5 Tips for Beginning Investors
Kiplinger's Personal Finance editor Janet Bodnar shares our best investing advice in a letter to her son -- and any twentysomething looking to get into the market.
I was impressed when my twentysomething son, Peter, told me recently that he was reading Benjamin Graham’s classic, The Intelligent Investor. Peter also subscribes (on his own) to Kiplinger’s Personal Finance magazine, of which I’m the editor, and he occasionally asks me for advice. I’m fortunate to have the expertise of our staff at my disposal, plus some thoughts of my own for beginning investors. I distilled them into an e-mail that Peter says he found “really helpful,” so I thought I’d share it:
1) Put safety first. Before you invest in anything, you should have money in the bank that you can easily get to in an emergency (say, your car breaks down) or that you can use for a new car, a trip abroad or even a house. Kiplinger generally recommends that you have at least enough in a cash reserve to cover your expenses for six to 12 months. Savings accounts are paying almost nothing right now, but you can eke out 1% or so in top-yielding accounts.
2) Build a solid base. For longer-term money that you don’t need right away—such as money in your 401(k) plan or IRA—you can afford to take risks in the stock market. The best thing to do when you’re starting out is to stick with mutual funds, which let you spread your risk—or diversify—by investing in a lot of different stocks.
The best funds to start out with, in my opinion, are index funds, which try to match a particular benchmark, such as the broad-based Standard & Poor’s 500-stock index or a total stock market index. Another benefit of index funds: They have very low fees, which means more of your money is working for you and not for the company that manages the fund.
Note: Peter, you asked about exchange-traded funds, or ETFs. An ETF is a kind of index fund. There are hundreds of ETFs that invest in all kind of indexes, some well known (such as the S&P 500) and some so obscure that you’d never need them. They are popular because their fees are even lower than those of index mutual funds, and you can trade them throughout the day like stocks. We’ve compiled our favorite ETFs into the Kiplinger ETF 20.
3) Aim for a target. Another broad-based way to invest is a target-date fund, which you probably have access to through your 401(k) plan. That’s a one-stop fund with a mix of stocks, bonds and other assets that are tied to the date of your retirement and gradually become more conservative as that date approaches. If you go this route, a target-date fund is probably all you need.
4) Add a little spice. With actively managed funds, managers use their own judgment to try to get returns that beat the stock market. That’s tough to do, and some managers are better at it than others. The trick is to pick the best ones that have staying power. At Kiplinger, we try to do this for you by choosing the Kiplinger 25, our 25 favorite actively managed funds. If you have index funds as a base, you can use actively managed funds to complement your portfolio.
5) Take a flier on stocks? In some ways, stocks are the most fun to invest in, but they also require a lot of research to choose the right ones. And, of course, if you invest in any single stock, you’re taking on more risk than if you invest in a mutual fund that holds shares in many companies. For someone in your position, I’d recommend starting with a solid fund foundation. Then, if you have extra money and want to take a flier on a stock (or stocks), you can do that.
There’s a lot more, of course. But I think this gives you a good overview of the basics, and I hope it helps.