I'm 26, where do I put my money to get the most out of it?
I have a 401k at work with a decent amount of change in it. I’d like to open a stock trading account through one of the online brokers with my income tax check. I also plan on purchasing a few bonds in the next couple months. What would be your input on how to invest in the stock market correctly and safely with minimal risk? Also, what should I look for in the fine print when buying a bond? What kind of bond is best and pays the most? I won’t need the cash for 5-10 years. I'm trying to get my ducks in a row so I can make a few dollars now, and save a few dollars for later. Thanks.
First, risk and return go hand in hand. There is no such thing as a free lunch. For someone who is 26 years old, it is imperative for you take a healthy amount of risk (at least 70% in stocks). The best way to gain exposure to both the stock and bond markets is to hold a globally diversified portfolio of index funds. Forget trying to day-trade, pick winning stocks, time markets, or invest money with hot mutual fund mangers. All of these strategies have led to more destruction of wealth versus a low-cost index alternative. There are times when markets are going to be very turbulent, but you need to stay in it through thick and thin. Time is on your side.
Stay away from buying individual bonds. Transaction costs are too expensive for the amount of money you are looking to invest. Buy a low-cost bond fund instead.
Ideally, you should have 6-12 months of living expenses set aside for a rainy day, with the rest of your assets invested based on your longer term goals. This can include retirement, college planning, purchasing a home, starting a business, etc. Your 401(k) should be heavily invested in equities since you have 35-40 years before you will touch those assets. Shorter term goals should be invested very conservatively using money market funds, short term bond index funds, and maybe a little bit of stock index funds.
Before any investment decision is made, you must have a solid assessment of your investment objective, risk tolerance, and time horizon. This assessment will be your guide and help you make prudent investing decisions. I wrote in more detail about this in my article DIVERSIFICATION ISN’T ENOUGH.
Make sure to understand that stock trading is NOT investing. If you’re looking to build wealth, you need to think long term. Avoid the temptation to trade stocks. Unless you are an institutional or professional trader, you are at a disadvantage. Instead of trading, a more prudent approach would be considering some broad based index mutual funds or ETFs. But don’t put any money in the stock market that you expect to use within 24 months.
I would caution you on investing in individual bonds. If exposure to bonds is warranted for the allocation you are trying to achieve, you might consider bond funds instead. Which type of bond fund depends on your investment objective, risk tolerance, and time horizon. Investing in bonds is more complicated than you might think. I highly recommend reading an article I wrote called BOND MUTUAL FUNDS – WHAT YOU NEED TO KNOW.
Please note that this should not be considered investment advice and is only educational in nature. Be sure to consult your own investment, tax, or legal professional for help with your specific situation.
Best of luck!
David N. Waldrop, CFP®
You are in luck! Commisions for stock transactions are at an all time low and look to stay that way. I would suggest opening an account with Fidelity or any other company offering trades for $4.95. Compared to when I started in the business in 1982 when trading costs were hundreds of dollars, this is an excellent opportunity. I research individual stocks and build portfolios for my clients and have quite a few companies that I currently recommend. A good place to start is to look at an established company that pays a dividend and start buying shares as you can afford them. Look to own 8-12 companies over time, but start with just one. If you have $500, simply buy as much as you can of your first company. I think a company like Microsoft is a good start as they currently pay a 2% dividend (yes, you get paid 2% a year to own the stock). They changed their business model to a monthly subscription that worked out very well for companies like Adobe, Netflix, and any other company that collects monthly for their services. Again, if you have $500, you could buy 6 shares of the stock and look to build it to around $2500 total value and then start on your next company. Plan on holding this company a long, long, time and do not worry about the ups and downs. You will be rewarded in the long run. I would avoid bonds right now because someone at your age should focus on growth. Interest rates are bound to rise over the next 10 years and that would not be good for bonds.
that's great that you are investing in your 401k at work, and also looking for other ways to save money.
I would consider a mutual fund that holds bonds, rather than individual bonds, for short-term savings. Your long-term investments (in your 401k) could be invested more aggressively, given your age.
Besides investing in your 401k, I would consider a Roth IRA, which is a post-tax retirement account. It has tremendous tax advantages, and the money isn't locked away until you retire - you are able to withdraw the contributions tax-free at any time, without penalty. This would be a good way to get some short-term savings set aside. You can pull out what you need later, but whatever you don't need (which must include the earnings in the account) can be left there, where the tax-advantages are the greatest.
Congratulations on wanting to invest and save more. To give you a better recommendation, I have a few questions to clarify your objectives. What are your goals for the stock account? Do you need to pay off any student loan or credit card debt? Are you saving money for a downpayment for a house? Will you add to the taxable stock and bond investments regularly such as monthly? Are you looking for dividend income? How is your 401K invested? You want to keep your overall assets diversified with these additional investments. Why do you want to buy a bond and not a bond mutual fund or ETF? What is the goal of the bond investment? Do you need tax exempt income which would imply a municipal bond fund? Mutual funds and Exchange Traded Funds (ETFs) offer the opportunity to diversify your bond investments. Just buying a single bond can be risky. Thanks, Ann Zuraw