Category Archives: Investing

A Beginner’s Guide to Index Funds

A Beginner's Guide to Index FundsIf you have more than a few months of savings in a checking or savings account (and have a pretty stable situation), you should consider investing your money. Once you have an emergency fund saved up, it’s time to put your money to work. Your money should earn money, and the best way to do that is investing.

You may be a novice, but by now you should know the basics of investing. The best part about investing these days is that you don’t need to be an expert. In fact, you don’t even need to know what you’re doing, because there are systems in place that can take care of everything for you. I’m someone who is constantly plugged in to Wall Street, and yet I still rarely pick stocks. Why? Because I like diversity, and why invest in one stock when I can invest in hundreds? This is exactly where index funds become our best friend

If the stock market bewilders you, don’t feel bad. Understanding the inner workings of the market takes dedicated study and constant attention and it’s not for everyone. We don’t need to pretend that we’re better at picking stocks than someone who spends all day researching. Most people don’t have the time or money to make consistently profitable decisions on individual stocks; index funds exist for that very reason.

What is an Index Fund?

To better define an index fund, it’s important to know what both an “index” and “fund” are within the context of the stock market. A stock market index is the valuation of an individual section of the stock market based on the prices of certain selected stocks. Unlike a mutual fund, which is comprised of stocks selected by a human person (or group of people), an index fund is managed automatically by computer. There are global indices, national indices, and indices that track specific market sectors. You may have heard of the S&P 500 or Russell 1000. These are examples of index funds that contain (you guessed it) 500 and 1000 stocks, respectively.

A fund is simply a large repository of capital that belongs to many investors and is used to purchase stock. This arrangement gives individual investors more opportunities to diversify their investments. If you buy one stock and it doesn’t do well, you could be out a significant amount of money. But if you spread your money throughout many stocks, you’re spreading out your risk. The likelihood of many stocks tanking is much lower than the likelihood of just one stock decreasing a lot.

Index Funds vs. Mutual Funds

So, if an index fund is run by a computer and a mutual fund is run by a person, which one is better?

With an index fund, the goal is to match the performance of the index. If the index increases by 6% in a year, the index fund should increase by 6%, too.

With an actively managed mutual fund, there’s the chance to beat the market. But pound for pound, index funds have a reputation for outperforming managed funds over-time. On top of this, index funds allow you to succeed on the stock market with virtually zero experience. In addition, index funds usually have super low fees (as low as 0.05%), while mutual fund fees regularly exceed 1%.

The Benefits of an Index Fund

Warren Buffett, the world’s most famous investor said it himself: “Just making monthly investments in a low-cost index fund makes a lot of sense.” Why? Because “Owning a piece of America, a diversified piece, bought over time, held for 30 or 40 years, it’s bound to do well. The income will go up over the years, and there’s really nothing to worry about.” In fewer words: keep it simple, stupid. Quite often, the easiest approach is the best approach, especially for the beginning investor.

Where to Get Started

Getting started with your first index fund is designed to be easy. Take a look at some of the more popular index funds, like the Vanguard 500 or Fidelity Spartan 500 and you’ll find that both the risk and the barrier to entry are very low.

How to Invest With No Experience

Maybe you’re fresh out of college in your first job, or maybe you’re getting a late start on your financial health. Either way, you’ve decided that you want to start investing. You’ve got some money saved up from your Bar Mitzvah, or maybe you’re keeping to your budget and throwing $500 a month into your savings account. And now you want to start investing but don’t know where to start. You’re in the right place, we’ll guide you through your best options.

Are You Investing For Retirement?

First, you have to decide what you’re investing for. If it’s for retirement, consider your 401(k) and IRA options. If you’re young and are in a low tax bracket, the Roth IRA is a great option. Whether you’re looking for a retirement account, or a taxable investing account for the short-term or medium-term, consider a low-cost company like Vanguard or Fidelity. Getting set up with them is very easy. Simply create an account on their website, and they’ll guide you through the process to get you set up. If you’re not sure which kind of account you need, there’s a clear hierarchy of investment accounts that you should follow.

It may feel overwhelming at the beginning. You have so many investing options and may not know where to start. You can invest in stocks, bonds, ETFs, and the list goes on. Thankfully, we’re here to help. If you’re young, you likely want to invest heavily in stocks, which tend to perform best over long period of time. If you’re in your 20s and 30s and you are going to have this money for 40+ years, stocks make a lot of sense.

Don’t Invest It All In One Stock!

Now that we know to invest in stocks, that still leaves almost an unlimited number of options. Should you put all your money into one stock? Apple has performed well, right? So should we just buy that and let it ride? Absolutely not! Diversification is really important. One stock might be volatile, but if you own bits of a lot of stocks across industries, you’ll be better protected from large swings.

Let Mutual Funds Do The Work For You

To diversify properly, we want to buy different stocks that cover different industries. And the best way to do that is to invest in a mutual fund. A mutual fund is a collection of stocks, so instead of you buying a little bit of each stock (which can add fees for each trade), you can effectively own parts of many stocks, without having to pay a $5-$10 fee for each trade.

You don’t need to be an expert to begin investing. Unless you want to do a lot of research, why not let someone else do the work for you? This is what makes mutual funds so attractive. Mutual funds are often run by groups of experts, so they do all the work, and you get to take advantage for a relatively low rate of 0.5%-1.5% of fees, or $5-$15 of each $1,000 invested.

Index Funds Are Incredibly Cheap

To take it a step further, an index funds are a type of mutual fund that tracks a specific index, like the S&P 500, for example. The reason I am such a fan of index funds is that since nobody is doing any manual stock picking (the stocks in an index are fixed, so a computer can do the work for us), the fees can be really low. For example, Vanguard has an S&P 500 index fund with fees of just 0.05% of your investment. Practically, this means that for every $1,000 you have invested, you pay just 50 cents!

The thought of starting to invest can be daunting, but getting started doesn’t have to be hard!

Would You Sell A Percentage Of Your Future Income?

I was recently turned on to a site, Upstart.com, that allows people to “raise money in exchange for a small share of their income over 5 or 10 years.”

I love this idea for some people and the idea is really interesting, though I think there may be some downsides to consider as an investor.

Who Upstart Can Help

While many of the upstarts (people looking for others to invest in them) have a business idea they want funding for, there are some upstarts with very different reasons and needs for an upfront payment in exchange for giving up a percentage of their future income (and total payments are capped at a certain amount).

Some would like to pay off student loan debt or pay for their education, while others are looking to train for the Olympics or other athletic endeavors.

How Upstart Works

Each applicant (or upstart, as they are called on the site) creates a profile, and Upstart verifies his or her identity, credentials, and credit status. Then, Upstart assigns each applicant a fybdubg rate, the amount an applicant can raise for each 1% of income share, either for a 5 year or 10 year term.

Upstarts get to choose how much money they want to raise, up to 7% of their future income, with a minimum of $10,000 raised from backers.

Upstart attempts to target an 8% annual return to backers, though clearly there can be a large variance as some are more successful than others.

The Rules For Backers

Backers can invest in increments of $100, and upstarts have the right to choose whether to accept any particular backer. Upstarts provide updates to their backers about their progress, and backers can be involved in the success of the upstarts by giving advice and making introductions. Everyone is involved in the success of the upstart, and everyone is on the same team trying to make money!

Backers must be American accredited investors, which means a minimum of $1 million net worth (excluding primary residence) or a minimum of $200,000 annual income in each of the past two years ($300,000 if married). This clearly limits backers to a small subset of people.

The Future of Upstart

I love the idea of certain individuals getting funding now in return for a small percentage of their income later. If they don’t make much in the future, it doesn’t cost them a lot, and if they are very successful, they share some of that success with those who helped them. And for some of those entrepreneurs who want to start a business, they can get extremely valuable advice and connections, which may be worth even more than the original investment amount.

For backers, I don’t see the same benefits. An 8% target isn’t that impressive (I’ve done better with Lending Club the last few years), and on top of that there will be work to do if you want to get involved in the business the upstarts are doing. This may be best used as a fun way to try to make the world better and help young people who want to grow their business ventures, but as purely an investment platform, I’m not sure it’s the best idea.

I’m sure there will be many success stories, but I’m equally as concerned about those who try to scam the system, similar to what occasionally happens with Lending Club.

What do you think of Upstart? Would you use it as either an upstart or a backer?