Investing 101 For Millennials : The Basics

Please understand this: There are SO many different investment vehicles to put your money into that I would have to write 3 books about it instead of a post to cover it all. I am giving you the bare bones in the hopes that it will convince you to start researching more.

The key to investing is literally to get started early. Use the time that you have left in life to your advantage so that you can be wealthy later on!

I have put three indicators underneath each option that will give you a general idea of how risky the investment is, how much that particular investment is diversified (which also limits your inherent risk), and what level of fees you will have to pay to use the investment vehicle.

Red = Bad.  Orange = Meh.  Green = Money!

I hope you like my color system, as it helps my fifth-grade mind understand these options more clearly.

Also – just because something is considered risky doesn’t mean you shouldn’t choose it as an investment vehicle. It’s all about knowing your risk tolerance and fully understanding whichever strategy you choose.

Here are 5 of the many options that you have as a millennial to get started with investing:

Stocks

Risk: High to Moderate

Diversification: Low

Fees: Low

Stocks – “Security that signifies ownership in a corporation and represents a claim on the part of the corporations assets and earnings”.

Most people have a basic understanding of what your run of the mill stock (or commonly called share or equity) is. You are basically buying a small part of the company with each share, and you want the value of the share to increase over time.

Here is what you need to know:

– Individual stocks have a moderate to high risk rate because they are not diversified. When you buy a share of an individual company you are subjected to the risk that the company may underperform, the stock market may drop, or any other number of factors will cause your stock to lose value.

– Some stocks are more risky than others. Established brands like Coca-cola, Chevron, Apple and similar companies tend to have a history over the years of performing well and making their investors money over a long period of time. These are called Blue Chip Stocks. They are the big boys of the stock world and are generally considered less risky than small companies without a history of being profitable. Small non-established companies are often considered speculative investments and can be more risky than blue chip equities.

– You have to go through a broker to purchase stock. Think Schwab, Etrade, Scottrade, etc. This means that you have to open a brokerage account and order the stocks through the company that you choose. Because the brokerage industry is very competitive and is largely accessible online, fees are low and can be as little as $7 – $10 per transaction or even less with some online brokerages.

– There are many different investment strategies for stocks, as well as ways to evaluate the quality. Debt/Equity (D/E) ratio, Price/Earning (P/E) ratio, and the Beta are a few indicators used.

– Also, because you manage your own stock in your brokerage account there are no fees needed for a fund manager like other investment options I will explain later in the post. Keep reading for more!

Exchange Traded Funds (ETF)

Risk: High to Low

Diversification: High

Fees: Low to Moderate

ETF – “An Exchange Traded Fund is a “marketable” security that tracks an index, a commodity, bonds or basket of assets like an index fund.”

ETF’s are very popular in the investment world because of their high diversification and variety of investing options.

Here is what you need to know:

– ETFs trade like stocks in your brokerage account similar to stock trading described above.

– For taxes, ETFs are fairly efficient compared to other diversified investment options such as mutual funds that I will explain below. There is no fund manager for ETFs and less transactions within the ETF than many other diversified investment options. This means less transactions that could be subject to capital gains taxes!

– For the same reason as stated above, ETFs can have very low fees compared to a Mutual Fund.

– There are MANY different types of ETFs. They can shadow markets like the DOW or S&P500, or follow different sectors like energy or biotech. The ETF will ebb and flow as these markets and sectors do because they are invested across their respective category.

– Because there are a range of investment options you can choose your level of risk. The plus side is that you are diversified in whatever investment area you choose, which is good.

Mutual Funds

Risk: High to Low

Diversification: High

Fees: Moderate

Mutual Funds – “An investment vehicle that is made up of a pool of money collected from many investors for the purpose of investing in securities such as stocks, bonds, money market instruments and similar assets.”

Mutual funds are an extremely popular investment vehicle, and specialize in providing strong diversification across different sectors. There several different types of Mutual Funds, I am going to focus on Actively Managed Funds for this post.

Here is what you need to know:

– Actively managed: Managed actively by fund managers. Investors are essentially paying the fund manager to select investments. Managers try to outperform the sector that they are investing in rather than shadow them like an ETF.

– Mutual Funds can be less tax efficient than ETFs because there are many transactions needed to manage the accounts. These transactions are subject to capital gain taxes.

– Because Mutual Funds utilize a fund manager, fees are higher than a non-managed investment vehicle.

– There are a large range of investment options across different types of mutual funds similar to an ETF.

– There are mutual funds that actually invest in other mutual funds (weird right?).

– Many brokerages offer their own Mutual Funds, which may have less fees.

– Mutual Funds often have higher required balances than ETF’s.

Bond Funds

Risk: Moderate to Low

Diversification: Moderate

Fees: Moderate to Low

Bond Fund – “Fund that invests in bonds or other debt securities.”

A bond is a debt-investment where the investor loans money to a borrower for a certain amount of time and is repaid with interest. Check out my previous bond post for more information!

Here is what you need to know:

– Bond funds are managed in a similar way to an actively managed mutual fund with a dedicated manager. This management brings on extra fees that the investor should consider before investment.

– Individual bonds are generally sold at the maturation date, but Bond Fund managers can sell the bonds before their maturation dates and reinvest the funds.

– Interest rates have a MAJOR effect on Bond Funds. A raised interest rate by the fed can significantly lower your asset value in a Bond Fund. Just FYI, the FED will raise interest rates slightly later on in the year.

– Bonds are generally seen as a safe investment, but Bond Funds can carry more risk than individual bonds.

– Bond Funds are often used for monthly income, whereas a stock can provide income through quarterly dividend payments.

Money Market Accounts

Risk: Low

Diversification: Low

Fees: Low

Money Market Accounts – “An interest-bearing account that typically pays a higher interest rate than a savings account, and which provides the account holder with limited check-writing ability.”

Money market accounts are a good option for someone who doesn’t want to jump in to investing yet, but wants a slightly better return on their money than a savings account through a bank. There are also Money Market Funds, which are different than a Money Market Account. I will be focusing on the Money Market Account in this post.

Here is what you need to know:

– This is seen as one of the safest investments, but produces a low return compared to the other investment vehicles in this post.

– Investment capital that is held in a Money Market Account is FDIC insured up to $250,000, but Money Market Fund capital is NOT insured.

– Provides some limited check writing ability out of the account.

– Funds are invested by banks in low risk vehicles like debt securities with short maturities or certificates of deposit.

Now it’s your turn. Go learn stuff.

Again, I can’t emphasize enough how many different options there are for investments. The summaries above only scratch the surface! I will provide all of my sources at the end of the article. Do yourself a favor and look deeper into these investment vehicles. The most important thing is that you get started while you have time!

One thing I have learned about investors is that they all have a strategy that works for them, and they will gladly share their information with you! (Even if you don’t want to hear it).