Most people know they should be investing to build a more secure financial future. And yet many people still don’t invest. The most common reasons they cite are: they don’t think they have enough money to invest, they feel overwhelmed or intimidated, and they don’t know how to get started investing.
Fortunately, the answers to those reservations are pretty straightforward.
Don’t think you have enough money to invest?
This is one of the most common reasons out there for not investing. The reality is that every little bit of investment matters. That’s because of the power of compounding. See how just $50 per week can add up over an investing lifetime. (The example below is based on $50 invested every week, or $200 per month, for 40 years with an annual return of 9.8%-the historical average return of large cap stocks.)
That’s right, $200 a month can potentially grow into over $1 million over a long investing time horizon. Note that most of the growth take place in the latter years, due to the power of compounding. The secret there is to get started investing as soon as possible to give your money more time to compound and grow. Even small amounts can really add up, so don’t worry that you don’t have enough money to start investing. With fractional share trading and no minimums, investors of every size can now start investing.
Here’s another tip to consider: To minimize your investing costs, you might want to bundle your deposits over several months. Instead of investing $200 every month, with the accompanying transaction costs such as commissions, save up for 3 months and make 4 deposits of $600 per year. The math will work out pretty much the same over the long run.
Feeling overwhelmed or intimidated by all that investing and market lingo?
Wall Street spends a lot of time and money trying to make investing seem complicated when it can really be very simple. The key is understanding that even the market pros regularly underperform their benchmark, especially over the long-term. (A benchmark is a reference point, usually an index such as the S&P 500, used to gauge the performance of an investment manager.
In other words, even highly experienced portfolio managers can’t beat the market on a regular basis. As an individual investor, then, you shouldn’t be worried about outperforming or underperforming the market. Just focus on being invested in the market and you’ll get the market returns. The simplicity of index investing is at the heart of an effective investment strategy.
Don’t know how to get started investing?
This is the biggest hurdle most new investors face. It’s daunting looking at the thousands of stocks and other investments that are available. Fortunately, Wall Street actually did create an investing option that simplifies your decision process—ETFs (Exchange Traded Funds). Please see the important risk disclaimer at the bottom.
ETFs are baskets of stocks or other securities that trade like regular shares, meaning they can be bought or sold throughout the trading day. ETFs are designed to replicate the performance of a market index, such as the S&P 500 index of US stocks, or the STOXX Europe 600 Index, an index of European stocks. There are ETFs for other asset classes, such as bonds, commodities, and real estate.
With ETFs, investors get built-in diversification. Some ETFs contain thousands of stocks or bonds—you can’t get more diversified than that. It also means you don’t have to worry about picking individual securities and hoping you get it right. ETFs are typically passively managed, which makes them low-cost, and have some tax advantages over mutual funds. Learn more about ETFs here and here.
So how can you go about investing using ETFs? The first step is to decide what you’ll invest in, a process known as asset allocation, which is just a fancy term for how you’ll divide your investments between the various asset classes. For most people, that typically means stocks and bonds. The general rule of thumb is that the longer the time you have to invest and the greater your risk tolerance, the more you should allocate to stocks. The shorter your investing time horizon, or the more conservative your risk appetite, the more you should allocate to bonds, or fixed income.
Asset allocations are typically based on percentages of the total amount of investment funds, such as 80% stocks/20% bonds, or 60% stocks/40% bonds, for example. After you’ve decided how you want to split your investments, it’s time to select an ETF that covers that asset class. There are literally thousands of ETFs covering all manner of asset classes, so how do you know which to choose?
Keep it Simple
To keep it simple, you can focus on broad index ETFs that cover a wide range of a particular asset class. For example, an ETF that follows the Russell 1000, an index comprised of the 1000 largest stocks in the US, would give you exposure to the broad US stock market. If you want to invest in stocks globally, you could find an ETF that covers all the major global stock markets, or just developed or emerging economy stock markets if you want to get more focused.
Depending on your experience, you could select narrower stock ETFs that focus on companies of a particular size (large/mid/small cap), sectors, or geographic regions, for instance. For the bond portion of your investment, you could choose an ETF that invests in a broad range of bonds, covering multiple maturities and types of issuer, as well as geographic regions, as an example.
With ETFs, you can focus as narrowly as you like, or as broadly as you like. If you’re looking to get started, simplest (i.e. broadest) is probably best. Then you’ll need to keep investing on a regular basis, adding to your initial ETF investments over time, and perhaps as you gain experience including new ETFs with a more targeted focus, such as bio-tech stocks or high-yield debt.
With just a few decisions, you can get started investing and start building a new financial future:
- Find out how much you can afford to invest on a regular basis.
- Decide how you want to split your investments between asset classes.
- Find ETFs that cover those asset classes and start investing in them on a regular basis.
And remember, investing is for the long haul, not short-term gains. If you keep that in mind, you’re well on your way to becoming the investor you always wanted to be.
Important risk disclaimer:
All investing carries risk. Past performance is not indicative of future returns, which may vary. Investments in stocks and ETFs may decline in value, potentially leading to a loss of principal. Online trading has inherent risk due to system response and access times that may be affected by various factors, including but not limited to market conditions and system performance. An investor should understand such facts before trading.