Expert: Steve Hach - 5/9/2009

Question
hi, im 18 years old and my dad suggest that i go into the stock market a bit. he says if i put in a few bucks into some stocks, by the time i retire, some of those stocks may be worth a lot. but i know nothing of the stock market, and how it works. and anything that i read online or my dad says just doesnt really make sense. if you could, i would just like to know information on how the stock market works, some strategies to keep in mind, and anything else. im pretty much a clean slate when it comes to this.
thanks in advance.

Answer
Hi Bryan,

Thanks for the question.

The best/easiest thing to do would be to put your money into a stock market index fund.  Most major investment firms offer some sort of index fund.  On average, these funds will pay 5-10%/year and over time this will really add up.  Of course, the fund will go down sometimes, but will usually increase over a lifetime.

If you get more sophisticated over time you could begin to manage your own portfolio instead of using the index fund.  Yahoo finance has lots of information for individual investors.

Successful investing takes discipline, education, and patience. A plan should be established and strictly followed for decades. My suggestion is to spend the next six months researching. Start with "Investing for Dummies", available at amazon.com and most major bookstores. This will give you the basics on most major forms of investment, and you can do further research on what appeals to you. In general, the higher the possible return of an investment, the more risky it is. As an example, a money market account will earn you about 2%/year; this is a very low gain. But it is perfectly safe and you would get that 2% every year without fail.  CD's (Certificate of Deposits) can earn perhaps a few percent more in annual returns and are also perfectly safe, most banks offer CD's.

No risk here, but your investments are locked up for one to two years depending on the CD. A portfolio of stocks can earn you much more each year. But some years will be good, and others bad. Many investors lost half or more of their worth during the bad markets recently. However, over a long period of time, the risk evens out and the returns are much more substantial. An average of 20% return each year would double your investment every four years.  

You cannot count on this, but the key is that if you start now at 18 you will have MANY years for the compound interest to work and over time this really adds up.

Another good resource here are any of the books written by William O’Neil, founder of Investment Business Daily. Keep in mind this is one approach, but he goes into depth on how he successfully selects stocks and builds a stock portfolio. Always read with a critical mind, no one has the holy grail when it comes to investing. If they claim that they do, it is a scam. There will always be failures, but the idea is find more successes than failures. This is very possible over time.

I believe that the ultimate solution is two fold. First, move slowly. While stocks and other investments can treat you well, they can also treat you very poorly if the wrong decisions are made. Start with a money market, this is a great place to 'park' your savings while you learn more.

Then I suggest mutual funds. Do your research. The book I mentioned above will help, and www.morningstar.com is perhaps the best-known source of mutual fund information available. Lipper is another. When you have more than $5,000 invested, branch out to several mutual funds that specialize in different areas such as real estate, technology, health care, utilities, or others. That way if a specific industry does poorly, you will not feel it too badly.

Only after a few years or whenever you feel confident should you venture into stocks. But start practicing right away. Begin researching possible stocks you would want to invest in (again the book I mentioned will help you learn what to look for).  Track your ideas on a free service such as yahoo.finance.com and see what your stock picks do.

There is another alternative. If you want to get started right away, consider an index mutual fund. These are funds that exactly copy the major stock market indexes. For example, the Vanguard S&P500 index fund is a good one, this one copies the Standard and Poors 500 Index. If you invest in this one fund, your performance will exactly match that index. You will never perform better, or worse, than the overall index. Over the years you could expect perhaps 12 returns on average, again some years will be much greater and some much worse. The symbol is VFINX, and you can buy this on any major trading service website. It is a great way to get started while you learn more.
--and again, you should be able to find products for foreign exchanges so you could diversify your holdings via a mix of domestic and foreign stocks.

Please keep in mind that right now the markets are in real turmoil.  It may be best to just keep saving money in a safe vehicle for now and to not invest in stocks until it is a sure thing that the market has turned.


I would just stress the following points:

1. Avoid debt like the plague!  Do NOT run up credit card debts.  

2. Save money.  If you can save 25-50 dollars a week and invest it you will end up with a huge amount of money by the time you are 65.

3. Read a good newspaper everyday--like the New York Times or Wall Street Journal.  Read the news AND the business section.  I also like some of the financial blogs like this one:
http://bigpicture.typepad.com/

4.  Take a college course in finance and/or US economic history.

5.  Invest your money in a stock market index fund.  Try to find one with low fees.  Leave that money there and do not try to chase the markets.  You want to gain over time, you don't need to day trade or worry if things go up a bit or down some.  Think long term.

Hope this helps, and remember that if you are trading online it is best to reduce your costs as much as possible.


Good Luck,

Steve