Help a financial NOOB!

[Rock&Roll Ninja]

Hi, I'm poor But I'd like to change that.

Can anbody explain how I would go about building a (small) portfolio with a limited initial investment (maybe $500), followed by small monthly amounts (say $100).

I know its not much, but I assume anything is better than nothing, especially after a few years.

 

[audiorookie]

You can try selling cheap speakers out of a white van on the street lol

 

[Seth=L]

Yes, and don't forget a baseball bat.

 

[MDS]

Mutual Fund companies like Vanguard and T. Rowe Price have many funds with initial investments of $1,000 and minimum investments of $50. I'm sure there are a few others that may have a fund or two with initial investments of $500 but don't pick a fund just because its initial investment is low - managment expenses are the key factor over the long term because high expenses eat into your return.

If you are just starting, your first fund should be a broadly diversified index fund with low expenses. Vanguard has the lowest expense ratio funds of any company. Which type of fund depends on your risk tolerance and time horizon. You could start with something like the Total Stock Market Index or for lower risk (and lower returns) one of their Balanced Index Funds. If this is for retirement you want an IRA (Roth or traditional depends on your income) and a good choice for a core fund is one of the target retirement funds. Target funds automatically adjust the ratio of stocks to bonds in the fund over time, becoming more conservative (more bonds, fewer stocks) as the target date approaches.

If you don't yet have $1K to start the fund, add whatever you can to a savings account until you reach that amount and then buy the fund. There is a wealth of free financial info on the web and it would be a good idea to start reading; in fact the websites of the fund companies I named are a good place to start.

 

[xboxweasel]

Mutuals are the way to go. Try sticking with dividend mutuals funds. They invest in banks and insurance companies. And we all know those will always make money, therefor the mutual fund should always be doing okay. Try talking to a financial advisor (at banks or private investment companies). I don't remember the term, but the company I invest with has no fees for buying or selling. However, they take their cut of the top. The value you see for the fund's performance is what you get.

Keep in mind that mutuals are more for the long term. 10 years or so.

Banks will set you up in an investment portfolio based on your knowledge and comfort level. Then you can make automatic contributions (weekly, biweekly, monthly, whatever is offered) to make your investment grow. Also, my making frequent small contributions you average out your $/unit figure. Because you might be buying when the cost/unit is low versus making one lump sum payment and buying at a higher cost/unit.

A good book to read is "The automatic millionaire" by David Bach. It's a little wordy in what it is trying to say. But if you stick with it you can save up a pretty large sum of money. It just takes dedication and a little time.

Good luck.

 

[Rock&Roll Ninja]

I'm going to reinvest any rebates/dividends back into the fund company. I'd like to be able to buy a real nice house by age 40.

In addition to the $100/month, I'm also planning on Christams bonuses, tax returns, and my settlement from my motorcycle accident. So it'll be 100/month minimum after the inital buy-in.

 

[annunaki]

A solid fund is a good way to start. I would suggest reading the book "The Intelligent Investor" by Benjamin Graham. He was last century's single greatest investor. Warren Buffet adheres to many of his principles. As the market dip in 2001 proved even portfolio managers for mutual funds can make bad decisions and buy into hype. Like audio, do your homework and educate yourself.

 

[Sheep]

My dad is a Financial Planner, would you like to be a client?

SheepStar

 

[MDS]

I'm going to reinvest any rebates/dividends back into the fund company. I'd like to be able to buy a real nice house by age 40.

In addition to the $100/month, I'm also planning on Christams bonuses, tax returns, and my settlement from my motorcycle accident. So it'll be 100/month minimum after the inital buy-in.

If the purpose of this investment is a near-term goal like buying a house, you want something lower on the risk scale than you would if it were a longer term investment.

Everyone should have a short term emergency fund equal to at least 6 months living expenses placed in a 'risk free' investment (money market mutual funds, treasury bills, CDs, etc), a medium term investment for goals like buying a house, and of course long term investments for retirement.

I know it's hard initially to fund all of those investments but it can be done over time. The most important variable in finance is time. Start early and life is much easier (financially at least) as you get older.

Be sure to set up automatic investment for your monthly contribution. Nearly all fund companies offer it for free. You just provide them with an account number and they automatically make ACH transfers from that account to your mutual fund account on the date each month that you specify.

 

[mtrycrafts]

Hi, I'm poor But I'd like to change that.

Can anbody explain how I would go about building a (small) portfolio with a limited initial investment (maybe $500), followed by small monthly amounts (say $100).

I know its not much, but I assume anything is better than nothing, especially after a few years.

MDS has some great points to pass on.

Is this also a retirement fund? Do you have one of those? You should. Also, don't forget the power of compound interest over time.

 

[Nick250]

Common Sense on Mutual Funds

You will want to read Common Sense on Mutual Funds by John Bogle.
http://www.amazon.com/Common-Sense-Mutual-Funds-Imperatives/dp/0471392286

He is the father of Mutual Funds (founding Vanguard) arising out of a graduate thesis he did at Princeton way back when. It's the bible for the savvy small investors. My biggest holding for long term retirement money is the Vanguard Whole Market fund. VTSMX is the symbol. It is very conservative with very small fees and basicly is instep with the market as a whole. If you are going to use the money in the next five years, then Cd's T-Bills or money market funds (paying around 5% at the moment) are the way to go IMO.

Max out all retirement investments, IRA and/or 401Ks at work. Invest as much as you can when you are young, then let time and compounding grow your retirement nest egg. Also, I agree with everything MDS said, good stuff.

Nick

 

[Audioholics]

I feel pretty strongly about financial freedom and actually teach a class on it from time to time. Here are some basic suggestions (not my original ideas) for anyone looking to make smart financial decisions in their lives:

Overview of financial life:

• DO NOT LIVE ABOVE YOUR MEANS. If you can't afford to pay for it in cash, don't buy it. This includes cars, but does not include houses (more on that later). I live by this rule.
  
• DON'T try to keep up with the Joneses... They're just trying to keep up with the Smiths anyway.
  
• If you're in debt - get out quick and NEVER get back in.

Specific steps (whether you are in debt or not):

1) Accumulate $1,000 to start an emergency fund. Put this into a savings account and don't touch it unless you need it to avoid going into debt. This needs to happen ASAP, even if you have massive debt - otherwise you'll have car trouble and fall off the horse when you're trying to do step #2.

2) Pay off all debt using the "debt snowball". This is a simple theory. Say you have 4 debts:

- Debt 1, a $250/month car payment ($12,000 balance)
- Debt 2, a $350/month student loan ($4,000 balance)
- Debt 3, a $450/month credit card payment ($11,250 blance)
- Debt 4, a $700/month house payment ($96,000 balance)

You take the lowest debt BALANCE - in this case your student loan - and pay it off as fast as you can. Get an extra job, throw more money at it, whatever... Just work on that until it's done... You pick the lowest balance (as opposed to the highest interest rate) because we want to see quick results. IGNORE interest rates. Pay off the lowest balance first.

When it is paid off. DO NOT CELEBRATE. DO NOT GO OUT FOR A STEAK DINNER... Now, take this newfound $350/month and PAY DOWN THE NEXT SMALLEST LOAN (in this case the credit card). Instead of paying $450/month on it, you'll be dumping $800/month onto it. It will dissipate much more rapidly...

When that's done, DON'T CELEBRATE... take the extra $250 + $450 and pay down the next loan (Student loan). Instead of paying the minimum $350, you'll be dumping $1050 on it per month (how long will that take to pay that off - not long). Keep going until all your debts are done...

Wait to pay off the house until some other goals (below) have been met.

3) Put away three to six months of expenses into a savings account (we do six). This will keep you from going back into debt should you lose your job. NOBODY'S job is secure, so take this to heart.

4) Once you've done EVERYTHING ABOVE - you are ready to invest 15% of household income into Roth IRAs and pre-tax retirement. If you have an employer who matches 401k contributions, do that first (it's free money). After that do Roth IRAs.

5) After you are doing all this, put additional money towards college funding for your children. 529 plans are excellent for this.

6) NOW you are ready to pay off your home early. Think about this - how much would you have to work if you were completely debt free including your home? You could basically work part time and still make a decent living - all you'd have to pay for is food, clothing and taxes.

7) Build wealth and give it away! Once you're debt free you can really start to zero in on people who are less fortunate than you and help them out. This is a great opportunity and if more people weren't willing to get into so much debt we might be able to knock out some real problems in our society.

That's my $0.02.

 

[MDS]

• DO NOT LIVE ABOVE YOUR MEANS. If you can't afford to pay for it in cash, don't buy it. This includes cars, but does not include houses (more on that later). I live by this rule.
  
• DON'T try to keep up with the Joneses... They're just trying to keep up with the Smiths anyway.
  
• If you're in debt - get out quick and NEVER get back in.

Absolutely excellent advice. I live by the same rules and I've been debt free since 1998.

My favorite quote is from my friend and co-worker J. Jones: 'I am a Jones and I don't try to keep up with them'. If you live beneath your means, those means get larger and larger every year.

 

[gnagel]

NOW you are ready to pay off your home early. Think about this - how much would you have to work if you were completely debt free including your home? You could basically work part time and still make a decent living - all you'd have to pay for is food, clothing and taxes.

Your advice about living within your means is outstanding!

If you start saving early in life, the power of compounding over the years is astounding. My approach was to lock my budget in based upon how much money I earned early on in my career.

As I continued to advance in my career and earn more money, I used the excess to pay off all debts (including my mortgage). While other employees were buying bigger houses and cars, I was paying off my existing house as quickly as possible. I owned the house by the time I was 35.

Without a mortgage payment, my budget requirements really dropped! I now work on a few projects now and then out of my home office. By age 40, I was financially independent---working only when I want to and doing the things I wish to with my time (coaching youth sports, golfing, backpacking, etc.).

On the other hand, my friends who decided to purchase the bigger houses and cars are still working long hours to pay off those items. I happen to value my time more than those possessions. And, with the compounding of invested money, you can have both your time and your possessions.

Bottom line---start saving as early as possible and live within your means.

 

[Nick250]

A lot of good stuff from Clint. I have some comments and questions. After reading my inertial response to Clints post, it is more clear that the "snowball effect" is the prime directive ahead of strict dollars and cents in Clint's strategy. Am I correct Clint? My comments are dollar and cents suggestions that offer some different options that could be mixed with Clints suggestions. It's not one size fits all.

You take the lowest debt BALANCE - in this case your student loan - and pay it off as fast as you can. Get an extra job, throw more money at it, whatever... Just work on that until it's done... You pick the lowest balance (*** opposed to the highest interest rate) because we want to see quick results. IGNORE interest rates. Pay off the lowest balance first.

Why ignore interest rates when selecting which loan to pay off first? Or are you suggesting that clearing out the smaller loans to build momentum and the put the "snow ball effect" into play even though someone (me in this case) could argue against it in a strict dollars and cents model.

Car loans are a different beast. They are usually front loaded so you pay off a disproportionate amount of interest early on in the loan. The car lenders (even your own bank in most cases) use a different formula as contrasted with "simple interest" as found in a home loan or a credit card balance. Best bet is not to borrow to buy a car, but if you are half way through one it usually does not make strict economic sense to pay it off early.

Wait to pay off the house until some other goals (below) have been met.

3) Put away three to six months of expenses into a savings account (we do six). This will keep you from going back into debt should you lose your job. NOBODY'S job is secure, so take this to heart.

4) Once you've done EVERYTHING ABOVE - you are ready to invest 15% of household income into Roth IRAs and pre-tax retirement. If you have an employer who matches 401k contributions, do that first (it's free money). After that do Roth IRAs.

As I mentioned above, it makes more sense to me pay off the high interest loans first and then once they are gone to always max out 401ks and Roth IRAs year in and year out.

5) After you are doing all this, put additional money towards college funding for your children. 529 plans are excellent for this.

6) NOW you are ready to pay off your home early. Think about this - how much would you have to work if you were completely debt free including your home? You could basically work part time and still make a decent living - all you'd have to pay for is food, clothing and taxes.

I agree about paying off your home early unless interest rates go higher than they are now and you are able to invest in for higher yield than the mortgage carries. Tax consequences will also play in this assessment. That being said, I think it doubtful interest rates will go up anytime soon. The economy is slow and I think Bernanke is more likely to keep the fed funds rate as they are now, or even lower them 25 to 50 basis points over the next twelve months.

7) Build wealth and give it away! Once you're debt free you can really start to zero in on people who are less fortunate than you and help them out. This is a great opportunity and if more people weren't willing to get into so much debt we might be able to knock out some real problems in our society.

And if you don't have the funds to donate, do volunteer work! I do volunteer work about 20 hours a week at a local hospital and it adds to my quality of life in a way money can not. Don't misunderstand me, being well off and volunteering both would be just fine with me.

Nick

 

[BMXTRIX]

You know, why not call some local investment places like Smith Barney and ask to setup an appointment with a Certified Financial Planner.

While you may not have that much to invest right now, you can get a good idea of what fees you may encounter and you will be speaking with a professional about your goals. He will be able to give you some advice on what products are available and what may make the most sense for your specific needs at this particular point in your life.

My brother is a CFP and one of the things he points out is that a home loan is one of the cheapest ways to get money in the wolrd. If you actually do the math, if you invest your extra money, instead of putting it towards your mortgage payments, you will be far better off in the long run than if you pay down your loan. That's 7% interest vs. 12% return we are talking about.

Likewise, the psychological benefit of paying off a student loan makes a lot of sense. But, not if the student loan is 4% while your credit cards are 15% or more on interest. Debt is clearly one of the things to avoid, but certain types of debt may lead to better rewards down the road - especially things like mortgages which have incredibly low rates comparitavely.

But - I'm not expert for sure and talking to a CFP makes a lot of sense. But, be sure to get info on what fees you should expect to pay and how many places are out there which may have lower fees/higher returns for your dollar.

 

[MDS]

Car loans are a different beast. They are usually front loaded so you pay off a disproportionate amount of interest early on in the loan. The car lenders (even your own bank in most cases) use a different formula as contrasted with "simple interest" as found in a home loan or a credit card balance. Best bet is not to borrow to buy a car, but if you are half way through one it usually does not make strict economic sense to pay it off early.

A lot of lenders call it 'simple interest' but it is not in a strict sense. Simple interest is simple - if you borrow $12,000 for 12 months at 12% interest your total repayment would be $13,440 and your payment each month would be $13,440/12 but that's not actually how it works.

The way it reallly works is they calculate the total amortized cost of the loan over the repayment period to determine your monthly payment - the same way a mortgage is calculated. This is the A/P factor ('A given P'; ie what A or annual payment it takes to pay off the principal P over the repayment period at the given interest rate). From memory because my calculator battery is now dead and I have to reprogram it, the formula is ((1+I)^N)/((1+I)^N-1). Naturally if your payments are monthly, N has to be in months and I has to be divided by 12 to get a monthly interest rate.

Now here is why they get away with calling it simple interest:
Your payment is the true amortized cost per the above formula BUT it is calculated each month. So using the above example of $12,000 at 12% for 1 year: the loan ages for 1 month and your balance is now $12,120 (the starting $12,000 + 1% of $12,000). Now you subtract the payment and that is your balance for the next month which will again be charged 1% and the payment subtracted. If you pay it off after 2 months, you don't pay the fully capitalized cost of the loan because you won't pay 10 months worth of interest.

It is in your best interest to pay it off early to save interest charges but it is definitely NOT 'simple interest'.

 

[MDS]

My brother is a CFP and one of the things he points out is that a home loan is one of the cheapest ways to get money in the wolrd. If you actually do the math, if you invest your extra money, instead of putting it towards your mortgage payments, you will be far better off in the long run than if you pay down your loan. That's 7% interest vs. 12% return we are talking about.

I think he simplified things a bit and I'm sure being a CFP he is fully aware of all the little issues that were glossed over.

First to make the determination whether it is better to keep your money and invest it vs use it to pay off the mortgage, you have to use the 'risk free' rate of return. The only things considered risk free are short term fixed income investments (not bonds as they carry interest rate risk - as rates rise, bond prices fall and vice versa). It's easy to say you could earn 12% in a stock or mutual fund investment but they are not risk free by any means and you could easily lose money over the time horizon of the mortgage.

Fixed income investments are taxed at ordinary income rates. If you are in the 28% tax bracket and your mortgage interest is 7%, you have to earn 7% / (1 - .28) = 9.7% to BREAK EVEN. Is it so simple to earn 9.7% interest risk free - not at all!

Now if you feel like taking on risk to earn more than 9.7% and can deal with the potential for loss, then so be it, but if things don't go your way you will be in the hole. You also need to figure in property taxes and the deduction from income taxes you get for paying property taxes, so it really isn't so simple.

Note that I am NOT a financial professional but I took Engineering Economy (Finance for Engineers) in grad school and I have been hooked on finance ever since. I read the financial news every single day and have a very good grasp on how things work. I opted not to pay cash for my house precisely due to the above kind of calculations - instead I put 50% down and whack the mortgage every month so the repayment period will be no longer than 5 years. After all you have to play the credit game a little bit...but I play using MY rules - I pay next to nothing in interest (and ZERO on credit cards or other revolving debt).

 

[MDS]

Sorry to bombard you all with this stuff, but I thought I would mention one simple rule that I think everyone should know (I like this stuff almost as much as I like audio). It is called the 'Rule of 72' (not to be confused with the rule of 72 that allows lenders to charge you the fully amortized cost of a loan even if you pay it off early - NEVER accept terms like that).

The Rule of 72 is a simple shorthand to calculate either the interest rate or the time required to double your money.

If you know your interest rate is 8% annually, it will take 72/8 = 9 years to double your money; likewise if you want to know what rate of return you need to earn to double your money in 9 years it is 72/9 = 8%.

For all those that think a house is always a great investment, consider this: If you borrow $200,000 at 6% and pay it per the terms over 30 years you will pay over $200,000 in interest (which is double+ the amount you borrowed). Using the rule of 72, we can calculate that the house has to appreciate 72/30 = 2.4% per year for you to BREAK EVEN. Over the long term (forget about the current housing bubble) homes appreciate roughly at the same rate as inflation, which tends to average 2.5% per year over the long term. So your stellar 'investment' may yield absolutely nothing over a 30 year term. Figure in property taxes, maintenance, et al and things look even worse.

A home is a place to live and in reality for most people is the biggest liability you will ever have - not necessarily the sure path to riches that the simpletons make it out to be. Food for thought from your local cynic that crunches the numbers instead of going along with the crowd.

 

[mtrycrafts]

If you start saving early in life, the power of compounding over the years is astounding.
.

That is a great idea. But, one has to stumble on this early in life. Where does that come from? Parents? Not if they are in debt, or living beyond their means, pay check to pay check, or worse.

School? Hardly, or little advice, once and forgotten. So, it is one of those hit or miss propositions, unfortunately.
The marketeers have done a great job of convincing, must have everything now and the latest and greatest.
Everything is stacked against most of us.