Answers to some basic investing questions
Don't worry...the answers aren't from me!
(That would be like the blind leading the blind.)
Since I'm not well-versed in investing, I sent some questions to Eric and Wendy Nissan of DIY.FUND, and they were kind enough to answer them for me.
Kristen: Beginning investors often feel overwhelmed, and thus don’t ever get started with investing. What’s the simplest way for investing newbies to get started?
Eric and Wendy: Our recommendation for a newbie is to not focus on individual stocks. Start by following the overall market. SPY ETF, which tracks the overall S&P 500 is a good start
Next, you need to understand the mechanics of purchasing securities. Consult with resources such as Investopedia and introductory online courses to get familiar with the terms and jargon used in investing.
Your next step would be to open an online account with a broker. Nerd Wallet does a great job comparing the different platform an investor can used to purchase their securities.
Finally, when making your first transaction, start with buying a small amount of an ETF (exchange-traded fund), so you can get familiar with how to do it. When getting familiar with something new, it’s best to start with small, baby steps.
Kristen: Those of us who are risk-averse are scared of losing money in investments. Help us understand why an investment account is a smarter choice than a savings account, despite the potential for loss.
Eric and Wendy: The stock market has returned around 9.5% over the long term. It is one of the best opportunities for wealth creation out there. The key to investing in the stock market is having a long-term focus, patience, and doing your research. Of course, nobody should put all their eggs in one basket.
Regular savings account and investing in the stock market have two different financial objectives. The former is generally for shorter term objectives when the funds need to be more readily available. The latter is for longer-term objectives such as general future savings or retirement.
It is always wise to have a combination of both vehicles at all times.
Kristen: Most people look into investing in order to save for retirement. What do you think about investments for other shorter-term goals, such as a home purchase, a home remodel, or future college expenses?
Eric and Wendy: In the short term, it is much harder to predict where the market will be. The market fluctuates on a day-to-day basis and therefore it is much harder to know if the market will be up next year vs 20 years from now (which is much more reasonable to assume). Over the long term, we know that historically the market has performed well.
If you need the money in short term, you need to understand the increased risk with investing in the stock market.
While each individual investor’s risk tolerance is different, we generally don’t advise putting your money in the stock market if you need those funds within the next 3-4 years. If that is the case, you are better putting your money in treasury bills (T-Bills) or guaranteed investment certificates (GICs).
Kristen: Do you have to pay fees to invest? If so, what are some of the lowest-cost ways to invest?
Eric and Wendy: There are always fees, some hidden, some not. The cheapest way to invest is with a RobinHood account as they do not charge commissions. They make money on the interest in your accounts and other behind the scene ways.
The other online brokers have pretty good commission rates as well, so you might not want to base your choice of broker solely on commission costs. You should look to buy ETF’s instead of mutual funds as they have much lower fees associated with them as well.
Kristen: What's the difference between ETFs and mutual funds?
Eric and Wendy: Great question! It is really important to understand the difference between the two. Both investment vehicles are similar in the sense that they bundle together securities to offer diversified portfolios.
Yet the two investment types are marked by key differences that have important implications for the investor.
Most ETFs track a particular overall index (such as the S&P 500 or a particular economy or industry) and therefore are passively managed, leading to lower operating expenses.
Mutual funds, on the other hand, are actively managed by portfolio managers trying to beat their benchmarks and they therefore have higher management fees.
ETFs offer an attractive investment opportunity for passive investors looking for a low-cost vehicles capable of matching the performance of the overall market.
(Note from Kristen: after reading Wendy and Eric's advice, I was happy to realize that Ellevest accounts are ETFs, which is exactly what Wendy and Eric recommended. Yay!)
Readers, if you have thoughts on what Wendy and Eric had to say, I'd love to hear!
DIY.FUND’s mission is to enable individuals to invest with full transparency and control. Husband and wife founders Eric and Wendy Nissan were in the middle of successful career on Wall Street when they realize a huge gap existed between the tools afforded to institutional and individuals. The couple made the decision leave Wall Street behind and embark on the mission of empowering individual investors everywhere DIY.FUND was born, a FinTech company, allowing individuals, to simply manage and understand their investments using the same quality tools professionals use.
I believe there are two important steps to be taken before investing your first dollar. The first step is to be sure you have an Emergency Fund of six to twelve months' salary built up to protect against unexpected emergencies (my car just died!) and job loss (I didn't see that layoff coming!). This is standard advice from most financial planners. The second step is to learn about the investing process so that you truly understand into what type of investment your money is going and what level of risk that investment harbors. Read a basic book on investing to educate yourself like "Investing for Dummies." The Dummies series, despite the name, is an excellent series that is written in the most basic language. Consider following a well respected source of personal financial information such as Money magazine which can be found online or in print. Educating yourself will allow you to ask better questions of your financial advisor and help ensure that the investments you make are right for YOU.
Please note that, with all due respect, I disagree with Eric and Wendy regarding mutual funds. While it's true that "actively managed" mutual funds are likely to have higher fees than Exchange Traded Funds (ETFs), there are plenty of mutual funds that track indexes and are not actively managed, have no loads (loads are fees you pay to "buy in") and have very low yearly expenses. In fact, indexed mutual funds were around long before ETFs made their debut. (Actively managed funds often have higher expenses because they have fund managers who actively buy and sell for the fund. Index funds are set to mirror a particular Index or benchmark in the world of investing and the investments that compromise the fund don't change that often.)
Your best bet? Build a solid Emergency Fund and, while you're working on that, educate yourself about the world of investing. It's really not as complicated as you think - anyone can become a smart investor!
Ooops! That should be "comprise," not "compromise!" My apologies!
The Wall Street Journal Guide to Understanding Money and Investment is a great starting point. Lots of good info, not very long, simple language.
https://www.amazon.com/Street-Journal-Guide-Understanding-Investing/dp/0684869020
The Wall Street Journal Guide to Understanding Persona Finance is equally as good.
https://www.amazon.com/STREET-JOURNAL-UNDERSTANDING-PERSONAL-FINANCE/dp/0684833611/ref=pd_sim_14_4/147-0910406-8114467?_encoding=UTF8&pd_rd_i=0684833611&pd_rd_r=0Z0P94MH0YXSZR1WVSSC&pd_rd_w=Patyj&pd_rd_wg=5gvsx&psc=1&refRID=0Z0P94MH0YXSZR1WVSSC
I have no affiliation with Amazon, earn nothing from them, and am not recommending them above other booksellers.
I thought the same thing, then read the post and decided that it's about what you do when you have money to invest.
These are the common savings goals, in approximate order of importance. Note this is about ~savings~; when to pay off debt is another matter (which I can address later if y'all want). Note also that while I am financially literate, I am not a certified financial planner. The below is simply a summary of what one reads from The Wall Street Journal, Motley Fool, what my planner told me, and other such sources.
1) Build up a basic Emergency Fund - maybe $1000. You'll make it bigger later.
2A) Maximize anything you can get matched. Most commonly, this is your employer matching a percentage of your 401(k) account. So if your employer matches your contribution up to 5% of your salary, work to contribute that amount.
2B) Increase your Emergency Fund; 3 months's expenses is a common recommendation.
3) Create your Life Happens fund(s). These are for expenses that are inevitable but timing and amount are unpredictable, such as car repairs from an accident, larger-than-usual medical expenses, or appliance damage. Use these before you use your Emergency Fund.
4A) Increase your Emergency Fund, working toward your goal (commonly 3-6 months but can vary depending on personal circumstances).
4B) Increase your tax-advantaged savings, such as 401(k) or IRAs, to reach your goal for these accounts. Note that most people can't max them out - frex, the 401(k) is $18,500/year.
5) Invest, which is what FG's post is about. Keep in mind that for most of us, investing is higher-risk than a 401(k), with higher reward. In the long term this tends to work out.
Oh yes, I definitely agree about the emergency fund! That is the first goal...I just was posing these questions to Wendy and Eric, assuming that we're talking about someone who is out of debt/has an emergency fund, etc.
Awesome points, I totally agree! The For Dummies series helped me so much when I graduated from college and had no idea what I was doing with finances.
Great additional info, Mary! I think it's very sound advice.
In general terms mutual funds are actively managed and ETF's are not. Most mutual funds have much higher fees then ETF's. Vanguard is certainly an exception here. There are other differences as they are unique vehicles, and are structured differently. Mutual Funds can cause you to have capital gains to report as the underlying fund sells securities. This does not happen with ETF's. In short I always look at fees, when comparing 2 similar vehicles. Personally I tend to get the corresponding ETF, as I feel it is a better investment vehicle for equities.
I understand the confusion. The term mutual fund is typically understood to be actively managed fund. This is how mutual funds started out. Actively managed with high fees. Then ETF's came along initially used to follow an index. Where a Mutual Fund would charge 2% per year a typical ETF that followed an index might charge .10%. So then mutual funds started creating index mutual funds. Further actively managed ETF's started appearing. The lines got blurred.
What everyone is referring to is index funds vs active managed funds. which is different than ETF vs mutual funds.
https://www.fool.com/investing/2016/08/27/index-funds-vs-mutual-funds.aspx
Still active ETF's tend to be much cheaper than active Mutual Funds due to the requirements of running them. https://www.investopedia.com/articles/investing/110314/key-differences-between-etfs-and-mutual-funds.asp
If you really want to get into it, there real differences is in how the instruments are constructed. There are advantages to ETF's beyond fees (tax implications, and how they settle/are traded). Mutual Funds can have other advantages related to how the individual securities are held (you can read all about it in the above post).
I hope this helps.
Hi Kristen - I'm not familiar with ETFs, but there are index mutual funds available (one that we are invested in is the Vanguard 500 Index fund which I believe tracks the S&P 500). So perhaps it may be more accurate to say "Most mutual funds, on the other hand...."?
Oops, sorry - I didn't see Mary's comment that said the same thing (and much more eloquently!) before I posted!
I am extremely familiar with these investment vehicles (I have an MBA specializing in finance and accounting and am a CFA charterholder) and I second both comments.
This statement: “Mutual funds, on the other hand, are actively managed by portfolio managers trying to beat their benchmarks and they therefore have higher management fees” is an outright LIE. Why would they lie about this? Because their business cannot exist if everyone simply invests in low cost index funds, such as those offered by Vanguard. Kristin, I hate to say it, but you are being used by people who are furthering their own business interests by presenting incomplete and misleading information.
So, I was reading on Investopedia about the differences between mutual funds and ETFs, and they do say there that ETFs tend to have lower costs: https://www.investopedia.com/ask/answers/09/mutual-fund-etf.asp
"Most ETFs track to a particular index and therefore have lower operating expenses than actively invested mutual funds. Thus, ETFs may improve your rate of return on investments."
Are you just saying that they should have clarified that some mutual funds are actively invested, not all of them? Help me out!
An investment that is tied to an index will have lower fees - it doesn't matter if that investment is a mutual fund or an exchange traded fund (ETF).
An example of an index is the S&P 500 which is a list of the 500 largest U.S. companies that are publicly traded. You can easily find both mutual funds and ETFs that are tied to that S&P 500 index and they will have lower annual fees than an actively managed fund. (If you look back at the investopedia link, you'll see that the comment about lower fees for ETFs relates to ETFs connected to a particular index, not to all ETFs.) Because the ETF or mutual fund that is tied to an index simply holds the same stocks or bonds that are in the corresponding index, the company doesn't have to pay a manager to make decisions about buying and selling individual stocks or bonds. The lower costs are passed on to investors in the form of lower annual fees. If a mutual fund or an ETF is actively managed, then a manager or a team of managers is doing a great deal of research and making decisions as to what stocks and/or bonds should be held in the mutual fund or ETF. Because the company has to pay those managers, an actively managed mutual fund or ETF will have higher annual fees.
The bottom line is that both mutual funds and ETFs that track a particular index will have lower expenses than mutual funds and ETFs that are actively managed.
To answer your question, Kristen, Wendy and Eric's comment, "Mutual funds, on the other hand, are actively managed by portfolio managers trying to beat their benchmarks and they therefore have higher management fees" is misleading because it makes it sound like all mutual funds are actively managed and that just isn't true. Please know that I'm not recommending any particular investment, but this discussion is a good example of why it's important to understand any investment you might be considering. Hope this info helped!
So, it's not that ETFs or mutual funds will necessarily be higher or lower cost than each other...it's the "actively managed" part of things that matters, in terms of cost.
This is a little aggressive. I have a portfolio that includes both low cost index funds and a few well researched mutual funds that are actively managed. While many of the FIRE blogs advise to stick to Vanguard's index funds, there is nothing wrong with having a mutual fund or two as well. The one that I am invested in, Fidelity Contrafund, has a top notch manager who has made me more money than I ever thought possible. When I account for management fees (which are still small), I have made FAR more from this fund than any of my index funds, when compared over the time frame I've had them (which is VERY VERY long, I'm no newbie).
There is a time and place for both options. This constant bombardment of "EVERYTHING IS THE DEVIL BUT INDEX FUNDS FROM VANGUARD" gets really old after a while.
First, Kate, Vanguard's index funds are mutual funds (index funds are a type of mutual fund, actively managed funds are another type of mutual fund). Second, in addition to the Vanguard index funds in my portfolio, I also have some index funds from Fidelity in my 401k 🙂
Mountains of research show, decade after decade, that you simply cannot predict which active managers will beat the market. As every financial product ad says, "Past results cannot predict future returns," and Kate's actively managed fund from Fidelity probably got LUCKY. That is different from SKILL, and you can't tell the difference by looking at the performance #'s. If you enjoy paying higher fees, go for it, nobody in the financial industry will stop you and they'll just tell you how smart you are (because their livelihood depends on you believing they are skilled and not just lucky, lining their pockets in the meantime).
You don't need to pay more than 0.15% a year in total fees, TOPS. Anything more and you can probably get the identical financial product elsewhere for less. Saving and investment should be boring and can be extremely simple. Don't let the industry people snooker you into paying more than you need to. In recent years, Wall Street has seen the vast majority of new investment $ going into index funds because younger investors have gotten the message about indexing (older investors keep doing it the high-cost way, because change would require admitting they made mistakes in the past, and that's very hard), and the industry folks need to come up with new ways to keep their jobs. They are scared, and they should be.
I'm actually replying to the comment below this one from Stephanie. For some reason, there is no reply button to her comment for me.
I know that index funds are mutual funds. My distinction was between actively managed mutual funds and index based mutual funds, which I stated in my 2nd sentence. Just wanted to clarify that 😉
Sure, many mutual fund managers might have gotten lucky, but if you research the specific fund I mention (FCNTX), you will see that the manager has been at the helm for almost 30 years. That ain't luck. Actively research the man and his approach and you'll see what I mean. The point I'm trying to make is that not all actively managed mutual funds should be ignored simply because of their cost. FCNTX has an expense ratio of 0.68%. Is that more than my index mutual fund? Yep. BUT, I have made that back in spades on my returns.
I take a bit of offense in your statement that "older" investors keep doing it the high cost way. I'm 39 years old and certainly don't consider myself old 🙂
TL;DR: With everything, do your research.
Thanks for the great Q&A. I have to admit I'm a newbie investor. The only things we have invested in are our house and our 401k.
I want to look into the S&P 500 one Fay since everyone has such great things to say about it. I have been thinking about real estate, but it's just a lot of work!
Honestly, the best way to grow your money is to invest in a low-fee index mutual fund. Unless you're Warren Buffett, it's statistically improbable that you'd do better than the market over time. Add in fees paid to money managers and you could actually lose anything you've earned.
This Freakonomics Radio episode (and the one following) are hugely informative and presented in simple language. http://freakonomics.com/podcast/stupidest-money/
Our credit union has a financial advisor who can assist in investments. He does not charge for his time or advice, this is a service our credit union provides. People might want to check with their credit union or bank to see if this service is provided. We have been pleased with the service we've received.
Our bank always recommends their own high-fee mutual funds, so be very careful accepting investing advice from a bank. It’s like asking a car salesperson whether you should buy an inexpensive used car or a fully-loaded new one - you’re likely to get the expensive answer.
Agreed Kate. (I'm a different Kate :)) One must always do diligence in researching fees.
I have to agree with Mary, get an emergency fund in place, first. We had six months saved up when my husband was laid off due to the company having to shut down most of its operations, and that savings all got used up completely -- he was too old to get a new job and too young for Social Security or his IRA. Don't let anyone tell you age doesn't affect your hire-ability. Once you have a safety net, then invest. Most of my retirement is in indexed funds, but I have to make a rollover soon after changing jobs, and I need to investigate more about this. Thanks for the tips!
I would also point out that NOT investing can be considered risky if you consider that inflation causes your dollar value to be worth less over time.
Yep, this is so, so true. Which is why, at the end of the day, picking WHICH way to invest is not as important as just getting around to actually investing in SOMETHING. Better an "imperfect" investment than none at all. Even one that has slightly higher fees will still probably leave you money ahead vs. where you'd be if you parked your money in a savings account.
Lol, blind leading the blind?! That cracked me up. You have got to give yourself more credit!
The info given on ETFs and mutual funds was not very good or accurate. Mary already pointed out some of the reasons why. There are many, many good resources for learning about investing and I really don't get why anyone would look here for investing advice! Really, I don't watch CNBC during market hours for the recipes or visit Vanguard for help with plumbing. If you are starting out with investing, go read/watch the educational material from some highly regarded financial/investing sites, read financial magazines, read any of the many investment education books and/or talk with a certified financial planner.
Following up on Lacy - I imagine specific recommendations would be helpful. I posted links to two books from The Wall Street Journal, above. I have a finance background and have read both books - they're good and they don't overwhelm the reader with too much info.
WilliamB, in my opinion this is an inappropriate forum to help people learn investing. I didn't get into specifics because I think nobody should be looking for that information here. It is ludicrous. The more people post tips the more bad information also appears. The clueless don't know which is which and the forum isn't run by a financial expert to point out or remove the bad. Thus, it really shouldn't be a topic of discussion here.
I'm a little confused then - if you think this forum is inappropriate for giving advice, why did you give advice?
Reading to start learning a subject like investing is what I would consider to be common sense for an adult. Like most people expect an adult to know to visit a medical doctor for health issues instead of an auto mechanic or landscaper. Thus, I don't see what your confusion is here. Some people care enough to point out impending danger , others like to silently watch, and yet others can never comprehend what the fuss is about until something bad actually happens to them. End of discussion.
I agree with Lacy. In fact, I would go further and add that the "advice" given here by two people promoting their own business is full of **intentional** misinformation (no, opening a "brokerage" account is NOT the best way for someone to get started investing - it's just a great way to pay a lot of fees to investment managers..."omitting" a discussion of low cost index mutual funds was no accident on their part). Spreading bad information is not cool, particularly when you might be negatively impacting people's financial security. It is entirely possible to have brokerage fees whittle away someone's investment account such that they would have been much better off sticking it in a savings account (this is called "churning" and investors sometimes win lawsuits when their brokers churn their accounts). Kristen, I think you should be very careful about who you allow to use your blog.
You have it backwards. In general mutual fund are much more expensive than ETFs. The majority of mutual funds have much higher fees vs ETF's. The equivalent Vanguard's ETF's and Mutual Funds have very similar fees (if not the same), so it's not like you lose by purchasing Vanguard ETF's.
Further ETF's are much more efficient tax vehicle.
https://www.fidelity.com/learning-center/investment-products/etf/etfs-tax-efficiency
Further mutual funds settle at the end of day, while you can buy and sell an ETF at any time during the day.
Does anybody have experience with Timothy Fund?
As you learn about investing, be sure and look at dividend stocks, which will grow your money faster than just putting money into any EFT or mutual fund. Of course, there are EFTs and mutual funds that hold a basket of dividend stocks and re-investing the dividends will grow your money much faster. There are many excellent stocks that continued to pay dividends even during the crash of 2008-09, even though the price of their stocks went down.
As I learn more about investing, I do check to see if the stocks pay dividends and how much on average. Good comment.
We've had good and bad luck with stocks. We bought into stocks from USAA when the kids were born and both have not recovered in 20 years. We still haven't made back what we put in!
Some stocks were a good choice and we did make some money. Of course, we didn't spend thousands to buy the stocks, so we didn't get a ton back. But we tripled our investment.
Stocks/ETF's/mutual funds are a gamble. I'm very conservative and have rolled my 401k from a previous employer into an annuity. I felt that it was a safe bet for that money and am happy with that choice. I do have some stocks/ETF's and the market has slumped, so it will take a bit to recover. But I did not invest anything I WASN'T PREPARED TO LOSE. I never bank on stocks funding my retirement account. We have made good decisions on real estate purchases. I also use CD's on occasion for a short term gain.
The jlcollinsnh Stock Series is so good it's worth another mention.
http://jlcollinsnh.com/stock-series/
Thanks for the comments, I think I learned more from the comments from the post, and that is a huge compliment to this blog! :)_)
My biggest problem with investing has been that many mutual funds investing in a wide variety of industries or products, and some of them I don't agree with. For example, I would not want to have my investment money be in a mutual fund that invest in companies that sell cigarettes, even if it was $1. I don't want to have anything to do with that, it's a personal thing. But I have found yet to find a way to take a low-key approach to find an ethical investment fund that makes money. I would really love some tips on how to find them. (I'm in Canada).
My Husband and I consider it critical to know WHERE our money is being invested, so that we don't unwittingly help to fund companies/causes we would not choose to support. After a lot of research, the only one we could find that consistently honors our values as Christ-followers is The Timothy Fund.