NOTE: This is strictly what the title itself literally says: What I wish someone would have said to me about investing when I was 22. It's information of a general nature only. The author takes no responsibility whatsoever for the consequences of your decisions to do anything at all with, about, or because of this essay.
1. Figure out how much debt you have and know how you're going to get rid of it
First, understand the difference between revolving debt and installment debt. Revolving debt is the bad stuff: Usually credit-card debt, it's never actually "due" in full. If it isn't paid off in full, then it's a perpetual stream of income to whomever lent you the money and a huge deadweight on your future. Revolving debt isn't quite pure evil, but it's really close. Any financial plan or budget must include a specific strategy to get rid of it as soon as possible.
Installment debt is usually the kind you have when you're paying for a big-ticket item over the length of time you plan to use it. A mortgage payment converts the huge expense of buying a house into small monthly chunks that you pay while you live there. You pay for student-loan debt over the course of your working career, presumably with some of the extra money you earn because of your education. Installment debt isn't perfect, but for things like houses and education it can make sense. Besides, you owe it in fixed amounts each month, so you already have a built-in plan to handle it.
The main goal has to be the elimination of revolving debt as fast as you can stomach it. The interest rate you're paying on it is probably well over 10%. Paying it off is like getting an instant return on your money, since you'll stop paying interest to someone else.
2. Assess your safety net
Everyone needs insurance. Figure out how much you need of each type and get them worked into your budget:
- Health insurance
- Catastrophic coverage
- Property insurance (including renter's coverage)
- Auto insurance
- Personal liability insurance
- Disability insurance
- Long-term care insurance
3. Figure out how much money you can make yourself put away each day
Can you force yourself to put away $5 every day of the week? $2? $10? Everyone has a number. Find a jar, a piggy bank, a shoebox, or whatever you have to use to make yourself physically set aside a specific amount every single day of the week. Once it goes into your makeshift piggy bank, you can't touch it for any reason. If you need a rainy-day fund or an emergency fund, get a second piggy bank. But don't touch that first one until you have $100 inside.
At $5 per day, you'll have $100 inside after three weeks. At $2 per day, it'll be about seven weeks. At $10 per day, a week and a half.
4. When you have $100, open a savings account
Find a credit union near you and open two accounts: One for savings and one for checking. Put the minimum amount possible in the checking account, and put the rest in the savings account.
Why use a credit union instead of a bank? Because credit unions tend to offer better terms to beginning savers than commercial banks, usually including lower minimums, lower fees, and higher interest rates on savings.
Go home and go right back to saving your next $100 in your piggy bank. If you're dedicated enough to make a budget and really stick to it, you can skip the piggy bank stage and just budget the right amount. But almost nobody has that much discipline when they're just starting out, and putting the money in a piggy bank makes it a physical process that helps to make the savings habit much harder to break.
5. Psychologically separate this savings money from everything else
The money you're saving through this plan isn't for a down payment on a house. It isn't for a rainy-day fund. It isn't for vacations or emergencies. It's strictly for investing. You can (and should) save money for those other things, but keep those savings completely separate from this savings pile. The worst temptation is to use the money in this savings plan for a down payment on a house. The problem is that you have to live somewhere, whether you rent it or buy it, so you're always going to be spending money of one kind or another on housing. If you allow yourself to use the savings-plan money for housing, you're going to have a hard time getting back into the habit. Choose the amount you put in the piggy bank each day so that you won't be tempted to siphon it off for something else.
6. Start learning about stocks
Your next savings goal is the $1000 mark. Until then, have some to start learning about what you're about to get into.
Don't buy any stocks yet. Just learn what they are: Shares of ownership in a company. When you buy a share of stock, you're buying a tiny part of the company.
7. Use what you learn about stocks to start learning about mutual funds
Buying shares in a mutual fund is essentially like buying shares of stock in a company whose only business is to buy shares in other companies. By owning mutual-fund shares, you own part of a company that owns lots of parts of other companies.
8. Use what you learn about mutual funds to start learning about index funds
Mutual funds come in all kinds, including funds that invest only in large companies, only in small companies, only in technology firms, only in health-care companies, and so on. Index funds don't try to pick certain kinds of companies: They just buy shares in all of the companies available in the market. The two main types invest in the "S&P 500" list (basically the 500 largest companies available on the stock market), or in the "Wilshire 5000" or "total market" list (which includes almost every company available on the stock market).
By buying shares in a mutual fund that's based on a large index like the S&P 500 or the Wilshire 5000, you essentially are buying a tiny fraction of almost every big company in America.
9. Learn about the different kinds of savings plans you may be eligible for
Depending on where you work and how much you make, you could be eligible for a number of different kinds of plans:
- Roth IRA
- Traditional IRA
10. Keep saving and depositing $100 at a time until you reach $1000
At $5 a day, it'll take about 29 weeks. At $2 a day, it'll take about 16 months. At $10 a day, it'll take just over 14 weeks.
At this point, you're ready to buy into your first stock-index mutual fund. You should avoid paying any loads or commissions (look for a "no-load" fund), and you'll want to find a fund that has the smallest "expense ratio" you can find. The load is what they charge you to buy shares of the fund up-front, so you're obviously better off with the funds that don't charge a load. The expense ratio is what they'll charge you each year for their management services. Obviously, the less you spend on management fees, the more money you get to keep for yourself, so lower expense ratios are better.
Vanguard has the best reputation for low expense ratios, and they offer a "Total Stock Market Index Fund" and a "500 Index Fund". Since most of the money in the total stock market is invested in the 500 largest companies, either one is a good choice.
You will need to open an account with whichever fund company you use before you can buy shares in a mutual fund. The best way is usually to open a Roth IRA account. The Roth IRA is a retirement account that will never be taxed. You can only invest a few thousand dollars a year in a Roth IRA account, and there are some limits based on how much income you make, but most people who are just starting out won't have problems with either limit. Just follow the instructions given by the mutual fund company. Be sure that the minimum investment required for the mutual fund you plan to buy is $1000 or less.
Once you open the account, you will need to send them a check to fund the account. Transfer $1000 from your savings account to your checking account at your credit union and then send the check to the mutual-fund company. You might have to over-shoot the $1,000 goal in order to keep up the minimum account balances at your credit union. The point is that you keep both accounts open at the credit union and open a brand-new one with the mutual-fund company. Then buy $1,000 worth of shares in the index fund of your choosing and go back to saving.
11. Keep saving just like before, and start learning about dollar-cost averaging
Dollar-cost averaging is a bit of jargon for a simple idea: Buying the same dollar value of shares each time you invest, and investing on a regular schedule. The basic principle behind dollar-cost averaging is that when shares cost more, you buy fewer of them, and when shares cost lest, you buy more of them, because you invested the same total amount of money each time. By taking this route and buying more relatively cheap shares and fewer relatively expensive shares, your average cost would be lower than if you bought the same number of shares each time, no matter how much they cost.
Especially when you're just getting started with investing, you're going to be forced to dollar-cost average anyway, since most mutual funds set a both a minimum initial investment amount, and a minimum subsequent investment amount. The assumption here is that (like many funds), you're investing in a mutual fund that has a $1,000 initial investment minimum and a $100 subsequent investment minimum. And since you're saving at a regular rate anyway, your investments will automatically be dollar-cost averaged.
12. With the next $100 you save, buy more shares in the same stock-market index fund
Again, the assumption is that the subsequent (or additional) investment minimum is $100. For some funds, it may be lower; for others, it may be higher. Adjust accordingly (though investing $100 at a time is psychologically appealing; it's a nice, round number, but it's not so big that it should seem overwhelming).
13. Continue adding $100 at a time to the index fund until you reach $10,000
Why $10,000? In part, because it's a convenient round number. Also in part because many funds will add special charges to any account that has less than $10,000. They're usually not huge, but it's nice to get rid of as many extra charges as possible.
14. Use the time while you're building the first $10,000 to learn about bonds and bond funds
Bonds are the other major investment class besides stocks that most companies use to raise money. A bond is a loan to a company (or, in the case of what are called "municipal bonds", loans to city, state, or other levels of government). If you've ever had a US Savings Bond, you've been a bondholder.
There are thousands of books on the market that will try to tell you how to invest in stocks, but far fewer that say much (if anything) about investing in bonds. That's unfortunate, because bonds can be a good way to make money, and they are an important alternative to stocks. Stocks tend to fluctuate in value much more than bonds do, since people are always trying to make a fortune in the stock market. But bonds are usually a safer investment than stocks, because if a company goes bankrupt, it has to pay bond holders before it would ever have to even think about paying stock holders. A company can lose money in a given year (and, thus, not pay any dividends to its shareholders), but it still has to live up to its obligation to pay interest on its debts and pay them off when they come due. Some companies (and even some governments) will fail to pay even the bond holders, but it's a much less-common occurrence than, say, a company losing money and not paying a dividend.
15. Once you've saved $10,000 in a stock-market index fund, save up another $1,000 in your credit union savings account
16. Once you've saved $1,000 in a savings account, invest it in a no-load bond fund
The best way for most people to invest in bonds is to buy a mutual fund that invests in bonds. Just like stock-market funds, a bond fund can be a "load" or "no-load" fund. There's no reason for most people to pay a "load." Buying shares in a no-load bond fund is the best way to invest money in bonds. A bond fund is like a stock fund: With a stock fund, you're buying shares in a company that buys shares in lots of other companies. With a bond fund, you're essentially buying shares in a company that loans money to lots of other companies. If that seems a little strange, think about it as though you're becoming part-owner of a bank that specializes in making loans to other companies. By making lots of loans, the bond fund spreads out its risk so that in case a particular loan doesn't work out and can't be paid off, there are still lots of other loans out there to make up the difference.
Most mutual-fund companies that offer stock-market index funds also offer mutual funds that invest only in bonds.
17. Add $100 at a time to the bond fund until you reach $10,000
18. Use the time while you're building the next $10,000 to learn about international investments
The US economy is great, but it's already very wealthy. There are lots of other parts of the world that aren't wealthy yet but are growing much faster than the US. Investing internationally can help you take advantage of faster growth rates, while also spreading out your risk a little more. If something terrible happens to the US stock market and to the US bond market, having some investments outside the country might help soften the blow.
Investing money outside the US also helps diversify what's called "currency risk" -- which is the fluctuation in the value of things based on how much people want or don't want to be holding particular currencies (that is, when economists say that "The dollar is weak" or "The dollar is strong"). If you have money invested at home and abroad, the effects of currency fluctuations are at least partially evened out.
19. Once you've saved $10,000 in a no-load bond fund, save up another $1,000 in your credit union savings account
Once again, we'll use $10,000 as a stopping figure because it's a nice, round number and it's also the level where some of those extra charges usually go away.
20. While you're saving the next $1,000, look back over the first $20,000 and consider the risks and rewards of each investment
If you'd been investing in individual stocks all along, you probably would have seen many more highs and lows alike. You would also have paid a fortune in brokerage commissions that would have put a huge dent in your total investment returns.
21. Consider whether you prefer the risks of one region or would feel better investing in a global-type index fund
So far, you've been investing almost exclusively in the stocks and bonds of one country (the USA). The next step is to diversify outside the US. Depending on what you think about the global economy and about different parts of the world, you may decide to invest in a global-type index fund (investing in the stocks of the entire world) or in just one region (like Europe, South America, or Asia).
22. Once you've saved $1,000 in a savings account, buy shares in a no-load international mutual fund
23. Add $100 at a time to the international fund until you reach $10,000
24. Use the time while you're building that next $10,000 to decide on your next investment
You're probably best-off in one of two directions:
- Investing in some specific type of investment that you're comfortable with (real estate investment trusts, growth funds, value funds, large-cap index funds, small-cap index funds, etc.)
- Going back to your original three investment types and adding to them
25. Once you've reached $10,000 in your international fund, either follow the normal cycle to add a fourth component to the portfolio or start adding to what you already have
26. Once you have your either three or four funds in your portfolio, each funded up to $10,000, start adding to them
- Add to each in round-robin form in order to dollar-cost average
- Compare each investment and invest in whichever is "cheapest" at a given time, based on P/E ratios