It's never too early to start squirreling away your newfound salary. Find answers to your most pressing questions about investing, then learn about three funds you should check out before you can say 'year-end bonus.'
Eva-Marie Cusack is a 30-year-old first-year associate at LeBoeuf, Lamb, Greene & MacRae in New York City. It's no secret that she earns a base salary of $125,000 plus a year-end bonus-that's what all first-years at LeBoeuf take home. But when it comes to knowing how to invest her tidy new income, Cusack, like a lot of other young lawyers-well, she ain't no Warren Buffett. "All the money I've made from the small amount of investing I've done has been a total accident," she says. Somewhere, Warren weeps.
Enter Karen Altfest. A New York-based financial adviser, Altfest counsels young lawyers and other newly minted professionals on how to turn their money into ... more money.
Why worry so soon about saving? Do the math, says Altfest, whose clients include partners and associates at some of the country's biggest law firms, and the answer is obvious. Let's say Cusack immediately begins saving 10 percent of her $125,000 base salary, or $12,500, per year. She saves that sum every year for ten years, socking away $125,000. After that, she never saves another penny. Assuming she earns 8 percent annually on her savings, she'll end up with roughly $1.3 million by age 65 (not factoring in for taxes).
Now let's say Cusack doesn't start saving until age 40. She then saves $12,500 a year for the next twenty-five years-a total of $312,500. Assuming the same 8 percent rate of return, she'll amass just over $900,000, even though she saved two and a half times as much in the second example. Sold? Good. Read on for answers to beginning investors' most frequently asked questions.
Q: How much should I invest?
Altfest suggests you save at least 10 percent of your annual earnings. The critical thing, she says, is that you set up an automatic-savings plan (such plans transfer a fixed sum, often as little as $25 or $50, from your checking account into a bank or brokerage account or a mutual fund once or twice a month). "Like many promises, resolutions to save on a regular basis aren't worth much unless they're backed up by a contract," says Altfest. "I know of hardly anyone disciplined enough to save without putting an automatic system in place." Automatic-savings plans are easy to come by: Just ask a bank, a broker or another financial-services firm for an application. Investing a fixed sum at regular intervals (also known as dollar cost averaging) has an added advantage: Over time, the average price you pay for shares of a stock or a mutual fund is apt to be lower than it would be if you invested at random.
Q: What, exactly, should I invest in?
In short, stocks, bonds and mutual funds. Bonds provide somewhat higher potential returns than cash investments such as money-market funds. But stocks and stock-based mutual funds should be your mainstay. According to the consulting firm Ibbotson Associates, stocks have gained roughly 13 percent annually during the past fifty years, versus around 6 percent for intermediate-term bonds and 5 percent for stable cash investments. "Stocks or stock funds are by far the best way to keep ahead of inflation," says Altfest.
If you're a do-it-yourself type, you might choose to assemble a portfolio of individual stocks and bonds with the help of a broker. The trouble is, you may have to pay commissions or other fees that could take a sizable bite out of your returns, especially on a small portfolio.
Instead, most beginning investors should focus on mutual funds, which pool cash from large groups of investors to purchase stocks, bonds or other investments. In exchange for minimum investments of about $1,000 to $3,000 (or $25 or $50 a month for automatic-investment plans), mutual funds offer a nice mix of professional management (the best ones are run by seasoned pros with established track records), low costs (annual fees typically are about 1 percent of your investment) and liquidity (you can sell your shares at any time). If popularity is any gauge, then mutual funds are a mighty fine idea: A total of $7 trillion is currently invested in U.S. mutual funds, up from $1 trillion since 1990.
Q: What kind of mutual funds should I invest in?
The number-one goal is to follow the rule of diversification, says Altfest. Instead of picking just one fund, build a portfolio of five or six, each from a different sector. What sectors you choose depends on how aggressive you want to be. Generally speaking, you want to be more aggressive when you're younger, less when you're older. The younger you are, the easier it is to ride out short-term dips and let the historically upward long-term curve of the market kick in. Let's assume you've got forty or more years of investing ahead of you and you have a moderate tolerance for risk (you're no money-under-the-mattress grandma, but you're no Black-Scholes option-valuation formula expert, either). Altfest suggests you consider the following categories:
Small-company (or "small-cap") funds: These funds invest in shares of emerging companies that carry considerable risk, as well as the potential for outsized rewards. As such, they're ideal for young investors.
Large-company (or "large-cap") funds: Shares of big blue-chip firms can serve as an anchor for your portfolio. And many blue chips offer the potential for exceptional growth in the global economy, in which sheer financial strength can create opportunities.
International funds: Overseas markets account for about half the world's stock market wealth. Young investors should consider a fund that includes shares of stocks from emerging markets. Those markets can be volatile, but rapid economic growth in developing countries can lead to exceptional long-term returns.
With more than 10,000 mutual funds on the market, how do you choose? Altfest recommends looking for funds that consistently outperform other funds with similar objectives, without taking on additional risk. And avoid funds with high expenses, she says (the average annual fee for stock funds is 1.44 percent). Visit Morningstar (www.morningstar.com), a leading independent fund research site, to find funds that meet such criteria. Or check out the box below.
This article is for informational purposes only. It is not intended as a recommendation to buy or sell stocks. Please don't sue.
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