Sunday, 31 January 2010

Congratulations, You're an Investor!

Congratulations, You're an Investor!
By Dayana Yochim
January 29, 2010 

During this monthlong Fiscal Fitness Boot Camp, we worked some money magic -- saving big bucks by scrutinizing our major (and even some minor) expenses.

What's the point? Sure, padding the bank account is good. Freeing up cash to more quickly pay down high-interest debt is even better.

But once the basics are taken care of -- once that debt is but a distant memory, and you've got a decent emergency cash cushion for life's just-in-case events -- the very best thing you can do with your money is to make it grow. In other words: You've mastered the art of saving. Now it's time to become a bona-fide investor.

Channel your inner Warren Buffett
The truth is that every one of us is already an investor. Every dollar decision we make is an investment, whether for long-term gain (retirement savings), short-term safety (emergency fund), or immediate pleasure (mocha latte -- hey, I'm not one to judge). (This mind-set -- "Treat Every Dollar as an Investment" -- is such an important part of successful money management that we've made it a key part of our Motley Fool Magna Carta.)

However, today we're going to venture into the world of traditional investing. If you complete today's homework, you'll snag the most handsome payoff of this entire series -- adding tens of thousands of dollars to your bottom line.

Don't start mentally spending that money just yet. Investing is a long-term exercise. The kind of savings we're talking about will accumulate over years -- decades, even. But it's not going to happen magically on its own. So let's get started.

Your first investment
As scary as the stock market has been as of late, it's still the best place for your long-term savings. (Note the emphasis on long-term. We're talking about money you do not need to touch for five to 10 years, depending on your tolerance for risk.) With that in mind, when it comes to traditional investing -- as in IRAs, 401(k)s, stocks, bonds, mutual funds, gold doubloons -- start with the basics and you're 90% of the way there.

Last year, we recommended three stocks -- Costco (Nasdaq: COST), Paychex (Nasdaq: PAYX), and National Oilwell Varco (NYSE: NOV) -- to our Fiscal Fitness graduates. But if you don't want to jump into individual stocks, that doesn't mean you shouldn't invest.

One of the easiest ways to get started investing is to sign up for a 401(k), 403(b), or 457 plan at work, if your employer offers one. The money is deducted from your paycheck and sent straight to your 401(k), 403(b), or 457, before income taxes are taken out.

Another reason to do so? Free money! Many employers add money to your account based on the amount that you sock away. Incredibly, however, many people don't take their employers up on the offer. That's essentially dissing an instant, guaranteed return on their money. For example, save $5,000 with a 25% employer match, and you suddenly have $6,250. (Whatever you do, don't make one of these six common 401(k) blunders!)

Once you've maxed out your 401(k) -- or if you don't have one at your place of employment -- it's time to move on to phase 2 of building a portfolio.

How to invest $50, $500, and $5,000-plus
First, determine how much you have to invest. Depending on how much money you've freed up to invest, some investment battle plans make more sense than others. Here's advice on how to proceed with $50, $500, and $5,000-plus.

How to invest $50:Thanks to the miracle of compound interest, even small sums can add up to big nest eggs over time. (Get a load of these charts to see what I mean.) If you're just starting out, the very best thing you can do is to commit to investing on a regular basis.

One of the best ways to invest small amounts of money regularly and cheaply is through a DRP -- dividend reinvestment plans. They and their cousins, direct stock purchase plans (DSPs), allow you to bypass brokers (and their commissions) by buying stock directly from the companies or their agents. They also allow you to reinvest dividends directly into more shares of stock. More than 1,000 major corporations offer these types of stock plans, many of them with fees low enough (or free) to make it worthwhile to invest as little as $50 at a time. Some plans even allow investments of as little as $20. Once you're in the plan, you can set up an automatic payment plan, and you don't even have to buy a full share each time you make a contribution.

What to do with $500: With this amount of money your investment options open up. You've got enough money to meet many companies' minimum initial investment requirement to open an IRA (or even a taxable brokerage account). (Here are 10 ways to size up a broker.)

Mutual funds are a popular investment option for many investors. You'll want to consider whether to go with an index fund, which simply tracks a particular benchmark, or an actively managed fund. You may want to start with a large-cap-oriented fund, which will give you exposure to well-known companies like ExxonMobil (NYSE: XOM), AT&T (NYSE: T), and Procter & Gamble (NYSE: PG). But you can also buy funds in just about any category, from bonds and small-cap stocks to shares of international companies like Vale (NYSE: VALE).

Some funds require as little as $250 for you to invest (typically restricted to IRAs). After your initial investment, you can add as much money as you like, as frequently as you like -- and if you choose a no-load fund and purchase directly from the fund company, there won't be any commissions. For beginners, a high-quality mutual fund is a great portfolio building block.

How to manage a $5,000-plus portfolio: As you establish a decent-sized retirement kitty (yay, you!), diversification should be your aim. You want to spread your money around -- allocate your assets -- owning both mutual funds and stocks to cushion yourself from stock market belly flops. (Here's the Fool's rules for asset allocation, including a handy chart that'll help you determine how much of your money should be invested in stocks.)

At this savings level, again, the power of making regular investments over time is very strong.

If you start with $1,000 at age 25 and invest an additional $1,000 each year, and your money earns 10% annually, then when you're ready to retire at age 65, you'll have more than $500,000 set aside. Yup. The key is to make sure that your costs of investing (including brokerage commissions, mutual fund management fees, etc.) add up to less than 2% of your account's overall worth. That's money that you've worked hard to save -- so make sure it's not slipping away in dribs and drabs!

Finally, let's end with the secret to investment success ...

Save more and invest more
End of story. Sounds dull, but if you get serious about those two things, you will turn your entire financial future around.

Let's say your Fiscal Fitness Boot Camp frees up 3% of your salary to invest this year. If you sock away $1,500 (3% of a $50,000 salary) and earn an 8% average annual return over five years (for a grand total of around $2,200), you'll bank $700 more than if you hadn't become an investor. Commit to the 3% savings goal for the next five years (for a total of $7,500 invested), and your portfolio will blossom to more than $11,000 -- that's an extra $3,500 in nest egg padding.

What's the point?
At the beginning of this article, I asked, "What's the point?" The example above just puts a dollar figure on the benefits of investing.

But the real point of this entire exercise is what that money represents.
  • For some of you, the savings we've found during this month means freedom from the shackles of debt.
  • For others, it means peace of mind, being financially prepared should you lose your job or if the water heater goes on the fritz.
  • And for a few folks out there, this month of becoming fiscally aware will pave the way to an early retirement, the ability to put a down payment on a house in 10 years, or even just a sense of control and stability that you've never felt before.

So what's the point of saving and investing for you? Do share in the comments area below.

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