While a Peer Financial Counselor will not provide specific investing advice, they can certainly answer common questions about the process and help you identify if you're really ready to begin investing. College is a great time to start thinking more about the future, and a healthy relationship with investing is part of any long-term financial plan!
Before you start investing, there are a few questions you should ask yourself to make sure you're protecting your financial security.
- Are you paying your bills on time?
- Are you paying your credit card bills in full each month?
- Is your budget balanced and meeting all of your basic needs? Do you even have a budget?
- Do you have an emergency fund with 3 months worth of basic expenses (e.g., rent, food, cell phone)?
Honestly, if you cannot answer "yes" to all of the above questions, you are not ready to start investing. Instead, we recommend you head over to the budgeting portion of our site to get started on developing some sound fundamental skills first. There's a reason you don't start taking classes in your major at the 400-level during your first year!
Getting Money to Invest
Once you have determined that you are ready to start investing, you'll need to determine how you're going to fund your investment account. The most reliable option is to create a balanced budget and set a savings goal that you try to meet each month, and then invest a portion of that money marked for savings.
Another smart strategy is to keep making "payments" towards a debt (like a student loan) in your budget after you finish repaying it, but instead of the money going towards the debt now, you can invest it. This way you should not have to make any drastic changes to your spending plan and you'll be investing in your future.
Finally, putting aside one-time “found” money is a good way to start investing as well. This can take the form of birthday money, tax refunds, bonuses, etc. And when you are out of school and start getting raises in your job, that "new" money can go in to investing and help you avoid "lifestyle creep".
Figuring Out Your Investment Goals and Strategy
Identifying your goals is one of the most important things to think about before you start investing. Money is not a goal; it's a tool. So why are you even investing in the first place? Do you want to save for a car or a down payment on a house? What about an adventurous graduation trip with your friends? Or are you in it for the long haul and want to start saving for retirement, maybe even an early retirement? These goals are all very different and require their own investing approach to meet them. Choosing the right strategy for your goals will be dependent on two things: your risk tolerance and how much time you have to invest.
Typically, investments with the potential for high returns carry a higher risk and fluctuate more in value day to day. Stocks are a perfect example: they have potential for higher returns, but you also risk seeing your investments decrease in value more in the short term. Not sure what your risk tolerance is? Don't worry! This quiz can help you figure it out.
This is why time is also such an important factor - the more time you have to invest, the more price swings you can endure. If you’re investing for the short term, such as saving for a new car in a year, you would probably want to be in lower-risk investments like a high-yield savings account. If you had those savings in the stock market and it decreases in value when it comes time to spend it, you may not be able to afford the car you planned for.
On the flip side, if you’re saving for retirement, you may not need to touch that money for a very long time. This can allow you to stay in higher risk investments with higher potential returns and not worry about decreases in value today. Watch the video below for some additional tips on beginning to prepare for retirement.
Before going any further, you'll want to educate yourself about the common kinds of investments you’re likely to run into.
- Stocks: Also known as equity, stocks represents the ownership of a fraction of a corporation. This entitles the owner of the stock to a proportion of the corporation's assets and profits equal to how much stock they own. Units of stock are called "shares."
- Bonds: A fixed income investment that represents a loan made by an investor to a borrower (typically a corporation or the government). Bonds can be thought of as an I.O.U. between the lender and borrower that includes the details of the loan and its payments.
- Mutual Funds: An investment vehicle made up of a pool of money collected from many investors to purchase stocks, bonds, money market instruments, and other assets. Mutual funds are operated by professional money managers who allocate the fund's assets and attempt to produce capital gains or income for investors.
- Exchange Traded Funds (ETFs): A type of security that tracks an index, sector, commodity, or other asset, but can be purchased or sold on a stock exchange the same way as a regular stock. It's sort of a hybrid of a stock and a mutual fund. An ETF can be structured to track anything from the price of an individual commodity to a large and diverse collection of securities.
- Index Funds: A type of mutual fund or ETF with a portfolio constructed to match or track the components of a financial market index, such as the S&P 500. An index mutual fund is said to provide broad market exposure, low operating expenses, and low turnover.
Choosing a Brokerage
The final step is to decide where you'll invest your money, meaning selecting a brokerage. You've likely heard of many of the most popular options, such as Vanguard, Fidelity, E*Trade, Charles Schwab, and Betterment.
There are a few basic features that you should be looking for. You likely want to pick a broker that:
- Has low or no trading fees
- Has no annual fees
- Provides access to buying a variety of low-cost index funds
- Allows you to open up individual retirement accounts like a Roth IRA.
Practicing long-term investing typically prevents common mistakes, especially as you're getting used to the process. Follow the tips below to help you become a long-term investor!
- Buy-and-Hold: A passive investment strategy in which an investor buys securities and holds them for a long period regardless of fluctuations in the market. Over the long term, price drops in high-quality assets are usually temporary, and holding on to your investments in down times can prevent you from locking in losses by selling off your investment.
- Diversification: By diversifying, you protect yourself from poor performance in one particular investment, sector, or asset class. Lots of research has been done on diversification, and most has found it to be a way to decrease your risk without sacrificing long-term returns. This is where mutual and index funds factor in; by buying a quality mutual or index fund you are automatically diversified, since your money is spread across hundreds of companies in many different sectors of the economy. Index funds may be the ultimate "set it and forget it" type of investment for beginners or for those who just don't want to have to think about their investments all that much.
- Dollar-Cost Averaging: Investing money at regular increments over time instead of all at once. This can be helpful psychologically; if you invest a large amount of money all at once and it drops 5% the next day, you might find yourself wanting to sell. However, if you’re investing money every other week, you won’t have to stress since you know you’ll be investing more money at better prices. Think of it like a discount!
- Maintain Your Asset Allocation: Say you decide to invest for a down payment on a house in 5 years, and you want to put 60% of your savings in stocks and 40% of your savings in bonds. If stocks perform great over the next year, you might find yourself accidentally with 65% of your savings in stocks and 35% in bonds. By maintaining asset allocation and adjusting your portfolio back to the 60/40 split, you can safely stick with the strategy you decided on at the beginning of your journey and help avoid some unpleasant surprises. The allocation that works best for you changes at different times in your life, depending on how long you have to invest and your ability to tolerate risk.
- Reinvesting Dividends: Many stocks pay dividends each quarter, and it might be tempting to transfer them to your bank account for some extra spending money. However, most brokerages offer a dividend reinvestment (DRIP) plan, which will add the dividends to your existing investment and can greatly increase your returns over the long term due to compounding and reducing your income taxes at the same time.