Investing Money for Beginners
7 August 2006So you don’t have any clue where to start in investing your money. This post is for you - the absolute beginner with no experience with money or finance. You need to start doing a couple of things:
1) Learn. It is not a good idea to stay uneducated. There’s no way for me to explain everything you need to know in a single post. But I can give you advice on how to get to where you need to be knowledge-wise. Read this blog every day. Self-serving advice, but it will give you tips on pretty much everything - so you’ll gradually start learning what you need to know. In addition, go get a subscription to a personal finance magazine. Money Magazine is a good one, so is Smart Money, and so is Kiplinger’s. Read it every month, and read everything. You’ve got gaps in your knowledge and you need to fill them up. Also, you should buy a copy of Millionaire Next Door. It’s a good book that’s only about $10, and it will teach you some of the basic principles about how anyone can be a millionaire over time.
2) Set up an investment account. You probably want two - a 401k or an IRA and a private account with a brokerage. Why two? The government account (401k/IRA) will allow limited contributions that are tax-deductable. You should ALWAYS max out your contributions to these - put in the most you are allowed to each month. The reason is that you’re making instant money - you don’t pay taxes on the money you put in, so you get a free return of whatever your tax rate is. It’s nearly impossible to make 33% consistently in any other investment - but you can here. If you don’t take it, you are throwing money away.
But, you can’t contribute more than a set amount. And smart people will want to put in more. Put the excess in a private account, because you usually have more investing options and you have no constraints on what you can do with it.
3) Invest in the stock market. Contrary to what people say, it is NOT risky to invest in the stock market. In fact, it is the most consistent way to make money. Returns average about 10-11% per year. New investors are always afraid of a crash - but this is irrational. Stocks are paper money. You don’t lose money until you sell them. And if you’re investing for the long haul, it is virtually impossible to lose money. In all of American history, there has never been a 20 year period in which, if you put money in the stock market as a whole, you would have lost money at the end of 20 years. This means starting from ANY date - right before the 1929 crash, if an investor had bought in at the highest, and waited until 1949 to sell, they would have made money.
4) Do not buy individual stocks if you’re a beginner. Buy “index funds.” - Index funds are mutual funds where the people who manage them do very, very little. All they do is take an “index,” which is a list of stocks that broadly represents the economy as a whole, such as the Standard and Poor’s 500 or the Dow Jones Industrial Average, and they invest the mutual fund’s money in those stocks on the list. This has several advantages for investors: the fund’s fees are low, which can save you deceptively large amounts of money over time. The stocks you own will be diversified, so your investment won’t be hurt as badly by problems with one company. You will tend to make 10-11% per year - it’s a given with index funds, a gamble with other funds. You also don’t have to think about it or do anything. And finally, individuals rarely “beat the market” over time by getting more than 10-11%. It is very hard to do, even for experts. Usually they end up making lots of money in some years, and losing lots in others - averaging less than what you would have made in an index fund.
5) Understand what compounding is. Compounding is the most important concept in investing. It has been called the greatest force in the universe. All it means is that you earn money on the money you’ve made in the years before. So if you have a dollar in an index fund, in the first year you make 11 cents on average. The next year, however, you don’t have a dollar - you have $1.11. So you make a little over 12 cents that year. And then you have $1.23, so you make even more, and so on.
It doesn’t sound like much - but over long periods, those little compounded increases mean you make a LOT of money even with small amounts. Let’s say instead of that dollar, you put $100,000 in an index fund and waited 20 years. How much would it be worth? If you made the 11 percent average each year, you end up with $806,231 - eight times what you put in, just for waiting. What if you leave it there another ten years? You end up with $2,289,230! All for doing nothing but waiting and leaving your money in there. That’s nearly 23 times what you put in initially. So if you can save $100,000 by age 35, you will be set for a nice, cushy retirement when you hit 65. The key thing to understand about compounding is that you need to set a long time frame, keep putting money in regularly, and wait patiently. That will make you rich.
Still have questions? A great resource for learning more is the Free the Drones Forums. Register and ask away.
2 Responses to “Investing Money for Beginners”
August 13th, 2006 at 7:52 pm
[...] Investing Money for Beginners, from Free The Drones which included all 5 tips that you must know to get started. [...]
August 25th, 2006 at 2:55 pm
[...] You’re probably wondering how the heck that can be possible - unless you understand the idea of compounding. The real reason that she can easily save that much is because she’s 24, not 34. If she had to save for only 30 years, she’d end up with about $1,000,000 - if she had to save for only 20 years, only $367,000. If you’re starting young, you have a HUGE advantage - which is why everyone plans on having a six figure income in retirement if they’re 25 when they start saving. So my advice: go get a Vanguard index fund and start popping in that $5,000 a year - or a little more if you can afford it. Come 65, you’ll forget there ever was such a thing as penny pinching. [...]