Someone recently posted a thread asking for some financial advice. Since I'm pretty knowledgeable in finance and I enjoy helping others learn about it, I wrote up a long reply to his thread. I figured I would expand on that information in a new thread also which hopefully will make a difference in at least someone's life and finances. I know not everyone is interested in saving for retirement, but hopefully I can convince some of you it is very important to start saving now. The younger you are the better. Since it seems there are a lot of young people at ClubFrontier (including myself), this will be especially beneficial to you, as the longer your money has to grow, the more power of compounding will help you. If this sounds like something that interests you, please keep reading. I will warn you the thread is very long, but I've done my best to summarize some good information for you guys. If you're not interested, click
here to be returned to ClubFrontier!.
Rest assured there is no marketing with this thread. I have no ulterior motives; my only intent of this thread is to inform and help my friends here at ClubFrontier to learn about investing. This is very basic knowledge, and should only be used as a starting point in your research of investing and personal finance. A great website to check out for further information is
Investing for Beginners by Joshua Kennon.
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It's true what they say: Youth is wasted on the young.
I'm not going to get all sentimental about how responsibilities are nil and possibilities are endless. No, the real waste is the time young folks have to compound their money.
The One-Year $1 Million Challenge
At a certain age, if you:
* Max out your 401(k) contributions for one year,
* Max out your IRA for that same year, and
* Merely meet the market's historical 10% annual returns
... you'll wind up a millionaire by the time you hit retirement.
That age? Twenty-six. In 41 years of compounding at 10% annually, $20,500 ($15,500 in a 401(k) and $5,000 in an IRA) will turn into $1 million. And you'll never have to contribute another dime. Of course, inflation between now and then means that $1 million won't buy nearly as much four decades in the future as it does today. Still, it's a remarkable feat of compounding.
In fact, that's how you win the $1 million one-year challenge: You make time your biggest ally in amassing phenomenal sums of wealth.
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The preceding paragraph was taken from an article entitled "The One-Year $1 Million Challenge" by The Motley Fool, a leading online investment website. I highly recommend everyone finishes reading the article
here. It shows you the power of compounding and an easily attainable way for people at any age group to become a millionaire. The earlier you start the easier it will be (and the less you will have to contribute).
The following paragraph is my reply to the thread I referenced earlier. There is some good information in the post, but it's intent was a response to a question. To save me the time of rewriting it for this thread's purpose, I will simply cut and paste his question and my response:
Question: Well I know the point of this stimulus bill coming in June is to boost the U.S. economy by spending it on anything you can. So, being the good American that I try to be I want to do my part in stimulating the economy however I really want to put that money in savings. So my question is, would I be doing my part by just throwing it in my daughters savings, OR would it be better to get a savings bond, mutual fund, etc. I know this is probably a strange question but I figured there has definitely been stranger asked on this question. thanks guys.
My Answer: This is the perfect opportunity for you to start a nice retirement or college fund for your daughter. I'm not sure how much you plan to put into an account for her, but let's assume you put in $900 (the amount you'd get for yourself and your daughter; not sure if you'd be putting in the additional $600 from your fiance)...well, for simplicity sake, let's just round up to a one-time $1,000 investment starting today. Over the long term, the stock market on average earns about 12% per year. We'll round down to 10% to account for inflation. To determine the amount you would have after XX amount of years, you would use the formula: $1000 * 1.10^XX
so, let's say you invested $1000 today for 20 years and it earned 10% real return per year. After 20 years, when your daughter is 21, the account would be worth ($1000 * 1.1^20) = $6,727. A general rule of thumb is you will double your money every 7 years. However, let's say you put this $1000 in an IRA for your daughter which you can not withdraw (without penalty) until she is 59 1/2 yrs old..so let's do that formula again changing the numbers around a bit... $1000*1.1^58=$251,637 in the account when she is 59 yrs old.
Here is a chart that shows the real returns (inflation adjusted) of the stock market (shown by the red line) from 1900 - 2004..As you can see, if you invest just one dollar in 1900, that one dollar would have been worth $719 in 2004. If it were $1,000, it would have been worth $719,000. Keep in mind this takes into account the stock market crash of 1929 and all the other business cycles that cause short-term volatility in the stock market.
I would recommend a basic index fund or mutual fund with NO-LOADS and low-fees. You want a fund with no-loads and annual fee of less than 1%. My funds are all no-load and fees of only 1/10th of a percent. One mistake people do while investing is focusing too much on the short-term. Stocks are very volatile in the short-term, but that's the way our economy works. There are business cycles (as you can see if the graph where the line goes up and down), but the overall trend is always up. Now is the best time to invest while the stock market is in a trough. In case you are wondering what the difference between mutual funds and index funds is, I will explain. A mutual fund is a professionally managed portfolio of different stocks. There are fund managers who choose which companies to invest in based on different strategies (aggressive growth, moderate, low-risk). You should have a mix of stocks and bonds..bonds are less risky than stock. Some funds invest 100% in stocks (these are known as aggressive growth funds), but some funds invest in a combination of stocks and bonds. A rule of thumb is to take 120- your age, and that is the % you should invest in stocks. For example, a 30 year old should invest in approximately (120-30)=90% stocks, and 10% bonds. This is because stocks are riskier and when you are 30, you have more time to make up for volatile losses. But a 60 year old who is close to retiring would want to invest much more in bonds than stocks, since they are much less risky. Stocks always have higher returns than bonds..More risk = more returns. The thing about mutual funds is the fund managers charge an annual fee to invest in their fund. Studies have shown than fund managers do not consistently beat the market, so it would make more sense to invest in index funds (which have very low annual fees), which automatically invest in whatever index you choose (ie. Dow Jones, NASDAQ, S&P500, etc). Investing in index funds will mimick the performance of that index it's following. A good technique is dollar-cost averaging..which reduces market risk..What I mean is instead of investing the full $1000 on one day, spread it out over months, this way your base cost is averaged over many months. For example, assume you invested $1,000 on May 1, 2008...the price of your mutual fund may be $100 per share on that day. You would get 10 shares. But let's say the value the next month went down to $92 per share. You account value would be less. The purpose of dollar cost averaging is spreading out your costs over time. This way, you invest $XXX each month, and the price may be higher or lower than $100 in the other months...You are averaging the amount of shares you get. This will usually make you get more shares. Hope I explained that ok. You can read more about that
here.
You should also know there is risk involved in the stock market, you may lose money in the stock market, but if you stay in it for the long haul and have a balanced (diversified) portfolio, you have a better chance of success. Since you are new to investing, I would consult with a agent at a broker. I use Fidelity, and they have people you can chat with online. Be careful though, they will push you into investing in funds with loads (fee) and higher annual fees, so make sure to do your own research as well. Best of luck to you! A good starting point is:
Investing for Beginners by Joshua Kennon
If you have any questions after doing some research, feel free to send me a PM, and I'll be happy to try to help.
In case you're wondering my credentials, I will have my Masters degree in Business (took a lot of finance courses) in 27 days from now, and should have my CPA license (TX) in June assuming I pass the 4th exam next month.
(Red line would represent the stock market, blue and green lines are bonds and t-bills)
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