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You can buy individual companies’ stocks, but newcomers can be in over their heads trying to research which companies to invest in while learning the basics of investment strategy. A better option for new investors might be mutual funds. Mutual funds are collections of stocks (and sometimes bonds, which we’ll talk about later) chosen by a group of fund managers. This gives you the benefit of having a diversified investment, meaning that your eggs are not all in one basket. If one of the stocks in your mutual fund drops in value, it may be balanced out by another stock’s increase in value. Diversification is one of the central pillars of investment, and should never be ignored (unless you enjoy losing money!).
Another benefit of mutual funds is convenience of payment. When buying stocks, you normally have to buy by the share. If each share costs $50 and you have only $149 to invest, you can only invest $100 (by purchasing 2 shares). Mutual funds will normally sell you partial units, so in a situation like the above, you could invest the entire amount without having money leftover. In addition to that, many funds allow you to make automatic monthly payments on a specified date, so that your investment will continue to grow without you lifting a finger.
Mutual funds come in a range of risk categories, and before you choose a mutual fund you should assess your own risk tolerance. The longer you are willing to keep your money invested, the more risk you can afford to take, because short term fluctuations won’t matter so much to you. If you’re not quite sure what your investment goals are yet, it’s probably best to start with something low risk as you learn about the markets.
Index fundsThere are great funds called index funds which are widely diversified and offer stability for the newcomer. An index fund mirrors the movement of a market index, basically an overview of how an entire industry or entire country’s economy is doing. For example, the S&P 500 is a US market index that includes the 500 biggest US companies. This index is widely seen as an overview for the entire US economy. An S&P 500 index fund is great for a beginner because it is stable and has had historical annual returns of 12%. Some years will be higher and some will be lower, but on average you can expect roughly 12% in interest. You won’t get rich overnight, but that interest builds up and compounds. At that interest rate your money will double in less than seven years.
Another benefit of index funds is that they charge very low service fees because they don’t have to be actively managed. Managed funds sometimes charge huge “load” fees up front or when you sell your fund units, and can charge high monthly or annual maintenance and management fees. These can really eat into your returns on your investment over time! All of those little fees could have been money that was compounding and growing and growing over the years. And on top of that, most managed funds do not perform as well as index funds, even though you are paying them such high fees! Index funds really are the simplest and easiest way for beginners to get their investing foot in the door and have stability while learning the game.
Actively managed fundsAs the name suggests, actively managed funds have fund managers who pick and choose the stocks and bonds etc. that make up the mutual fund, depending on their professional assessment of the market situation. Some of these funds do wildly well, and some do poorly.
Over the long term, few funds beat the returns of the general market. Beware of the various fees that may be charged. They can be exorbitant.
To give you an idea, I’ll tell you about my own mutual fund portfolio. I have some short term goals (such as buying a house in cash), so I have about 60% of my portfolio in stable index funds (one is a global index, and another is the S&P 500) and bond funds. I have 40% of my investment in higher risk funds (for example, India and China funds) which fluctuate widely over the short term, but which allow me to earn more over the long term. These are inappropriate for the short term because they often lose a large amount of their value very quickly before recovering later. You would be in for a nasty shock if you went to sell your mutual funds to pay for your tuition fees only to discover that they had lost 30% of their value overnight! But if my goals are long-term, then I can plan accordingly and when the price is high in the future I can sell them.
Before looking into which mutual funds to invest in, make sure to think about your goals and investment needs, specifically how long you plan to keep the money invested and the earliest time that you might need the money. The shorter term your goals are, the less risk you should take.