The Easiest Place to Start Investing
By Dr. David Eifrig, editor, Retirement Millionaire
Wednesday, January 15, 2014
It’s one of the most maligned and misunderstood investing vehicles in the market…
Ironically, it’s also one of the most accessible and easy to use.
And when you understand its benefits, it’s an ideal way to quickly diversify your portfolio and begin compounding your capital.
But why is it so misunderstood? And why is it so useful?
Let me explain…
Most people reach a point where they ask the question: “How can I get started investing?” The answer is…
The simplest way to start investing is through something called a “mutual fund.”
A mutual fund is a security that pools the assets of multiple investors and – with the help of a manager – invests the money. The large pool of money makes it easier to invest in several stocks, keeping the portfolio diversified so no one position takes up too much of the capital.
For a simple example, 100 people could invest $1,000 each… leaving the fund with $100,000 in assets. The fund manager could then buy a large basket of stocks. If the manager placed no more than 5% of the portfolio into an individual stock, then $100,000 would be enough to buy 20 or so stocks.
So instead of an individual needing $100,000 on his own to invest, he can pool his resources and invest in an array of securities resources with only 1% of that.
For people who don’t want to pick individual securities or want easy and instant diversification, mutual funds are great places to start. The buying power of pooled money also means better prices on the securities than if you were to try to buy all the individual securities by yourself, having to pay commissions and fees on each transaction.
There are two types of funds – closed-end and open-end funds.
We’ve discussed closed-end funds before, mostly when buying municipal bonds and making other fixed-income investments. Closed-end funds issue a limited number of shares. So the share price can fluctuate based on investor demand. This means that a closed-end fund can trade above or below the value of the fund’s assets – called the net asset value (NAV).
That fluctuation gives us easy opportunities to make money when the price of the shares moves closer to the NAV. Buying closed-end funds for less than NAV is one of my favorite secrets for making money in the markets.
Most mutual funds are open-end funds. This type of fund can issue as many shares as investors want to buy. Because your money is almost immediately invested, open-end funds always trade at their NAV.
Funds invest in just about anything… Others focus on specific strategies or types of investments. For example, some funds hold only blue-chip stocks, some invest in emerging markets, and others specialize in bonds.
Each fund has a charter that it must adhere to. That means a fund can only invest in what’s mentioned in its charter.
Some investors look down on mutual funds. They view them as simplistic options for “little league” investors. I urge you to put aside these prejudices.
Other people say when you invest in mutual funds, your returns are undermined by the fees they charge. This is a legitimate concern… but one you can manage.
When it comes to fees… you need to know the difference between “load” and “no load” funds.
“Load” funds are essentially charging you commission fees. And the charge can range from 3% to 9%. It means that for every $100 you want to invest, the fund takes up to $9 and you’re only investing the other $91. You’d have to make 10% on your investment just to be breakeven.
Don’t ever buy a load mutual fund.
The no-load funds don’t sap your principal this way. Also, research shows that both types of funds have equal returns on your assets, so why start from behind with a load fund?
But you also need to watch annual management advisory fees, which both load and no-load funds charge. When you’re looking for a no-load fund to invest in, stick with ones whose management fees are less than 1%.
The fees also raise another caution about mutual funds… They are not for trading. Mutual funds are designed for investors who intend to hold for a long period of time. If you plan to hold for less than three years, mutual funds aren’t for you.
One problem that often overwhelms folks venturing into mutual funds is the seemingly endless universe of funds. The mutual-fund industry is immense. In the U.S. alone, it totals $13 trillion in assets managed.
Here is the first thing to know that will help you sort through the options… There are “families of funds” – financial firms that specialize in offering investors a variety of funds for investment… Some common names you may have heard include Vanguard, BlackRock, Fidelity, and Invesco. They all offer many different types of funds…
Let’s take a look at Fidelity’s funds… (All of the funds I’ll describe are no-load with low management fees.)
Fidelity manages more than 200 funds: stock funds, bond funds, index funds (which follow a specific index, like the S&P 500), “target” funds (which balance the allocation in the fund based on your age), and many others.
When you buy shares of a fund, a manager uses your money to invest across a wide spectrum of investments depending on the fund’s charter. Fidelity’s website lists the funds depending on your needs.
The simplest way to start is to invest in a so-called balanced fund. Fidelity calls them “asset allocation” funds. The goal of these funds is to be a one-stop shop for investors who want instant access to a diversified portfolio.
This type of fund is comprised of several types of investments, including stocks (from small- to large-cap), bonds, interest-paying money-market accounts, and international investments.
Two simple examples of balanced funds Fidelity offers are the Fidelity Asset Manager 60% Fund (FSANX) and the Fidelity Asset Manager 85% Fund (FAMRX).
You’ll need at least $2,000 to invest in either of them…
But what if you’re starting with something smaller? Say, a small bonus at work, or socking away $25-$50 each month…
In tomorrow’s essay, I’ll explain how to build your own low-cost mutual fund combining the two most important concepts for investing success.
I’ll even share some examples that you can use right now to get started…
Here’s to our health, wealth, and a great retirement,
Dr. David Eifrig