Beginner Investing/Investing

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QUESTION: Hello,

I am in my mid-20's and was looking to invest around $100 a month and was wondering what you think the best options would be? I am thinking more of the long term (10-20+ years).

I've been reading a book called "America's Finest Companies" which argues that the best investment strategy is to invest in some of the more well-known companies like Walgreens and Coca-Cola if you wish to invest long-term. I was curious to hear if you felt this way, or if you thought there might be a better solution based on my situation.

Also, what site do you recommend for investing in stocks? I have looked at various sites, but with the various fees per trade, I'm wondering if it is really a smart strategy to invest $100 a month and paying fees that approach nearly 10% of that.

Thanks =).

ANSWER: Justin,
Thank you for your question!
Yes, I do have some suggestions on how to begin organizing an investment plan for the future. The earlier you begin to plan, the easier it will be. Investments take time to grow.  Congratulations on beginning to think and act on this while still in your twenties. This gives you many decades to build real growth for your investments and your future.
I believe that you should think of things in terms of three different categories, and I will offer further specifics on each:  1. Debt reduction to lead to debt elimination 2. Education about investing 3. Action

1. Debt Reduction and elimination of debt:
I am often asked how to invest funds while the potential investor has large credit card and other debt. Paying interest on debt more than offsets what you could reliably earn in good investments, so it makes the most sense to pay off debt first, then invest.
Start immediately with this. It is key to the financial well being of everyone in the future. People in this country have a very bad habit of running high debt in the form of credit cards, car loans, and all sorts of credit for just about anything.  Credit is so easy to get, it is difficult for many young people to resist. By the time most of us are adults, the terrible cycle of high debt is already established. The first key to a wonderful lifestyle in the second half of life is to resist this.
Most credit cards charge 15% or more in interest. It does not make sense to invest when folks are paying so much extra for each purchase! If you have credit cards and/or car loans, pay them off. This usually frees up hundreds and hundreds of extra dollars each month that normally goes to these bills. This can be used to both invest and improve your lifestyle. If you can't pay cash, you can't afford it! The exception is real estate, as that is 'appreciating asset' that increases in value.  It is a good move to purchase and own a home if it is feasible.
There is nothing worse than paying high interest on a car, then having that car decline so rapidly in value as you use it, possibly the worst of ‘depreciating assets’ that exists. Of course we all need cars, but if the money is not there, don't buy an Acura when a Honda will do so to speak. Put as much down as possible, and see about a 3 year or less loan. The goal is to pay it off as quickly as possible, then drive it 'free and clear' for as long as possible. Cars are perhaps the largest things standing in the way of most people having a truly wonderful second half of life.  We are conditioned to buy the most expensive car possible and this is a huge drain on our finances.
Good investors can double their money every five years. Take the $25,000 price tag of an average car these days, go out 40 years, and see how much that car actually costs!

2. Education
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% a 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 3% 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 on average 10% or 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 of 2001 and 2002. However, over a long period of time, the risk evens out and the returns are much more substantial. An average of 10% return each year would double your investment every eight years. (Not every ten, as you have to account for the growth in the portfolio for the next year returns).  Another good resource here is 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 account, this is a great place to 'park' your savings while you learn more. Then I suggest mutual funds or ETF’s (exchange traded funds).  Do your research. The book I mentioned above will help, and www.morningstar.com is perhaps the best-known source of mutual fund and ETF information available. Lipper is another. Yahoo finance and Google finance are two free sources. Start with index funds, but when you have more than $5,000 invested, branch out to several mutual funds or ETF’s 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.
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 10% returns on average, again some years will be much greater and some much worse. And that is based on history, the future can never really be predicted. 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.

3. Action
When you are finally ready, my suggestion would be to have 20% of your portfolio in safe investments such as CDs and money market accounts, 30% in stocks (this could be in the form of the Index Fund I mentioned earlier if you want something simple and easy) and 25% in ETF’s or mutual funds, and 25% in specifically in bond ETF’s or mutual funds.  You will likely not have a large amount to start with, so begin with the funds. Continue to contribute every month, and it should grow further in addition to the returns you get. When you have enough, buy into a second, then a third fund. When you have at least 10 to 15 thousand in funds, begin to think about a stock portfolio. Always hold a basket of stocks, not a single stock, as it is too risky if you are wrong in your decision. For trading services I like www.FOLIOfn.com the best, www.ScotTrade.com is also good.  These are discount brokerage firms that can make trades for you online for very low fees. You could establish an account with a major advisory firm such as Merrill Lynch, or Wells Fargo Advisors. I do not recommend this. They charge very high fees that come out of your returns, and they usually have minimum account size anyway.  And their so-called ‘experts’ do not have your concerns as their number one priority. Instead they are looking for the fees, and often push stocks or investments according to their organizations best interests, not yours. You will be much better served if you do the research yourself. Of course if you are not interested finance as a topic and the time needed (a few hours a week should do it), working with a full service financial advisor may be more attractive and would be better than not spending the time and making bad decisions yourself.

To keep you motivated, here is a link to an investment calculator. You can enter how much you plan to invest each month, the likely returns you will get (5% for a risk free CD's, 10% for an index fund, perhaps 20% for a stock portfolio) and the time until you need the funds.  

http://www.moneychimp.com/calculator/compound_interest_calculator.htm

It would be very advisable to consider forming an IRA or ROTH IRA account. This is a overall account type, within which you can buy or sell stocks, mutual funds, or other investments. The advantage is that with a Roth IRA, you do not pay income tax when you begin to withdraw the funds at retirement. With a standard IRA, the contributions are usually deductible each year if you do not have an employer retirement plan, although when you retire your withdrawls will be taxed. Of the two, a ROTH IRA is superior, as long as your income is not greater than the maximum limit for this type of retirement account. If it is, then you could still create a standard IRA. These tax advantages are substantial and should not be ignored. Most major online trading services allow you to select either a ROTH IRA or IRA account as the structure when you open an account with them.

The most important thing is to STICK WITH IT!! Even with a minimal income everyone in this country would retire wealthy if they avoided debt and planned for the future with at least a small contribution to their investments each month. I congratulate you on your interest and sincerely wish you the best. It takes work, but your finances should become a hobby, learn every chance you get. If I can be of any further service, please do not hesitate to follow up with me!

Sincerely,
Paul Henneman
President
ValuEngine, Inc.
www.ValuEngine.com

---------- FOLLOW-UP ----------

QUESTION: Hey,

Thank you very much for the reply! It's much appreciated. You gave me a lot of information, so I am definitely going to be saving this and continuing to look through what all you said. I did have a few questions though in response to some of what you said. Hope that is okay!

1. With a car loan, does the total interest change based on how quick you pay off the loan? If I was to start putting as much as possible on the loan each month, would I be saving money vs paying it off at the standard rate? Me and my fiancee have a car loan, but no credit cards or no other outstanding debt. Unfortunately, we made some of the mistakes you mentioned with getting a car loan. Me and my fiancee went with a 2-year-old used car at a 5 year loan. We've also put a lot of miles on it already, as my family lives across country and we've had to take multiple trips.

2. The mutual index funds sound interesting to me and something I think I will especially look into. Instead of paying a fee as I invest the money every month, is it better to better invest quarterly? (with 3X the money of course)

3. In addition to this investing, me and my fiancee are also saving up to buy a house. Lately, we have been taking our budget and whatever we come out ahead, we put 50% towards a down payment on a house, and 50% into our emergency savings. Would you recommend changing this to 50% house/25% emergency savings/25% paying extra on the car loan?

Thanks again for all your help. I will also check out the "Investing for dummies". I really like the "For Dummies" series, so I am especially interested in checking this out.

Answer
Thank you for the follow up question!

1.   Yes,  you absolutely save lots of money if you pay off your car loan more quickly. The interest you pay is based on the outstanding amount of the loan (how much you still owe).  So if you pay it off more quickly, the interest is less and less. You can save thousands by paying off a car loan quickly.

2. This depends up on how much you invest. If you plan to invest a few hundred or less each month, yes, saving up for 3 months and investing quarterly will work well. As long as you have the discipline to stick to it. Most people do not, and end up spending that money before it goes into the investment account. If you find that happening, then go to monthly so the funds are out of your hands and in the investment account.

3. This depends upon how large your emergency savings are.  You should have a minimum of 3 months  of expenses saved in emergency funds, so if you have less than that, I would stick to your current plan. If you have 3 months of expenses saved up, or more, then yes I would change to 50% savings for the house, 25% for emergency fund, and 25% for extra payments on the car. If and when you get to six months expenses saved as emergency funds, I would direct that amount to the car.  

When the car is paid off, and your emergency funds are at 6 months of expenses, then all of it can go to savings for the house.

These are just my suggestions, and the above is typically in line with the standard for savings.  But everyone is different, some people for example are comfortable with less emergency savings, some people prefer much more.  Its really up to you and your fiancee.

It is great that you are thinking and planning. Keep it up.  Things are just that, things.  Keep away from new expensive cars and the trappings of designer, expensive junk, and you will save and see the benefits years down the road. It can be hard when friends, family, and others show off their new fancy stuff. But stay the course, pay off and stay out of debt, and invest. You will sleep soundly at night, and be happier in the long run.  Big debt is a huge source of stress on relationships, your future marriage will benefit from sound finances.

Best of luck to you, and don't hesitate to follow up with me if I can offer anything additional.

Sincerely,
Paul Henneman
President
ValuEngine, Inc

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Paul Henneman

Expertise

I can answer any questions on investment strategies. Specifically, my expertise lies in long term investment strategies designed to beat market performance while reducing risk. Not get rich quick schemes, but solid investing strategies. DO NOT SEND ME YOUR HOME WORK QUESTIONS! Over one half of the questions I receive are clearly students in finance or economic classes asking for answers to their homework questions. Most of these come from India. I won't answer them, do your own work. However, I welcome all investors trying to negotiate how to invest in stocks, mutual funds, ETF's, and other investments.

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15 years in a leadership role at a financial research company. We sell research to institutions such as Wells Fargo, Fidelity, Thomson Reuters, Bloomberg, Bank of NY, Scotia Bank, and others.

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Florida International University, University of Florida

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Wells Fargo Advisors, Fidelity, Scotia Bank, Thomson Reuters, Capital IQ, Factset, Bloomberg, Bank of NY, CBSMarketWatch, Hoovers, Multex, Yahoo Finance, Zacks, Earthlink Finance, numerous large institutions and hedge funds, subscribers to www.ValuEngine.com

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