So it's been awhile -- life, the good and the bad, got in the way. But it's a new school year, I've got a million things in my head, and a friend of a friend just asked me for some of my capital-F Fabulous finance advice. And that has me all invigorated.
The question was pretty much - Where do I start? How does investing in stocks work, and how do I do that, and should I?
Which is pretty much the best question ever, because a lot of people are in that position. And because there is nothing I like to buy more than stocks, I feel very qualified to answer this question.
At the most basic level, there are two types of investments - stocks and bonds. Buying a stock in a company means you are buying a stake in the company, you are owning a tiny piece of it. So, if you buy a McDonalds stock, you are now one of the owners (shareholders), and when the company does well, so do you. A bond is the reverse - you are lending money to a company, in exchange for a certain rate of return the company promises to pay. Of course, companies can go bankrupt and be unable to pay what they promised, but usually they stay afloat. Bonds are considered more stable, but generally have lower returns.
The reason to invest, is because you want to grow your net worth. Because of a concept called inflation, money that you leave sitting around is worth less and less as time goes on (and this is the reason why Americans many, many years ago could buy hamburgers for five cents or a car for $500). When you invest, you are putting your money to work for you, rather than letting it laze around and do nothing for you.
But wait - how do you know what companies will do well? How do you choose what to invest in? For beginners and sane, realistic people, I would suggest index funds. Index funds essentially bundle up a bunch of stocks or bonds - so when you buy them, you are automatically buying a lot of companies and ensuring that one company blowing up won't blow up your money. This sounds a lot like being average - wouldn't you be able to get better results by picking stocks, as long as you pick them WELL? Turns out, it's not that easy to pick well, and the funds where managers are actively picking, buying, and selling (actively managed funds) cost a lot, and most underperform index funds. I am very happy to put in minimal work, pick average stocks, and get above-average returns.
So when should you invest? The important (and comforting) thing to remember is that over long-term horizons, stocks perform very well, beat inflation, and get you good results. Stocks go up! The risky thing, though, is that they don't go up predictably, they also go down ... A lot. They crash, as they have in the past, and will continue to do so. So the number one rule with investing is that if you need to use the money within five years (for say, a down-payment on a house, an upcoming big vacation, or a wedding), it has no place being in the stock market. Because when your money's there, it could go down by 40% ... in one month, or one year. While your investments will recover eventually, they may not recover by the time you need them.
When stocks go down, people panic. They often sell their shares and unfortunately miss out on the subsequent recovery. This panic makes complete sense - who wants to watch the 100K you invested go down to 50K, and do nothing? And yet, a market decline is actually a great opportunity to buy some stocks on sale, to be able to benefit from the recovery and make some money, instead of cementing your losses by switching to cash.
My recommendation for a beginning investor is to use a Roth IRA as a vehicle, or a 401k if your company has one and they offer a match. An IRA is an individual retirement account, so it's not linked to your job (like your 401k or 403b). With a Roth, you put in post-tax dollars (so, you've already paid taxes and this is what's left of your paycheck and sitting in your checking account). It's supremely flexible because you can take out the money you have contributed (max $5500 per year currently for us young folks) at any point for any reason, with no penalties. It's nice to know that in an emergency, you can access your money.
Vanguard is my fave financial company (I heart it) because it's owned by all of us folks who use it, rather than being a publicly traded company (whose obligation is to people who own its stock) or a privately owned company (whose obligation is to the individuals who own it), so Vanguard's interests are perfectly aligned with your own. However, a lot of its funds require at least a 3K investment. When I started investing, I just plonked the full year's max into my IRA at Vanguard, and continue to do the same as soon as I can every year. For me, because I know I can't time the market, I'd rather be one-and-done. However, another nice option would be to set up a recurring monthly payment, which is my second favorite method: set-it-and-forget-it. At Charles Schwab, I believe you can do this with any amount, and at Fidelity you can set it up with a minimum $200/month contribution.
I think investing is awesome, because money is so powerful and I want to have enough so that no person or job can control me and hold me down. Investing is how I intend to be in a position to control my life, to pursue what I want without fear of financial insecurity (because I definitely can't do that now). And in happy personal news, the Dina-and-Sebastien household recently passed the 100K in investments threshold. =)