Do You Even Invest, Bro? - Smart Money Seed

5/10/17

Do You Even Invest, Bro?

If you're not investing right now, it's probably because you don't know much about it. If you don't know much about it, now is the time to learn!

Investing is such a broad, complex topic. We could crank out a ton of specific definitions and examples, but that's what awesome sites like Investopedia do. Instead, we’d rather start out by giving a general overview of a few investment options that people are expected to know about but never really taught.

Are you investing your money right now? Stocks. Bonds. ETFs. Mutual funds. CDs. Savings accounts. IRAs. Hedge funds. Options. Checking accounts. If you have money in any of these, congratulations, you’re an investor... sort of.

Investing is simply the idea of making your money grow. Obviously a checking account that gives you less than 0.5% interest a year isn’t making your money grow much, but it is an investment nonetheless. So if you’re 25 and have some money in a checking/saving account, you don’t need to do anything else, right? Not so fast.

In order to optimize the rate at which you create wealth, you first have to know what types of options are available. Here's an overview of the most common investments in order or least risky to most risky.


Checking/Savings – Checking accounts and savings accounts are among some of the safest places to keep your money. For most, this is pretty common knowledge. If you deposit $500 into your savings account, you can sleep easy at night knowing it will be there the next day. Since you have such easy access to this money, you earn very little interest (checking is often less than 0.1% per year, and savings accounts rarely exceed 1% per year). Do yourself a favor and take the cash from under your mattress and put it in savings account.

How does Alex use it: I have an admittedly archaic way of handling my day to day funds. I keep most of my money in my checking account and do not have a savings account. Well, that's not including the extra money I make mowing or receive as gifts that my friends make fun of me for keeping in a bucket beside my bed. . . but I definitely don't recommend that investment strategy. Seeing one sum of money available to spend at any given time has probably caused me to feel more comfortable about spending more than I should at times. This is probably the area where I'm lacking the most in my financial life.

How does Christian use it: I split my cash up between a checking account and a savings account. Depending on the expenses I have in the upcoming month, I typically put between 15-30% of my net paycheck into my savings account. My goal is to essentially "forget" about this money so that it can be used someday for a downpayment on a house. I usually end up saving some of the money in my checking account, but I don't usually transfer it back to my savings. Right, wrong, or indifferent, I use my savings account for big future purchases, and my checking account for day-to-day expenses and emergency funds.


Certificate of Deposits – A certificate of deposit is another very low-risk option. In short, CDs work like a savings account, but you’re not allowed to access the money as easily. For example, let’s say you put $1000 in a 1-year CD that pays 2% interest. You can’t access that money for a year, but after 1 year, you’ll have $1020. Pretty easy, right? Rates are always varying, but CDs will almost always pay better than a checking/saving account.

How does Alex use it:
I don't currently own any CDs nor have I ever. I have considered it recently because I am getting to a point where my savings in my checking account are exceeding an amount I would reasonably expect to need within a year. I struggle pulling the trigger on a CD which is a low-risk, low-reward option because I like to keep myself available for things like potential business investments or emergencies.

How does Christian use it:
I also do not have any CDs, and I can't remember having any growing up. Because the interest rates are so, I would almost rather keep my cash in a savings account so that I have access to it at all times.


Government Bonds/Corporate Bonds
– A U.S. government bond is another investment option that is essentially risk-free. Instead of giving money to the bank for a certain period of time, like a CD, you can also give some money to the government. In return, the government will pay you some interest for letting them borrow your money. The rate of return depends on how long you let them borrow your money. In general, longer term bonds will earn higher returns.

Corporate bonds work almost exactly the same as government bonds, except you are lending your money to a company. Since an individual company has a better chance of going bankrupt than our government (mostly because companies can’t print money), corporate bonds have slightly more risk.

How does Alex use it:
I started out with a small amount of my 401k investment in bonds. It only took a matter of a couple months of watching that account stay flat to piss me off enough to force a change in my strategy. I wouldn't suggest buying bonds as a long-term investment. The story we all hear about the person whose grandparents bought them a bond and now they have thousands of dollars sounds great, but I'd be pissed that my grandparents didn't invest that money for me in the stock market.

According to Bloomberg, a 2 year government bond currently pays 1.34% which barely beats out my checking account. If you don't need the money within 5-10 years, I wouldn't recommend a significant amount of bond investment in your retirement account or outside of it. If you want a couple percent of your savings to go to bonds, knock your socks off. But just understand you're mostly just doing that for peace of mind in case the market tanks, and you're costing yourself money with long-term bond investments.

How does Christian use it: I have small portion of my 401k investment in bonds, but I have to agree with Alex, it's probably not the best option for younger investors. If you're under 30, I'd recommend putting the majority of your long-term investments in the stock market. It is pretty standard practice, however, to move more and more of your investments over to bonds the closer you get to retirement. Some investment funds will even do this for you automatically - talk about a hands-off approach!


Mutual Funds/ETFs
– Mutual funds and ETFs are not the same, but for the purpose of this article, we can agree that they generally provide a similar amount of risk. Without getting into too much detail, these investment types allow you to invest a small amount of money in a wide range of investments. Since your money is diversified, your risk is somewhat limited. You have the ability to earn more than bonds, but you can also lose money. Mutual Funds and ETFs are great options for people that want a more passive, hands-off approach to investing.

How does Alex use it: I choose to invest 100% of my 401k in an S&P 500 index fund which is essentially an ETF comprised of the 500 largest companies in the stock market. The S&P 500 index has provided a return of about 10% over the course of its existence. That is enough to make you some serious gains if you're investing over a long-term period. I invested a small amount of money in a mutual fund during college, but I have never seriously invested in mutual funds.

How does Christian use it: I am a big fan of ETFs and, in some circumstances, mutual funds. These investment types are great for people like us that don't have hundreds of thousands of dollars because they allow you to easily diversify smaller amounts of cash. My one caveat with mutual funds is their fees. If you're not careful, mutual fund fees can seriously eat into your returns.


Stocks – A stock represents a piece of ownership in an individual company. This investment type is the most risky because the performance of the company dictates how you gain or lose money. If you invest in a company that does really well, your money can grow rapidly; some stocks can far exceed a 10% return in just a year. On the flip side, if you invest in a company that does not do so hot, you can lose money. We’ll dive into the specifics of individual stocks another time, but for now just remember they are pretty risky for someone that does not actively monitor the market.

How does Alex use it: I currently have a small amount of money split between several different stocks, but my total return has been less than the return of the S&P 500 during the lifetime of my stock investments. I don't invest in individual stocks in my 401k, and I would not recommend you do that either unless you are willing to essentially devote your life to researching the stocks. There are a lot of people on Wall Street who make a lot of money devoting their life to researching stocks, so don't think you're going to do better than them by casually investing in individual stocks.

How does Christian use it:
I also have a small amount of money invested in individual stocks, but it is mostly just for fun. I realize that I can't possibly spend all day doing the research needed to truly be an informed investor, but I took some investment finance classes in college and I can't help but to at least have a little fun with it. So far, I've experienced a much higher return percentage than my 401k, but I'll chalk most of that up to pure luck.


Options/Futures
– You only really need to remember one thing about options and futures; they are too complex for the average investor. These types of investments are typically carried out by professionals that have years of experience in the securities industry or by overly confident college grads that think they know everything about investing. Unless you think you know everything, stay away from these investments.


Why Should You Invest Now?


Compound returns are probably more powerful than you think. Don't believe me? Here's an example from an earlier post, 3 Horrible Financial Mistakes You MUST Avoid:

Image courtesy of MSN Money


The Blue is your money you invested, and the Green is interest you make from the market. If you invest $3,000 a year for 40 years with an average 10% annual return, it equates to an astonishing $1.3M. The big M is for MILLION! Crazy, right?

You should probably check out that post to see what other mistakes you don't want to make.

The Biggest Myth of All Time


"I don't have enough money to start investing."

This couldn't be further from the truth; the example above is proof that you don't need a lot of money to do well in the market. Yes, you can open a brokerage account (an account that gives you access stocks/bonds) without much money (many brokers now offer accounts with no minimum balance requirements), and yes, thanks to Mutual Funds and ETFs, you can diversify your portfolio with no more than a few hundred bucks.

For what it’s worth, I'm 24 and over 95% of my investments (not including checking/savings) are in stocks, ETFs, or mutual funds.

If you're not investing now, you're losing money, plain and simple. So... do you even invest, bro?

4 comments:

  1. I have been using a CD for about the last 8 years now and it has taught me some good spending habits as opposed to using a checking/savings account. Not having access to the money at my convenience has been beneficial for me to actually save up for that down payment on a house or that engagement ring that everyone keeps harassing me about. Also, if i did need that money from the CD then that probably means that I'm spending way too much money to begin with. I'm interested in going down the route of an IRA soon. What are your thoughts? Any experience with them? Look forward to the need post!

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    1. Thanks for the comment Seth! That is a perfect example of how to use a CD, and how each person's investment strategy is unique. The most important thing is to do what works for YOU!

      I'm glad you brought up IRA's, that's actually something I've been interested in for a while, but I haven't taken action yet (and I don't really have a good excuse). If you want to get one started soon, I would encourage you to look into Roth IRA's as they offer some pretty sweet tax advantages. Alex and I will do some research and see about making an IRA specific post.

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  2. I’m north of 65 years of age. One adage you’ve maybe heard is keep the percentage of bonds in your folio at your age. Hence, our bond content is at about 65%. Since sticking to this since the mid-eighties, it has served well.

    And yes….expenses! Some funds with 2-3% ongoing expenses…plus redemption fees…and 12b1 fees…will tear your returns to shreds!

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    1. That's great you've found a strategy that works for you! Sometimes that's the toughest part. I think it's awesome that you've kept 35% in stocks since some people tend to panic around that 60 mark and dump everything into bonds and cash. Expenses and fees are the worst. 2% doesn't look that bad to an untrained eye, but many people don't realize those funds almost never beat the market by more than 2%.

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