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Beginner’s Guide to Index Funds

Written by Brett McKay

If your goal is attain financial freedom, investing should be part of your plan. If you’re like most people (including me), investing might be intimidating. Investing can require a lot of time and a lot of knowledge.

Thankfully, you don’t need to be a financial genius to receive the benefit from investing in the stock market. All you need to do is invest in index funds.

What are index funds?

Index funds are collective investments that aim to replicate the movements of an index of a specific financial market. Thus, you can have an index fund geared toward the technology sector, international sector, ect. There are even index funds geared to match the S&P 500.

What’s the difference between index funds and mutual funds?

The main difference between index funds and mutual funds is that mutual funds are actively managed and index funds aren’t. Actively managed means a fund manager, using his knowledge of the market, selects stocks and tries to time the market in order to get the best return. Index funds just try to mirror the market.

What are the benefits of index funds over mutual funds?

  1. They have low costs. Because there’s no fund manager tinkering with the fund, index funds have very low costs. Thus, you keep more of the money you earn when investing.
  2. They perform better than most mutual funds. Roughly two thirds of all actively managed funds fail to beat index funds.
  3. They’re low maintenance.

The key to success with index funds is consistency. You have to keep investing in them, even if the market turns sour. If the market takes big hit, keep buying. The market always rebounds and will outperform itself in the long run.

A good index fund that many people suggest buying is Vanguard Total Stock Market Index. The problem is that an initial investment will set you back $3,000. Most students probably don’t have that kind of money to throw around. If you’re not in a position to invest, make it goal to get there as soon as possible.

For more information on index funds check out these great posts from other personal finance bloggers.

What Every Young Person Ought to Know About Starting a Savings Plan

Written by Brett McKay

Over at CnnMoney there’s a great article about starting a savings plan. The author provides three things that everyone person should do to get started on saving for the future.

  1. Sign up for your savings plan at work. Most employers provide a 401(k) plan. Two things make 401(k)’s awesome. First, it makes savings automatic. Second, usually your employer will match a portion of what you put into the plan. If you employer doesn’t offer savings plan, sign up for Roth IRA at your bank. Roth IRAs have significant tax benefits. Withdrawals up to the total of contributions are federal income tax free, and withdrawals of earnings (anything above the total of contributions) are often free of federal income tax. You can invest up to $4,000 a year in an IRA.
  2. Invest smart, but keep it simple. The fancier you try to get the more likely you’re going to lose money. The easiest thing you can do is invest in target retirement funds. These are mutual funds with a mixture of stocks and bonds depending on when you want to retire. When you first start out, the fund has more stocks than bonds. As you get older, the fund shifts to more bonds than stocks, thus making your investments more conservative. You can also try mutual funds. Cannoned offers a list of the 70 best mutual funds on there site. The key with investing is to make it automatic. Set up an automatic deposit with your brokerage firm.
  3. Resist the urge to tinker. Don’t try to beat the market. Today’s hot stock will soon be tomorrow’s big dud. Just stick to simple mutual funds and you’re bound to get a good return on your investment. The author of the article does suggest to “re-balance” your “holdings every year or so by selling shares of funds that have done well and putting the proceeds into ones that have lagged to bring your mix of stocks and bonds back to the appropriate proportions.”

Are you saving too much for your retirement?

Written by Brett McKay

The New York Times has an interesting article about a report showing Americans are saving too much for retirement. According to a small group of economists, all the talk about negative savings rates in America is overstated. They argue that financial companies like Fidelity and Vanguard have an economic incentive to overstate how much people need to save because they earn fees on managing the money. The result it people save more money than what they’ll actually use in retirement. Mr. Kotilkoff, one of the economists, said we “we could end up squandering [our] youth than [our] money.” He suggests not to worry too much about saving because you’re probably already in OK shape.

I’m skeptical. While think that Kotlikof makes a good point about financial companies overstating the amount they save so they can make a profit, I think that’s a stronger argument for taking care of your own investment portfolio than the argument that Americans are saving too much. Even if I don’t use all my money during retirement, I think it would be nice to leave some for my posterity. Plus, my personality type is the laborious ant-working and saving in order to be prepared for the worst case scenario- as opposed to the grasshopper. The report is something to think about. However, I’ll keep socking my money away.

Should you pay off your debts or invest?

Written by Brett McKay

I’ve heard two answers to this question. Like one commenter, many people say you should not invest until you have paid off all you debt. Others say it depends.

According to this article on about.com, one should ask two questions before deciding to pay off their loans or to invest.

1. What is the rate of after-tax interest you are paying on your debt?
2. What is the after-tax rate of return you expect to earn on your investments?

If you your return rate for investments is higher than your interest rate on your student loans, you’ll be better off lengthening your payment on student loans and investing. Think about it.

Let’s say you decide to not invest and pay off your student loans. Depending on your salary, it might take you years to pay it off. During those years of paying off loans, you missed out on high investment returns where some of that money could have been working for you.

I’m not in that big of a hurry to pay off my student loans because we have the rate locked in at a low 4.25%. But additionally, the interest on student loans can be written off on taxes. So, in some weird way I’ll actually save money by having loans. The money that I save can be used to pay down my loans even more.

If most of my debt consisted of high interest consumer debt, then I agree that I have no business investing until I had paid it off. However, Mrs. FLS and I avoid using our credit card like the plague, so we don’t have any high interest debt.

My plan is to pay a reasonable amount each month towards my student loans. However, at the same time I plan on investing 10% of my income. That way, I’ll not only be working off the loans, I’ll be putting my money to work.

If the news says a stock is hot it’s probably too late to invest

Written by Brett McKay

One of the steps I’m taking to mitigate my debt is investing. Currently, I have several mutual funds with American Funds.

However, this summer, I decided to graduate from investing into mutual funds to individual stocks. I did some research. I read the financial magazines and watched CNBC. They all seemed to be in agreement that gold was the thing to invest in.

So, being the investment novice that I was and still am, I opened up an E-trade account, and invested $500 in gold.

Well, as soon as I bought my shares, gold started plunging in value. I didn’t sell, though. I thought if I toughed it out, then maybe it would rebound soon. It never did. I sold after three months and took a hit of $100.

Lesson: It’s good to research when investing. But if commentators say a stock is hot, it’s probably too late to invest in it. Just stick to fundamentals when investing.