Hey Colin,
I’m new to the world of being responsible with money, and I’m told it’s a good idea to start investing when you have extra cash on hand, so that you’re more secure in the future, which makes sense to me.
The trouble is I don’t really know what that means.
Right now, I’m making an extra $500-or-so more than I spend each month, and I’ve got a few thousand from earlier months that I want to put somewhere. I have that money in a savings account, but it kind of looks like the stock market is on fire, so maybe it’s a good time to buy some cheap stocks? Or bonds? I really don’t know what most of these things are, so any advice you can offer on what to do specifically, or in general, would be welcome and appreciated.
Thanks!
Brandy
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Hey Brandy-
First and foremost: I’m not a pro-financial advisor, so I’m mostly going to give you some general information and thoughts on the matter. There are as many potentially good investment strategies as there are people on the planet, and what works for me may not work for you.
That said, in general it’s a good idea to aim for diversity in your investment portfolio—your “investment portfolio” being the collection of things in which you’re invested: assets, in other words, which refers to things that store value, and/or earn you interest on the value that they store.
So money is an asset, a home is (potentially) an asset, stocks and bonds are assets, a business is an asset, intellectual property (like a book or music that you’ve created) can be assets; there are many types of assets, and in general, it’s an asset if it earns you money or stores value, but if it costs you money it’s a liability.
Liabilities are things like rent on an apartment, debts that you owe, and cars and other possessions that, rather than storing or earning you money, mostly just cost you money.
Some liabilities can become assets, at times: a car that you’ve paid off, and which helps you earn more money (or allows you to save on the cost of other modes of transportation) can be an asset.
Likewise, assets can become liabilities: a house that you own, but which is unoccupied—no renter to pay you each month to live there—but for which you’re still paying taxes and upkeep costs, can become a liability rather than an asset, depending in part on its overall and changing value on the real estate market.
A good heuristic here is to aim to accumulate assets of different types, and to lessen you collection of liabilities over time.
The diversity component of that mental shortcut is important, because it means that if the stock market crashes, you’re not looking at an asset portfolio made up entirely of devalued stocks. If you have some stocks, some bonds, some money in a Roth IRA or similar program, some money in practical assets (like a paid-off car, or tools that allow you to do lucrative work), some money in a savings account, you’ll be less likely to ever suffer a catastrophic event that knocks out all of your assets all at once.
So that’s a big-picture assessment of what to broadly aim for.
In your specific case, I would recommend, first, focusing on paying off debt, and accumulating three to six months of expenses—something many financial gurus and banks recommend, and a process that seems decidedly unsexy, but which makes a great deal of sense.
The debt is worth paying down as quickly as possible, because that’s a major liability that will cost you more the longer it exists. Credit card debt in particular tends to grow crazy fast, so $1000 in CC debt can explode to several times that if you only make the minimum payments.
Some debt might be a longer-term proposition, and there’s a chance that you’ll be able to pay it more slowly without accruing much or any additional debt on top of it (this is the case with education-related debt in some places, for instance). Focus on the higher interest-accruing debt, first, to avoid inflating what you owe as much as possible, and pay down the principle before hitting the interest, when you can.
After that, tucking away money in the bank—enough to cover your rent, groceries, and other basic living expenses for a quarter- or half-a-year, is an insurance policy, but also a stockpile that allows you to make better decisions in the future.
If you know that you have six months of expenses in the bank, that can allow you to quit a job that’s soul-crushing so you can go explore your other options, and it can allow you to avoid being bankrupted by an unforeseen medical expense. It can also allow you to take advantage of opportunities, be they investment-related or lifestyle-related.
In short, opting to pay off known aggregators of liability (debt) and accumulating a reasonable stockpile of liquid (meaning: accessible) wealth, will put you in a far more stable place to make future investment (and lifestyle) decisions.
From what it sounds like, you should be in a pretty good place to make these sorts of initial investments. And your efforts can be amplified, potentially, by other choices you make along the way that lower your existing expenses—being careful with money can allow you to pay down debt faster, store away more savings, etc.
Things get more complex after you’ve got your debt handled and your emergency fund tucked away, but one arguably quite boring, but also typically quite reliable option is to invest in some kind of managed fund: a mutual fund or some ETFs.
Mutual funds are programs that you buy into, and through them you basically park your money with a bunch of other peoples’ money, and professional investors often quite ploddingly buy up swathes of assets that do well over time.
Sometimes mutual fund managers actively watch the market and try to gauge what will do well and what won’t, but a lot of mutual funds are tied to indices—lists of stocks that are meant to fairly accurately track the performance of an overall industry or stock market—and these “index funds” are more coldly, rationally managed, scooping up only the stocks that allow them to keep your invested money aligned with the performance of those indices.
ETFs, short for “exchange-traded funds,” are similar in that they are funds made up of collections of other assets (most commonly, stocks), but they’re a little bit faster-paced, as you can trade shares of them like you would stocks (they’re available on the stock market). The main difference between ETFs and normal stocks is that each share of an ETF is actually a share of a bundle of shares of other stocks; you’re buying into an investment portfolio, rather than a single investment.
The benefit of both of these setups is that you don’t need to be an expert and spend tons of time attempting to figure out which companies are the right companies to bet on within each industry. That means you can reasonably expect to benefit from the broader movement of these markets: the stock market as a whole, or a particular industry.
As I write this, global markets are wildly uncertain, and though it’s tempting to buy low while a large number of typically reliable stocks are seemingly at sale-prices, it’s worth remembering the oft-repeated stock investment wisdom, “don’t try to catch a falling knife.”
There’s a good chance that things will go lower rather than higher for a while, and there’s always the chance that prices dipping in this way is not a momentary thing, but rather a realignment of the market with underlying economic realities: the stocks could go down and never again rise back up to where they’ve been—those higher prices may have been indications of a bubble, rather than the natural state of things.
If you’re really keen to get into stocks right now, consider, instead, buying things that you would gladly buy at full-price and then holding them for a while, rather than trying to time the market.
A bond is another type of asset that, instead of a share of a company, represents some kind of debt, either from a company or a government entity—an IOU, if you will, and that IOU typically pays out with some kind of interest if you hold it long enough.
Like any IOU, there’s also risk involved: the risk that you won’t get paid back by the debtor.
This risk is substantially reduced if you buy government bonds from stable nations or cities, or bonds from some other long-standing, unlikely-to-entirely-collapse entity. But the interest gained is also typically far less than you would get from some other, higher-risk investment, and thus, it’s often beneficial to hold some bonds alongside things like stocks, so that the two can balance each other out. This makes it less likely that you’ll either tie-up your fortune in bonds that cannot be liquidated for years or decades, or lose all your money in a stock market downswing; one counters the risks inherent in the other.
My advice would be to focus on debt and your emergency fund for the time being, and while you’re building that stable foundation for yourself, look into other very boring options, like Roth IRA and 401k programs you might be able to take advantage of (both of which help you keep more of the money you’ve already made, via different mechanisms).
During this process, do a lot of reading about stocks and bonds and anything else that catches you attention: I learned what I know through books and websites and forums, looking up any term I didn’t know, and then slowly but surely—after building up my fund and getting rid of all of my debts—making small investments here and there, to make sure my portfolio is diverse but also to make sure I understood what I was doing before making any more significant investment in any one place.
Get those fundamentals established, including some research to inform your future efforts, and you’ll be in a good position to build yourself a sturdy financial foundation.