Hi! I am Barbara, host of the Future Rich podcast and founder of Planancial. Before switching over to personal finance I started out working on Wall Street. With my background in finance I am frequently asked about investing. I wanted to put together a list of the top 10 questions.
1-What is the stock market?
The stock market is where stocks are bought and sold. We will get to what is a stock and what is a bond because there is actually a bond market too (but no one really ever talks about it because bonds are considered to be a bit boring).
Key Words:
Stock– Is owning a piece (1 piece=1 share) of a company which is also referred to as an equity (stock=equity). In order to own this piece of a company you have to buy it. What you buy it for is commonly referred to as the stock price.
Bond– is a creditor of a company. With a bond you lent the company money and they promise to return it and will pay you interest while they borrow it.
Stock Market Index: is a basket of stocks used as a way to measure the performance of those stocks. The S&P 500 index and the Dow Jones index are two indices you will hear about the most and see on the news.
S&P 500– Is an index made up of 500 stocks. It’s used as a way to evaluate the performance of those 500 companies but also used as a benchmark for the overall stock market. **For example, if the S&P 500 is down, it’s a sign that stock prices are declining.
DowJones– is an index made up of just 30 stocks and is also a very common index used to evaluate the performance of the stock market.
2- Are you financially stable enough to make an investment?
Before you jump into investing in the stock market, I think it is important that you have checked off the following items first:
A.)You have paid off debt (with exception of mortgage and student loan debt). I’m really talking about credit cards and potentially high interest loans or high interest student loans. For example, if your student loan is 11% it is possible that loan is generating more interest than you would make in the market. For example, this year, 2020, some investment accounts are down 10% for the year ( this is an approximate number as of the time of this article for a growth investment) and then you have a loan that is charging you 13% interest. In this scenario, you would have been better off paying off that loan rather than investing the money.
B.)You have a solid emergency fund. I recommend between 6-12 months of cash to cover 6-12 months of non-discretionary or essential spending. The reason I encourage people to stash some cash is because of the old adage, “when it rains, it pours”. This is unfortunately being experienced right now during the COVID-19 crisis. There are people whose investments account went from $10,000 to $7,000, lost their jobs, and can’t get in touch with unemployment or haven’t received it in time to pay bills. They now have to sell their investments, which are down, because they don’t have an emergency fund.
C.)Retirement- Start your retirement savings BEFORE you start an investment account, unless your plan is to work forever. If you’ve met any 70 year olds who are currently working who had that same idea, I can tell you they would much rather be retired (who wouldn’t?!). Retirement is actually just investing in the stock market, so this is absolutely investing, and I think a lot of people don’t view it as such. The best part about this is the account is tax-deferred, meaning you don’t pay taxes until you take the money out (after 59 ½ or when required to start minimum distributions at age 72.)
D.) Time Horizon- I would also consider how long you have to keep the money in the market. So for instance, if it is earmarked to pay for a life event or something in the near term I would not invest it. I believe money that is invested in the market should have a minimum of 2-4 year time horizon…meaning you will not need the money back for at least 2-4 years. I think the market and investing is really only suitable if you are a long-term investor.
3- What is an emergency fund and how do you recommend I start one?
An emergency fund is an account that you keep cash in soley for EMERGENCIES. Prior to COVID-19, this part of the financial plan received a lot of pushback. When recommending, I heard things like, “that is a lot of money to have sitting doing NOTHING” or, “there really isn’t any emergency I could foresee happening to me”. But that’s the thing, no one can predict when an emergency is going to pop up (if you can, you are psychic and I am jealous) but when it does, you’ll be happy you have the funds in place to cover it. Also, keep this money in an account (like a bank account) and not hidden away in your home. Heaven forbid you have a fire and the money gets destroyed.
4- What different kinds/ kind of retirement plan should I have in place?
There are various kinds of retirement so to keep it simple let’s start with: work retirement vs. outside of work.
Work Retirement will be offered through your job and hopefully will have a “match”, which means they will contribute money to your retirement plan…YAY!
Outside of Work: There are two main options:
Roth IRA: My personal FAVORITE, which is an after tax contribution limited to the annual amount, for under 50 years old is $6,000, and eligibility is based on income. It grows tax deferred and is tax-free once it has been in the account for 5 years and you are older than 59 ½.
Traditional IRA: This is a tax-deductible account, meaning you get a break on taxes for doing it. A Traditional IRA is also limited to the annual amount, for under 50 years old is $6,000, and availability is also based on income.
Self-Employed: For those self-employed folks two common options are either a SEP IRA or a Simple IRA. A SEP IRA stands for a simplified employer pension and has a higher contribution limit than a traditional IRA. A Simple IRA stands for a savings incentive match plan for employees this also allows for higher contribution than a traditional IRA. If you are self-employed I would recommend consulting a tax or financial professional to see what your best option is.
5- What is the minimum amount of money to invest?
Great news!! Most online investment accounts have very low minimums. Everything from $5 to some requiring a bit more, such as $250. That means once you have checked off the requirements to get started you could start with as little as $10 a week.
6- How do I know where to invest?
There are lots of online investment companies and brick and mortar investment companies. I would choose the one that fits you and your goals the best. It is always a good idea to ask a professional you trust for a recommendation along with doing your own research. For instance, you could ask your accountant or attorney for a recommendation. I would also consider a mutual fund or an ETF that matches your risk profile (see question 9 for an explanation of a mutual fund and ETF). A risk profile will help you access how much risk you are willing to take with your investments in order to meet your investment goals. Another way to think about this is how much are willing to see the value of your investments fluctuate….the more up and downs you can handle usually the more risk you will be willing to take.
7- Can you recommend websites/newspaper to read where to invest?
Reading and studying can be a huge help. I think Erin Lowry’s book, “The Broke Millennial Takes On Investing”, is a great introduction to investments. I would also strongly encourage reading a basic personal finance book (Like “The Millionaire Next Door” or “Rich Dad Poor Dad”). For a more modern take, Refinery29’s “Money Diaries” about overall financial health is a good read as well.
A lot of people tell me they want to start investing in the stock market because they heard about a stock that is going to have a huge return or that they can “get rich”. Remember, investing is some people’s sole profession, spending 60 plus hours a week doing only that. Think about how many people you know that made a fortune in the stock market. I personally know only 1 person. This person made more money in the stock market than with his own company which employed 10 people for over 30 years. I believe that investing in the stock market is a talent, just like an athlete has a talent, so the best course of action is to educate yourself (see books above) and have an overall financial plan, not just investments.
8- Once I start investing how long does it take to see money?
Once your account is set up you should be able to view it immediately with a website or app login. I would recommend not getting worked up over the small changes you will see on daily/weekly range but rather remember you are a long-term investor.
9- What are the different types of investments?
There are MANY MANY different types of investments so let’s stick to the basics and go over the two most common ways to invest:
Mutual Funds: is a basket of stocks that is usually managed by a portfolio manager, which is a person that can go in and adjust which stocks this mutual fund owns. It is priced once daily at the end of the trading day (which is 9:30 EST-4PM EST, Monday-Friday, and only closes for specific holidays)
ETFs: is also a basket of stocks that is usually not managed by a portfolio manager, so once created stays the same. The big difference is you can buy and sell this throughout the day unlike a mutual fund.
10- When should I touch/sell investments
This is a great question and is asked often. My answer is that it depends. I would NEVER sell investments as an emotional reaction, which we are seeing a lot of now. Just because the account goes down doesn’t mean you have lost money; you don’t lose until you sell. The reason investing is always so intriguing to people is because you can make money, OVER THE LONG TERM, if you stick with your investments. Long standing mutual funds have averaged returns of about 12% over 80 years. That means you have to be able to stomach the down turns and not “get out and wait for it to get better”. While that is a normal reaction it is also an emotional reaction that can prevent you from making money in the stock market. There is an old saying, “a smooth sea never makes for a skillful sailor”. To be a true investor you need to be able to weather the bad times as well as the good times. Most often when the market is falling is when there are the most opportunities.
Definitions:
After-Tax: means that you contribute the monies after you have paid tax on them. For example, this type of an investment is a Roth IRA.
Tax Deductible: This means you get the tax break when you contribute. For example, this is a Traditional IRA.
Tax-Deferred: This means you don’t pay taxes on the investment while it is in the account but pay taxes when you take it out., so you are deferring the taxes till later.
