This is the seventh installment of my review of Suze Orman’s The Money Book for the Young, Fabulous & Broke. The previous installment, Retirement Rules, covered the basics of 401(k)s and Roth IRAs.
“You will never truly be powerful in life until you are powerful with your own money” (page 220). What better way to be powerful with your money than to learn how to invest it! Orman is adamant about the fact that, in most cases, you don’t need a financial adviser to invest. Besides, most advisers get paid by commission so they have a selfish motive behind pitching certain plans and options. Let’s buckle down and become acquainted with the basics of investing.
First of all, Orman reminds us that saving is for short term goals while investing is for long term goals. You can’t risk the possible loss of value if you put your money in investments for short term goals. You won’t have time for the value to rebound before you need to withdraw your money. Investments are perfect for funding your retirement accounts; however, since you can let the money ride out the peaks and valleys and be in great shape when you finally need the money in 40 years.
Your options for funding your 401(k) and Roth IRA include mutual funds, stocks, and bonds. Mutual funds are premade packages of diverse stocks. Stocks are shares of a company. You usually only have the option to choose stocks of your own company for a 401(k), but you can choose any stocks for a Roth if it’s set up with a brokerage firm. Bondsare essentially loans you give to corporations or the government. They agree to pay you interest on your money until the bond matures and the principal is returned to you. Bonds are one of the most conservative investing choices available. Orman recommends waiting until you’re much closer to retirement to contribute any money towards them since bond returns aren’t very high. The key to investing is diversifying your money so that you’re taking the least amount of risk. Orman loves and highly recommends mutual funds for this reason.
There are different kinds of mutual funds:
Growth funds: earnings/profits are fast growing
Value funds: the share price is lower than the true value. Investors are waiting for the value to be recognized so they can increase their earnings.
Blend funds: both growth and value stocks are in the same fund
Small cap funds: smaller company stocks where big gains are possible
Mid cap funds: middle sized, faster growing companies that are more stable
Large cap funds: big, established companies that are the least risky
Actively managed funds: a money manager figures out the best investments for the fund
Unmanaged funds: also known as index funds, there is no manager, but instead investments are based on the existing market index (the market index is a number of stocks that represent a slice of the market, such as the Dow Jones)
Unmanaged or index funds have consistently outperformed actively managed funds. A big reason for this is that they have less fees, offering a larger net return for the investor. Orman believes that index funds are the best bet for 20somethings as they are simple and well diversified.
A few things to look for in a fund:
Expense ratio: the annual fees to cover the operating costs. Look for a low ratio in order to get the best returns. The average ratio for an actively managed fund is much higher than an index fund.
Long term performance of fund: how well it has done over the past 3, 5, or 10 years
Fund category: how the fund rates compared to its peers (large cap value, small cap growth, etc.)
Load: the sales commission used to pay the financial adviser. Orman urges never to buy a mutual fund with a load. To find out if a fund is loaded, call up the fund’s customer service and ask.
If you’re confused about which options are available within your 401(k), give HR a call. That’s what they are there for.
Orman explains that consistently contributing small amounts to a fund over time is key to investing success due to the wonders of dollar cost averaging. The price of funds changes over time: when a fund price is lower per share, you buy more funds with the money you contribute; when a fund price is higher per share, you buy less funds with the money you contribute. Buying more shares at a lower cost with steady, small amounts is better than putting all of your money into the market in a one time lump sum because you are taking advantaging of dollar cost averaging, allowing you to buy more shares in the long run. More shares mean higher profits when the price per share rebounds.
Orman offers one last piece of advice: the easiest one stop shopping for funds is a total stock market index fund. It’s the simplest and most diversified option available.
I have absolutely zero experience with investing as I’m yet to have a 401(k) or Roth. One day, and hopefully soon, I will be able to get some experience with mutual funds. I’m planning on sitting down with Jake to see about changing his 401(k) to better match what Orman recommends. Right now, he has a cookie cutter plan that isn’t offering the best returns. I’m really glad that I read this chapter as I knew very little about investing. Now I’m ready to jump in with both feet whenever I can get my hands on a retirement plan.
Next up for my Money Book for YF&B review is how to get the best deal when buying a car.
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