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How to Invest at a Young Age

There are a lot of benefits to starting an investment program while you’re young.  Find out what age to start investing Here.  

Now that you’ve made the decision to start investing, let’s talk about the different ways that you can invest your money at a young age.

When most people think of “investing” they think of Wall Street traders on a busy floor at the New York Stock Exchange.  Modern investing can be quite a bit different than that.  Before we start talking about the nuts and bolts of making investments, you have a few questions that you need to ask yourself:

 

How much time do you want to dedicate to making investments?

 

  • Are you going to meticulously research companies, learn how to read an income statement and balance sheet, read the reports of analysts, watch the business press and constantly re-evaluate and re-balance your portfolio?
  • Are you more likely to, possibly, sacrifice a bit of growth to have professional fund managers do the above for you?

 

How much risk are you willing to take?

 

  • Would you rather have risky investments that can wildly fluctuate in value, but likely give you more of a payoff, or, would you rather have an investment that gives you the stability of less fluctuations at a risk of less growth?

 

What are your goals with your investments?

 

  • Are you thinking short-term?  Are you saving to buy a car or a house?
  • Are you thinking long-term?  Are you looking to fund your retirement?
  • Making sure that your investment program is tailored to meet your goals is one of the most important things that you can do.  If you’re looking to use the money in your investments in the short term, you probably don’t want to have a lot of risk in them.  A bad day, week, month or quarter is not that big of a deal if you have 25 years to make it up.  A bad day, week, month or quarter is a huge deal if you need the money shortly after the investments drop.

Types of Investments

There are several different kinds of investments that you can make.  You can invest in a full range of products that include, but are not limited to:

  • stocks
  • bonds
  • mutual funds
  • annuities
  • bank products (savings accounts, treasury bills, etc.)
  • commodities
  • insurance

In each of the above kinds of investments, you can tailor your investments to suit your comfort with risk, your long-term goals and the time (and expertise) that you can spend managing your investments.  I’ll provide you with a brief overview of the types of investments listed.  I will also point you in the direction of where you could start an investing program in that type of investment.

 

Stocks, Mutual Funds, and Commodities

Basically, by buying a stock you become an owner in the company.  If the value of the company goes up, you make money.  That’s called a capital gain.  If the value of the company goes down, you lose money.   That’s called a capital loss.  If the stock pays a dividend (returns some of the profits of the company to you directly), you make money.  A dividend can either be paid out in cash or it can purchase more of the company that you’re invested in directly.

The best overview of how stocks work, that I’ve found, can be found here

A mutual fund is a pool of money that buys investments on the investor’s behalf.  It’s hard, and expensive, to properly diversify a portfolio with a limited amount of funds.  By pooling the money of multiple investors, mutual fund managers can invest in a mix of stocks, bonds, etc. that allow them to meet the goals of the fund.  Some are high risk, some are lower risk, some are focused on certain sectors (oil and gas, precious metals, financial companies, etc.).   They set out their objectives and their investing philosophies in a document called a prospectus.

Instead of buying pieces of a company (stocks) or lending them money (bonds), in some cases, you can invest in units of products.  These are called commodities.  Commodities generally fall into four categories (livestock, metals, energy and agriculture).  Typically, commodities work in opposition to stocks.  If the stock market is going up, commodities prices are falling and vice versa.

 

How do you buy and sell stocks and bonds?

Usually, you need to have an account at a brokerage firm.  Some brokerage firms are full-service, that is to say, they do their own research and help guide your investment decisions.  You can also find discount brokerages that tend to leave you to your own devices when making investment decisions.  Full-Service Brokerages tend to be more expensive to trade with, but you’re paying for their advice as well as the ability to buy and sell stocks.  When choosing a brokerage firm, it is important to consider the cost of a trade commission (the amount that the firm charges you to make a trade), the account minimum (especially when you’re starting out) and how much advice you’ll be needing.

 

If your investment portfolio is going to be self-directed your best bet would probably be a discount brokerage.  Here are a few of my favorites:

 

  • Options House.  $4.95 trade commission.  They don’t offer no-fee mutual funds trading and have limited no-commission exchange traded funds.  They don’t have an account minimum.  They do, however, have a great trading platform, good customer service and solid research at your disposal.

 

  • TD Ameritrade.  $6.95 trade commission.  No minimum account balance.  They have a huge selection of mutual funds and exchange traded funds at their disposal.

 

  • Robinhood.  $0 trade commission.  No minimum account balance.  Little in the way of research available to you, but, if you’re willing to do the research yourself, you can’t beat the price.

 

How do you trade commodities?

 

The easiest way is through a mutual fund or exchange traded fund that deals in commodities, through a broker.

You can, however, invest directly in commodities through a broker as well.

The best ones that I have found are:

 

  • MB Trading
  • TD Ameritrade
  • OptionsXpress
  • TradeStation
  • Generic Trade

Account minimums vary widely as do the costs of each trade.

 

Bonds and Bank Products

Instead of selling pieces of a company (stocks), sometimes that company needs some funds to help pay for an expansion.  They’ll issue bonds.  Bonds are like investors giving a loan to a company.  The investor doesn’t get to own a piece of the company, but they are able to get a return on their investment.  Say that a company needed $1,000,000 to buy a piece of equipment and didn’t have the cash on hand to do it, but that piece of equipment would generate $1,200,000 in profit in the next year.  They could issue a bond that promises to pay investors a fixed amount of money in a year.  They interest rate that they would offer depends on the riskiness of the investment and current market conditions.  Bonds can be bought and sold.  While the price of a bond can fluctuate, the interest rate (coupon) does not.  If the company looks like it isn’t going to be able to pay back the debt, the price of a bond typically drops.  Say that you bought a bond for $100 with the going interest rate of 5%.  It comes due in a year and will pay you $105.  The company has a bad quarter and investors think that they will have trouble paying back the debt.  The price of the bond drops to $90.  That same bond will pay out $105 at the end of the term, giving you an extra $5.  A person buying the bond after the drop would still receive $105, but they only put $90 into the investment.  Effectively, their return is $15 for the same investment.

 

Instead of the financial health of the company falling, say that interest rates fall to 3%.  Investors will see that the effective return of this will be higher relative to similar investments and the price will rise.  The bond will still pay out $105 at the end of the term.  The price will rise to the point that the effective interest rate will be 3% or $101.94 ($105 ÷ 1.03).

 

Because of price fluctuations, there can be a capital gain (or loss) on bonds.

 

Where Can You Buy Bonds?

 

It depends on the kind of bonds that you want to buy.  Treasury bills or savings bonds can be bought through a broker or directly from the government.  

Savings bonds can be bought directly through the government or through brokers, banks or some payroll deduction programs at your workplace.

Bank Products

 

Bank products are things like savings accounts, treasury bills, money market accounts and certificates of deposit (CDs).  They are like bonds in that they pay out interest earnings, but there isn’t a market where the price fluctuates.  Some are liquid (you can get your money back whenever you’d like) and some are not (your deposit is locked in until a set time (CDs)).  Typically, they do not have a competitive rate of return.  They are, however, safe investments that aren’t likely to eat away at your capital.  As the name suggests, these products can be purchased through your bank.

 

Insurance and Annuities

 

Life insurance can come in two forms, term insurance and permanent insurance.  Term insurance is essentially like renting it.  It’s for a fixed amount of time, the premium is what it’s set out to be at the beginning of the term and, if you pass away during the term, it pays out a pre-determined amount to your named beneficiary.

 

Permanent insurance is more like owning insurance.  Like term insurance, there is a premium that’s set out ahead of time and a benefit that is payable to your named beneficiary.  The difference is that permanent insurance can accumulate a cash value, some policies have an investment component that help shelter some money from probate fees upon death.

Because of the complexity of these products, if you are looking to invest in them, speak with a qualified life insurance professional.  

 

Annuities are contracts with life insurance companies.  Essentially, you give the life insurance company a sum of money.  The life insurance company then guarantees you an income from it for a set time, or for the rest of your life.  Since you’re reading an article on investing at a young age, it is doubtful that an annuity would be appropriate for you.  It is important to know that they exist as an option though.

 

My Recommendation

 

There are a lot of various places to invest your money.  My advice to you is to start soon, but do your research.  Figure out where you land on the balance between being an active investor that constantly moves money around to get the highest return possible and making regular contributions and letting a financial services professional handle the question of what goes where, when.  Figure out what your risk tolerance is.  Be careful.  Be prudent.  Set your goals.  Then, work to achieve them.

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