I thought I'd share my decisions about investing with you in the hope that it helps you make your own. Many of you are just getting into work, and will have money to spare. What you do with it will determine your life in years to come. It is important, so please take the time to consider your own plans now.
Before you get bored by my post, some useful sites you should open and read first:
* The Motley Fool - sadly grown more commercial over time, but they don't spam, just sign up, go to the home page and then look at the investing and personal finance sections on the left. Read them through carefully and you will get a great basic understanding of how things work. Pay less attention to the news commentary.
* I Will Teach You To Be Rich - scroll right to the bottom and start reading up, it's a goldmine for just about everyone (and in any country)
* Morningstar is probably the best place to go to look up information on individual stocks. It also has some good retirement and general advice columns.
You really want to read them first - particularly the Motley Fool - as it will help you understand what I'm talking about later.
Now, firstly, I'm afraid that a lot of the specific advice I'm giving is only useful to those in the US. However, the principles on which I made my decisions are effective just about everywhere.
Secondly, I'm not an official adviser. Don't blame me if things go wrong. Do your own research as well. It took me a bit of time to learn this stuff - probably about a week or two in total if I had just sat down and researched it - but it is very much worth it. :-)
Thirdly, these allocations apply to my specific circumstances. I have relatively high income and relatively few expenses. I can afford to save a lot. Getting to that point would be another post in itself, but put it this way - stay in school, and don't be afraid to be a geek if you like it.
You may not be able to afford it so much - but if you do have a regular income I suspect you can afford to save more than you might think. There's a whole lot to say about trying to reduce your outgoings, but if you're doing things like buying new clothes every month or eating out nightly, you're probably wasting money. Look at exactly where your money goes, and ask yourself if you need to be spending it. Look at what your employer is offering. If they have a 401k or SIMPLE IRA, for example, you're just leaving money on the table if you don't invest, as they'll match your investments with their own money to a certain proportion of your wages.
So - where do I keep my money? There are basically five places:
* My current bank account. I am trying to keep as little money in my bank account as possible - maybe $1000 to $2000 - as it earns no interest there (which effectively loses you money, given that inflation - the increasing price of goods and services - is around 3-4% a year). Your bank account should be for immediate needs within the next month or so.
* My money market fund. This is a mutual fund (an organization that manages money from lots of people) which invests in short-term loans. These loans are offered by the government (both national and local) and public and private companies, in increasing - but generally still very small - levels of risk and reward. I am trying to keep a reserve fund of several months pay in here, so that I can pay for things if something bad happens, like losing my job, or needing a car now. Earnings are taxable, though possibly at a lower rate than a normal bank account.
** Money market deposit/savings accounts are also available from people like ING Direct and HSBC. You may find that they provide a more convenient service for you. This is especially true if you do not have a large amount to start the account off with - most funds require $1000 or more. I am investing in funds because it is easier for me to manage everything in one place, easier to transfer money between funds, and as a foreign national it is more difficult for me to get one of those accounts. Be aware that banks may decide to lower promotional saving rates later on. You also get interest, which is almost always taxed higher than the dividends you get from a fund.
* My regular stock fund. I don't actually have any money in this yet, for reasons I'll explain later, but it is planned out. This is for money that I have left over after the other parts are filled up. It is intended for fairly long-term storage, but it is likely to get used eventually. Earnings here are taxable, too, but at the lower capital gains rate.
* My 401k. A 401k - or, technically, 401(k) - is a tax-advantaged retirement savings account that is paid for by earned income. Money I put into my 401k is deducted from my paycheck. I pay no taxes on that money now, and none as it grows, only when it is withdrawn. I can save up to $15,000 this year, and will shortly be reaching that limit. The limit rises with inflation. The money is intended to be withdrawn only after 59 1/2 and is subject to penalties if not used in that way.
** There are a few cases in which you can loan money from a 401k. You pay taxes on it instantly and may also pay penalties if things go wrong. I do not particularly recommend it.
* My Roth IRA. This is is another tax-advantaged retirement saving account paid for from earned income, but it is separate from the one that my work provides. I do pay taxes on the money now. I can save up to $4,000 this year, and have already reached this limit (it increases in the same way as the 401k, and will be $5,000 next year).
** Roth IRAs are different from Traditional IRAs. An Traditional IRA is almost exactly like a standard 401k in that you can deduct the savings from your taxes. With a Roth IRA, you pay the taxes up front, but after that the money is yours (at retirement). This means that you can actually invest more (think about it - if you put in $4,000 now, you actually spent $4,500 on that or so, compared to the $4,000 you spent on the one that you didn't pay taxes on - so, overall, you devoted more money to savings, and will get proportionately more out later). There are Roth 401ks now, too, and they are worth considering if your company offers them - mine does not yet.
** You can withdraw your contributions tax-free from a Roth IRA. You can also withdraw the earnings in certain specific cases (for example, the "first time" purchase of a house). Again, it is not recommended, mostly because you can't put it back in, but you can do it in a pinch.
What's in these my accounts?
* My current bank account has cash, of course. Ideally, not much of it. :-)
* My money market fund is the Vanguard Prime Money Market fund. They invest mostly in short-term loans to stable companies, which give a better return than loans to the government, and their expense ratio (the percentage they take out of your savings) is 0.30% - pretty much the lowest around, and they don't take stuff off the initial investment or when you take it out, either. As I type the rate of interest is 5.13%.
* My 401k is with MassMutual (no choice there, it's what my company has). I currently invest it all in the Select Focused Value [PDF]. An example of the stocks they invest in are HP, Dell and McDonalds. This is a long-term fund that has the potential to be quite volatile in price, but that's OK as long as it makes it up over time.
** The biggest problem I have with MassMutual is that their expense ratios are really rather high - 1.30% for that fund! This is especially annoying as I know they're probably just giving my money to someone like Vanguard at the end of the day. Unfortunately, you can't just say "I want my 401k from someone else". However, if I had to make the choice between filling my Roth IRA or my 401k (after my company stopped giving me their matching share - they double up to 3% of my earnings that I put in) then it'd be the IRA.
* My non-retirement stock account doesn't exist yet, because all of the funds I am considering require a minimum investment of $10,000. They put that in to discourage day small investors who are likely to take their money out quickly, and also because they are too popular due to their good returns.
** The ones I'm looking at are the Vanguard PRIMECAP Core, Wellington, and Windsor II funds. It's a difficult choice - PRIMECAP has a great reputation (they have a closed fund that has done well over 15 years), but it's got a higher expense ratio than the first two and this particular fund is still pretty new. Windsor II currently has a higher 10-year return than Wellington. However, it's only just higher, and looking at the history it's been more volatile than the Wellington fund. Another I considered was the Asset Allocation fund, which moves money towards bonds when stocks are bad. This results in even less volatility, but the extra work involved increases the expense ratio too much, and it makes slightly less on average. I'll probably end up going with PRIMECAP Core, because I have a long time to wait until retirement (so I can afford it if it goes down temporarily), and it is significantly smaller than the others (which means that it can move more quickly - it doesn't have to worry so much about losing money because it owns so much of a stock that moving out of it causes the price to fall significantly).
* My Roth IRA is in Vanguard's Strategic Equity Fund. Their expense ratio is 0.40% - higher than most of the Vanguard funds I've previously mentioned. However, they have managed a return that is over the long term significantly higher than even the Windsor II. They are also devoted to doing it all with software that figures out the best deal, which I must admit was a factor. They are highly volatile, which is why I'm just using them for retirement funds.
** Vanguard actually closed this fund, because it was doing too well and too many people were putting too much money in. Fortunately, I got in beforehand, so I can still invest. They have a small-cap fund (small companies) that works similarly, but that's pretty young and it's hard to say how it'll turn out.
Things I decided not to do - yet:
* Invest directly in stocks and shares myself. It might be possible to make significantly more money this way, if I got lucky. I could also just as easily lose everything I put in. I am not qualified to pick stocks, and even the best get it wrong a lot of the time.
* Invest in funds that have a majority of international stock. Many of these have done exceedingly well in the last few years - but they are also very volatile, and have a high expense ratio (how much the fund takes away). Higher is worse. Some things are inherently more expensive, and that is usually one reason not to do it.
* Invest in market-specific stocks such as real-estate and energy. Again, these have done well in the last few years. I can't help but think that at least the real-estate market in the US is headed for a fall, and possibly the energy market too. Even health care - it's happened before.
* Invest in the very popular "top 500" index fund. This is an odd choice, perhaps, but when you think about it - it's definitely not possible to beat the market with an index fund, and it retains the moderately high volatility of stocks in general. Looking at the market returns it seems to be possible to beat the top 500 over a long period of time - even considering the higher expense ratios that come with it. Very few funds do this consistently, though, and it can take a long time to average out, which is why if you only had 5 seconds to choose a fund you should choose an index fund (I'd probably still go for an index fund that covered smaller companies as well - they have done better in the past, though it varies a lot).
* Invest in bonds, certificates of deposit (CDs) and the like - kinda like the money market, but longer term. These things have lower risk but offer lower rewards than actually investing in a company itself. I'm young. I can afford to take on quite a bit of risk. If things are bad for a few years, it doesn't matter, as I don't need to take my money out. They will pick up later. Putting money in bonds and CDs now would be a waste of valuable compounding time.
You've probably noticed the name Vanguard popping up quite a lot. I do recommend them, because I've had a good experience from them in terms of service and their policies seem sound. They've been doing this for a long time. They're also owned by their own funds, which means that their own objective is the same as yours - to increase the value and income of the funds, rather than make money for their other owners like MassMutual. That's what they say, anyway - whether or not you believe them, up to you. :-)
To make it clear, the order in which I would fill up my investments (and how you probably should) is:
* 401k to the point where my company stops giving me free money
* Roth IRA to the maximum contribution, because I can get the money out tax free at retirement
* 401k to the maximum contribution (because investments in it still grow tax-free, and are deductible now)
* My taxable fund.
(If you don't know what any of these are yet, go read The Motley Fool again)
This year I did things in a lump-sum fashion with the IRA. Starting year, I've set it up to make investments weekly. My 401k comes out of my paycheck every two weeks. Ideally, all I'll have to think about is how much I should be moving into the other accounts - and even that can be automated.
Oh, and I do have a credit card (and one from the UK, too). I'm trying my best not to use it, though. There is little point in doing so except to build up credit, and really, the best way to pay for most things is to save up for it. Things like houses, perhaps . . . but even then, a great way to get a good rate from an understanding lender is to point out that you could pay off half the debt tomorrow if you really had to. You want a car? Save up for it, and then buy a good one second-hand. As they say, you gotta squeeze every penny. ;-)
That's the end of the post. I hope you found it useful, if rambling. There are things I could have gone into even more detail on, but I felt this was already way too long. If you want to know more, ask questions! Just make sure you follow through with investing for the future; it's important, because it's your future. All it takes to start is a few dollars in a money market account or a few I-Bonds - from there you can decide to do what's best for you.