Holding bonds as well as stocks will help to diversify your investments, reducing your overall risk. Vanguard and T. Rowe Price offer no-load bond funds as well. While there are several different types of bond funds, a reasonable approach would be to choose a bond index fund that invests in government securities or highly rated corporations.
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