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Ask The M-Network: Investing Newbie

This week the Ask The M-Network question is about investing.  Investing can be an intimidating and scary topic for a lot of people, me included.  There is a lot of information out there and it is hard to sort out what you need to know.  The question I received from a reader was:

I’ve put in so much energy in the past few years to educate myself about finances. However the one BIG thing I just cannot grasp is investing. I still barely understand mutual funds, stocks, bonds, and how to handle and understand my own 403b plan. I’d love to know about the best, most concise, and simplest book or website about the issue, that is really made for people who need to start from scratch to learn all those terms! To top this all off, I’m really interested in socially responsible investing, so many of the traditional avenues of investing turn me off because of the inability to control or know where your money is truly going. Thanks!

And thanks for the question!  First, I turn to two of my fellow M-Network members who have a whole lot more background in investing than I do:

Pinyo at Moolanomy answers:

There’s two parts to this question and I’ll answer them separately.

For the first part about investing
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Yes, information about the stock market can be overwhelming, but it’s not hard for you to invest in the stock market. If your employer provides a 401k, that may be the easiest route. Just call up HR and have a small portion (e.g., 1-2% directed to the plan) and pick a Target Retirement Fund (TRF) to start investing. A TRF has a date (e.g., 2030, 2035, 2040, etc.) next to the name, you just have to pick the one with the date closest to your retirement date.

If you don’t have a 401k plan, make sure you start with money that you can lose. Then find a discount brokerage firm in your area. For first time investor, I prefer TD Ameritrade or Charles Schwab where you can physically go to the local branch and talk to someone who can help you open the right kind of account, deposit the money, and help you start investing. For the first time account, the key question to answer is how soon will you need this money again?

* If it’s within 5 years, do yourself a favor and deposit it in the best interest rate CD or high yield savings account.
* If you need it before your turn 59 and a half, keep the money in the a normal account
* If you don’t need it until retirement, then start an IRA. I prefer the Roth IRA due to the tax-free withdrawal (you pay taxes upfront) — but that’s another (and rather long) discussion for another time.

Now what should you invest in? Whatever you do, I would suggest you avoid buying individual company stocks — i.e., Microsoft, GM, GE, Citigroup, etc. With the small initial investment, you can’t achieve the kind of diversification needed for a good portfolio. For the very first investment, I’d suggest looking at Vanguard Target Retirement Fund, or any of the Vanguard Index Funds.

What’s next? There’s a lot of things to learn and I would suggest reading my investing resource page; focus especially on the “Basics” articles and go from there. Feel free to leave question via comment form on the article, or use the contact form.

Now, What About Socially Responsible Investing
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For this part feel free to disagree with me. I feel that SRI is very hard to define and not every SRI fund defines socially responsible the same way as you, so it will take A LOT of research to find one that’s socially responsible enough. Secondly, with everything so interconnected nowadays, it’s virtually impossible to find a company that is 100% socially responsible. For example, if a company deals with paper products, is it socially responsible because it contributes to destruction of trees? If a company buys parts from, or outsources services to, 3rd world country companies that use low-paid labor in sub-standard work environments, is it socially responsible? If a company lends money to borrowers who can’t afford to pay it back, is it socially responsible? I think I just described most companies in the U.S. Even a company that you’re sure is “clean” will probably have some kind of business arrangements with many irresponsible companies — it’s a web that we can’t escape.

Most SRI funds are more expensive (they charge you more for being socially responsible) and usually provide sub-par performance because of the more “limited” selection. Would you rather waste 2-3% or more in performance in an attempt to be socially responsible? You would be better off letting your investments do the best possible without any hindrance. You can turn around and donate the 2-3% difference to the causes that you care about. You are guaranteed to make more of a difference that way.

And Patrick from Cash Money Life adds his thoughts:

I think Pinyo’s answer is great. Right now I would focus on getting used to the idea of investing in a 401(k) or IRAat regular intervals through Dollar Cost Averaging (DCA). With DCA, you contribute the same amount of money each month, buying more shares when prices are low, and fewer shares when prices are higher. Over the long run, the markets tend to rise, so you will be buying into that theory.

As for where to put your money, I would also recommend a target retirement fund until you know more about stocks, bonds, REITs, and other forms of investments. A target fund will automatically give you an asset allocation based on your target retirement date, hopefully giving you the best balance of growth with the least amount of volatility.

I also don’t personally participate in socially responsible investing for many of the same reasons Pinyo mentioned. The fees are often inordinately high, which cuts into your returns, the “socially responsible” companies in the fund you purchase may not be as socially responsible as you think, and you are limiting your investment choices. I prefer to invest in very low cost index funds and give money to the charity of my choice.

And I’ll add my own perspective as well:

As for my thoughts, all I have to add is that a friend of mine recently started a blog called ABCs of Investing, where I have been learning the definition of all the investing terms that are thrown about in the media. It doesn’t teach you where to invest, but teaches you how to understand the terms you hear every day so you can make more informed choices.  I have learned a lot reading it!

If you have a question you’d like to Ask the M-Network, feel free to submit it via my contact form or by a comment to this post.  Not all questions will be answered, and we are not finance professionals - just people who spend a lot of time thinking about money.  I’ll try to feature one question of interest to readers a week.

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