Invest for Your Future
All you know is that you want to buy a car one day. Or a home. Have a kid. Or two.
Meanwhile, the little money you do have is just sitting there. You're afraid to touch it and afraid not to. At less than 1% interest, your bank account isn't doing your goals any favors. But it could be worse, right? At least you've got that money there in the bank in case you get laid off or have some other big financial emergency.
But where do you go now? Once you've gotten that emergency cushion started (or even if you're just wondering where to invest your 401(k) money), I've talked to some of the smartest minds on Wall Street about what they do with their own money. And whether you have $50 or $50,000, you can adopt their key strategy right now. It starts with two words: mutual funds.
- Invest in mutual funds
Some people try to make money buying and selling individual stocks. Some of them even succeed, but the problem with individual stocks is that you're placing all of your proverbial eggs in one proverbial basket. If your stock does well, terrific. But if it does badly (and we've seen plenty of stocks go bad over the last few years) you're stuck with a basket of rotten eggs.
Mutual funds are investments that can include hundreds, if not thousands, of different stocks. Essentially, they allow you to lower your risk by spreading your money around. That way, if some of the stocks in a mutual fund tank, others will hopefully make up for the loss. - Look for low annual expenses
The median stock mutual fund charges annual fees (known as "expense ratios") of around 1.4% per year. So if a fund returns 8% in a given year, your actual return could be more like 6.6%. These differences may not seem so bad, but over the years they could cost you tens of thousands of dollars.
That's why it's important to pay attention to expense ratios when you're deciding where to invest. Information about expenses can be found in a document called a "prospectus," which you can get from your mutual fund company before you put your money into any fund. The SEC provides a helpful calculator that shows how expense ratios effect your investments.
Now here's the part that kills me: historically, funds with high expenses have performed no better than funds with low expenses. Of course, there are exceptions. But in my book, unless you're willing to throw money away—and there are many more fun ways to do that—it's tough to justify going with high-expense ratio funds. - Don't pay commissions
In addition to their regular expenses, many mutual funds also charge one-time commissions known as "loads." A load is typically 2% to 3% of your investment, but can sometimes be as high as 8.5%. So if you invest $1,000 in a mutual fund with an 8% load, you end up investing just $920. The extra $80 goes right into the broker's pockets, which are probably full enough already.
The good news is that studies have shown for years that "load funds" do no better than "no-load funds." And there are now literally thousands of no-load mutual funds to choose from.
But how do you find the right one? - Here's a quick lesson on funds
The world of mutual funds is divided into two basic camps: actively managed mutual funds and index funds. Most mutual funds are actively managed, which means that someone, somewhere, is picking exactly which stocks will be part of your fund. As an investor in that fund, you end up paying a fee for the benefit of that manager's expert stock picks.
Then there are index funds-also known as passively managed funds. The fees are much lower (up to a hundred times lower) and the return over time has been just as good (and usually better) than what you get with actively managed funds. Though no one can guarantee that index funds will always do better, their lower expenses give them a leg up on their actively managed counterparts.
An index is a group of stocks that are bunched together to track all or part of the market. For example, one popular index, known as the Standard and Poor's 500, tracks the performance of 500 very large companies. Because these 500 companies account for a huge part of the stock market as a whole, the S&P 500 Index is very closely watched. - Go with index funds
Now, here's the part that matters to you. You can invest in a mutual fund-called an index fund-that purchases only the stocks in a given index like the S&P 500. These funds tend to have very low expense ratios, because no one is being paid to select individual stocks to put in them.
Let's talk numbers. Over the past 10 years, the S&P 500 has outperformed about 75% of large company stock funds over the past decade, even despite two big market downturns (2000-2002 and then starting in 2007). When you account for fees, the index outperformed about 80% of its actively managed peers.
In other words, index funds are not only less pricey than actively managed funds-they've usually been more lucrative, too. But don't expect your broker (even if he is your half-brother's cousin on your mother's side) to tell you that.
One of my favorite places to find an index fund is vanguard.com. (I don't get any free stuff or other kickbacks from them; I just think they're a good company.)