So, you worked all summer and now you have some extra cash on hand, maybe $1,000 or more. If so, nice job! Now, do you take that $1,000 and spent it on beer all year? Or do you take that money and invest it? Well, if you spent it on beer, you will drink fine all year. But if you invest it, by the time you retire, assuming you do nothing with that initial investment, it could be worth around $13,000. So, was the beer worth $13,000?
Investing is a great way to save for the future, as long as you are responsible and disciplined. It doesn’t require a huge up-front investment, and it doesn’t require a lot of time or effort. All it requires is a small tolerance for risk, a dedicated time horizon, and an up-front time investment of an hour.
If you are new to investing, the first thing that you need is a brokerage account. Investing cannot be done at a bank, but must be done at a separate entity (even though some banks do have brokerages within them). This is where you have several options:
- Cash Account: This is the most basic account. It allows you to purchase any type of security you want with your cash on hand. This option is suitable for most investors, especially ones starting out, and ones who don’t want their money locked up until retirement.
- Margin Account: This account is similar to the cash account, except that you can borrow money to invest. This account enables some features a cash account doesn’t, such as shorting investments, and selling uncovered options.
- Traditional IRA: This is the traditional retirement account vehicle. It is similar to the cash account in that you can purchase securities with the cash you have available. However, this account places a limitation that you cannot withdraw that money inside it until you are at least 59 1/2. However, you get a tax benefit for all money invested up to the limit (which is $5,000, or $6,000 if over 50). You will have to pay taxes on any money you withdrawal once you do retire.
- Roth IRA: This is similar to the Traditional IRA, except that you do not receive a tax benefit in the year you invest, but, at retirement, all of your withdrawals are tax-free.
So, what is the best option? If you want to save for retirement now, and you earned your income (meaning it came from work and not Mom and Dad), a Roth IRA is the way to go. The reason is the tax you pay on your income now is so low, that you get huge savings in taxes when you retire. However, if you don’t want to tie up your money for 40 years, a cash account is a great way to start. If you want a more detailed guide, check out What Type of Investment Account Do I Open?
If you are looking for a great place to put your money, check out my favorite discount brokerages. It compares two of the best brokerages available, so you can select one that fits your needs and wants.
So I Opened My Account, Now What?
Once you have opened you account, the money is just sitting there not doing anything for you. This is where a little time is involved to educate yourself, and a little discipline about your time horizon comes into play.
I want to start by saying you can, and may for short periods of time, lose money. For example, the S&P 500 (the largest 500 companies in the United States) returned a nice 27.11% in 2009. That is awesome. However, it lost a huge 37.22% in 2008. There are huge swings in the market. However, the reason people invest is because the return on the S&P 500 annualized for the past 20 years has been 8.12%. There were up years and down years, but if you just did nothing, you would have gained 8.12% annually. This beats the standard for a savings account, which grew by only 2.81% annually.
So, taking that into consideration, it is highly recommended that if you are investing for the long term, you look at index funds. Index funds come as either mutual funds or ETFs, and they track an index, such as the S&P500 or Dow Jones Industrial Average. The most common and highly recommended Mutual Funds and ETFs out there are here:
- iShares S&P500 Index (IVV)
- Schwab S&P500 Index (SWPPX)
- Vanguard 500 Index (VFINX)
- Vanguard Total Stock ETF (VTI)
- Vanguard Total Stock Market (VTSMX)
When you go to purchase these funds, you will pay a commission to buy it. This is paid each time you make a trade. If you read the post above about where to invest, you can see that commission vary widely, and there are often specials or promotions you can take advantage of.
Also, you will most likely be asked if you want to reinvest your dividends or take them as cash. Most large companies in the U.S. pay dividends to their shareholders. As a small owner in each company in the fund you purchased, you get your dividends too. The fund will usually pay these out quarterly or annually. If you are investing for the long term, I recommend reinvesting your dividends, as it will boost you return.
I Did It! Now What?
So, now you have invested your $1,000 in a good index fund. Congratulations. Now, just wait it out. The stock market will go up and down. The worst possible thing you can do is panic if the market drops, and sell your investments. The market will recover, and if you are invested for the long term, you will reap the gains.
Does anyone else have any tips or advice on getting started? Any great fund ideas for beginners?