Investing for Dummies.

[spiffy]

I've reached a point in my life where I have a substantial (to me) amount of money that I'd like to 'invest'. I use quotations because basically I'd like to use my money to make money, but I have absolutely no inkling of economics to know what my best option is. So far I've tucked it away in bank CDs making 3 - 4.5% (and maxing out my 401k), but lately it seems the interest has dropped to figures like 2.9% which sounds ridiculously low to me considering inflation and the rising costs of living.

What options do I have to make more money with this money, without knowing anything at all about investing? With so many investment companies floundering right now, I really have no idea where to go for a straight answer.. or an answer as described to a child (damned artschool education!).

[jeffd]

Short version: Go read "A Random Walk Down Wall Street" and "Asset Allocation"

Slightly less short version: Good that you're already maxing out on your 401k. Getting all the free money you can & deferring taxes is the way to go. Invest in market index funds, picking stocks is for suckers.

[shift6]

While you are researching other investment options, put your money into a diversified selection of index funds. I personally think 40% domestic equity, 40% international equity, 20% domestic bonds is best for people in their 20s-30s. You could do such a split with 40% S&P500 index fund, 40% MSCI World index fund, and 20% LB US Aggregate index fund, for example. Vanguard is a great starting option.

Talk to your financial advisor. I am not your advisor. I may or may not be licensed. My employer would shoot me if they saw me posting this. Etc.

[WarrenM]

Your first and best bet is paying off credit card debt and crap like that. Huge return there.

After that, if you want something dead simple and effective over the long term, buy shares in an index fund. Whatever the market does, your money will follow.

[spiffy]

Mhmm, zero credit card debt / loans, kids, house, etc. If I can keep the girlfriend from buying all new furniture for the apartment all we pay is food, rent, and entertainment. I'm in a good position to do this, I assume.

[Lorini]

Get a financial advisor. I use Ameriprise, a spin off from American Express. While they do suggest their stuff (and now they must tell you when they do) they also suggest other stuff. My mom used them for years and now that she has passed and I have her portfolio, I find them to be helpful.

[spiffy]

Okay, so what exactly do you look for in a financial advisor? How do you go about choosing one over another, and how much of a cut do they typically ask for? It absolutely sounds like I need one, considering I'm bascially saying I'm not willing or able to do the legwork or research myself.

[WarrenM]

I'm of the belief that you don't need a financial advisor. What for? Unless you have a net worth of several million dollars there aren't any hard questions you need to be addressing. Index funds will carry you along just fine and you won't have to pay someone to needlessly tinker with your investments to justify their fees.

[AndrewM]

Yeah, if you aren't investing millions of dollars I think you can get by without an advisor. Index funds let you easily invest in a broad array of stocks with very low expenses. Places like Vanguard even have some index funds where you just pick when you are planning to retire, and the fund invests in other index funds in a ratio they feel is appropriate, adjusting over time without you having to do anything.

Here are some previous threads on this very topic here on Qt3 (http://www.google.com/search?hl=en&q=site%3Aquartertothree.com+investing&btnG=Google+Search).

[Bill Dungsroman]

I'm of the belief that you don't need a financial advisor. What for? Unless you have a net worth of several million dollars there aren't any hard questions you need to be addressing. Index funds will carry you along just fine and you won't have to pay someone to needlessly tinker with your investments to justify their fees.

Yeah, you really don't in the internet age. All you really need is to devote some time and effort for a month or so, learning about it and talking to people. Hit up the book store for a book or guide as well.

[Phil_Stein]

Spiffy - don't run out and hire someone right away. You may ultimately decide that is what you want to do, but there are a lot of sharks swimming in the financial waters, and you need to educate yourself so that you can recognize and avoid them. Once you've educated yourself, you can make the call as to whether you want to implement things yourself, or hire an advisor. If you choose to do the latter, at least you'll know what questions to ask and what to look out for.

For books, David Swensen's "Unconventional Success - A Fundamental Approach to Personal Investment" is good, as is John Bogle's "Common Sense on Mutual Funds". Bogle also has a book called "The Little Book of Common Sense Investing" that is, I think, newer, shorter, and simpler, and may be right for you. I don't think I've read the latter book (perhaps I did read it or skim it and I've forgotten), but his other book is good, so "Little Book" is probably good too. Malkiel's "A Random Walk Down Wall Street" is also good.

Cutting to the chase...

You need to educate yourself to understand WHY one strategy or another is better, but my personal recommendation, assuming you want to take the reigns yourself, is to open an account with Vanguard, and invest primarily or exclusively in their low cost index funds. For a simple portfolio, consider US Total Market, FTSE All-World ex-US, and a bond fund that fits your tax situation, and perhaps a money market fund (for emergency cash). With these funds and others like them, your expense ratio will likely be in the 0.1 to 0.3% range, roughly, per year. If you use an advisor, he/she might put you in much more expensive funds (some of which might also have loads), and might also either a wrap fee.

If you want to spend a little more time educating yourself, with the possibility of doing a bit better than the above portfolio, read about a wider variety of asset classes. In my opinion, the best bet to beat a basic diversified portfolio, on a risk adjusted basis, is to add a bit extra in the categories of REITs (real estate) and small-value stocks. Other intelligent commentators disagree to varying extents - the merits of tilting a bit to REITs and small-value are debateable. There are a few other 'advanced' techniques that might tweak things for you in a positive direction, but really, if you start with low cost, broad Vanguard indexes, you're most of the way there. Also, much of investing is about creating a safety margin for the future. Various insurance products may be useful in achieving this. Again, though, some insurance products are good, and some, to my limited understanding, seem quite questionable at best.

[ElGuapo]

I read somewhere, and I have subscribed to this advice, that you should spend an hour a week (that is, 4 hours in a month) looking into your investments, reading about investing, etc. If you just commit to that you're much better off than most.

To be perfectly honest, you have to watch the markets a bit. Index funds didn't do so well last year, but interest rates for say, online savings accounts (like ING) were great. Now rates are dropping (have dropped) and it might be a good time to invent in the market (but not individual stocks). I generally don't invest in individual stocks unless I've heard something (last stock I bought was the VISA IPO, before that it was ... geez, 5 years ago).

Edit: I don't know why Phil mentions Vanguard specifically, but my good friend is a lawyer for the SEC. His opinion of Vanguard is very high, in that their management and investment sides are separate, and have been for years. The SEC is looking to them as a model for all services/brokerage houses.

[WarrenM]

I agree with the hour a week of research into general investing and reading Money magazine type publications. But, really, if he's investing long term and invests in index funds he really doesn't need to watch the markets unless he wants to do it for sport (which I do). Moving money around in reaction to market conditions is a good way to cripple your long term gains.

[Rimbo]

If The Motley Fool still has their free "Fool's School," that's a great place to start. It'll give you a great overview, but keep in mind that they do have their bias and there are other ideas.

[Phil_Stein]

The reason I mention Vanguard specifically is that they have a reputation of having the best conventional (non-ETF) index funds in the market.

Fidelity has a few which compete well with Vanguard, but not as broad of a range, IIUC.

TIAA-CREF, from what I hear, has some good offerings, but I think you need to meet their criteria to use them (teachers and some other classes, I think). IIUC government employees also have some good choices though some government funds, but I don't know much about them. Finally, there are some ETFs (including some from Vanguard) that are nice index funds, but frankly, for a novice investor, using conventional, open-ended index funds from Vanguard is probably the simplest way to go.

Vanguard and the index fund approach are sometimes criticized, especially by those peddling much more expensive alternatives.

These criticisms seem to fall along certain lines:

1) If you invest in an index, you're settling for average.
Misleading. It's true that an index will get you roughly the index average, less a small amount for expenses. But the index average is typically much better than the average mutual fund in a given category. While a Vanguard index fund will return you roughly the index average less perhaps 0.1-0.3% (mainly for their expenses), an active fund will likely return you less. Yes, for any given period, some active funds will generally beat the average. But it's quite difficult to know these funds in advance.

2) The S&P 500 has underperformed in recent years.
IMO, you should not be indexing to the S&P 500, but rather to a broader index, which includes smaller US stocks. IMO, you should also add in a significant exposure to international markets. Note that most funds, indexes or not, focused on large US stocks have not done particularly well of late. With a more diversified portfolio, you'll have lower risk. But in any case, you should be wary of making decisions based on the last 1, 3, 5, or even 10 years of performance of a category or of a fund. You are not buying the past performance, but rather, the future performance.

3) Fund X, that we recommend, has an outstanding record over the last 5/10 years. It has beaten the index by a significant margin.
Financial advisors are no fools (generally). They recommend what has been hot lately. Out of the universe of thousands of funds, there are certainly a fair number that have done well recently. The question is whether they will do well in the future. Essentially, advisor focusing on active funds will almost always emphasize what has done well recently. Perhaps they will tell you that had you invested in fund X back in 1998, rather than in a broad index, you would have done much better in the last 10 years. But the real question is, was that advisor recommending fund X back in 1998, or perhaps, were they recommending fund Y (which had done well from 1988-1998, but perhaps has not done so well since).

Oh, and the obligatory "I am not a financial advisor. Do not rely solely on my advice and information. Blah blah..."

[Lorini]

The reason I suggested a financial advisor is because there is a lot more to investing than index funds :). I don't have millions unfortunately, but I do have stocks, treasury certificates, mutual funds, IRA's etc. Now if you want to do all the work to find out what all of these mean and what they could mean to your financial future, then go for it. I use Ameriprise because it is a business that must be responsible to and responsive to its customers. It was associated with American Express for many years. Other credit card companies may also have investment arms with people who can advise you too. My mom's portfolio grew by 20% in 2006/2007 under them, which isn't bad for a conservative portfolio. She previously had a well meaning but not very knowledgeable private advisor, who I got her away from.

There's a lot out there and I just don't have the time or patience to discover it all. If you do, then go for it. You won't though, find out much spending four hours a month at it, I'm just sorry. The Dummies series of books probably includes an investing one, you could start there. Also fool.com is very good for beginners too.

Lastly, before you do anything, you need to figure out what it really is that you want. Do you want to retire early? Do you want long term investments (like property for example)? Do you want to make a killing in a few months? Do you care if you lose a bunch of money in the short term? High risk/high potential payout or less risk/less potential payout? Those are things that will shape your investment strategy.

[Phil_Stein]

Lorini - a few critiques of your post...

Starting with the last paragraph. "Do you want to make a killing in a few months?" This feeds into the view that there are few if any limits to what one can achieve, as long as one structures things appropriately. IMO, that view is NOT realistic. Of course, you can have a small chance of achieving a large fortune very quickly - buy a lottery ticket. But structuring things so that a given return is LIKELY - well, there are limits to what you can achieve. If someone promises you 20% annual returns, be **very** skeptical.

So, part of learning about investing is learning what is possible/likely, so that you can set realistic goals for yourself.

As for the merits of self-education and using an advisor: Again, I say that the first step is to achieve SOME degree of self education. If you don't know a stock from a bond, or have no idea of how advisors and mutual funds make money off of you, or what the reasonable fees for a given product or service are, then you stand a good chance of being taken advantage of, and the cost of being taken advantage of in the financial realm can be quite high. So start with some self-education. I'm not sure it should be 4 hours a month every month. It might be 16 hours up front (reading a few good books and some websites), and a lower amount later on. A lot depends on the size of your portfolio. If you're investing $1,000 to start, then the cost of being stuck with a fund or an advisor who underperforms or overcharges by 2%/year is only $20. If you're investing $100,000, then that 2% translates to $2,000 per year - much more meaningful, and likely worth investing a non-trivial amount of time to educate yourself.

Lorini is right that there is more to investing than simply index funds. But the real question is, how do you get yourself into a good position with a reasonable amount of time invested. Some advisors may help point you to things you might not have found on their own, but advisors may also give you bad advice (in many cases, their financial incentives do not do a good job of aligning their interests with your interests), or, they may simply charge more than the value that their advice adds.

Educate yourself, then make the decision as to whether to use an advisor or not.

[Islanti]

Another voice calling for investing in Index Funds. I went through a similar discovery process over the past year. The advice I've seen often repeated is that financial "advisors" charge an arm and a leg. Over the long run they don't make you more than an index fund will thanks to all the fees. The fact is that you'll do pretty well with an index fund as long as the markets are doing well. If you want to be more aggressive you're going to have to spend a fair amount of time researching yourself.

I am also considering a municipal bond backed interest bearing account as a way to earn some money tax-free. Lower yield, but without having to pay taxes that's OK.

[stusser]

Listen to these people; max your 401k and roth IRA (if possible) and invest in index funds. Diversify the indexes too; split between the US, europe, and asia. It's probably smartest to just keep it 60/20/20 but I've been at 20/20/60 since june 2006. Depending on the amount of money you're investing you can qualify for significantly better service in something like vanguard's flagship or voyager.

If you manage to pull in real money (>$1m or so liquid and flagged for investments) definitely get an advisor. And finally, don't play it too safe if you're <50 years old. That's a trap many responsible people end up falling into.

[Shadarr]

I've never been a fan of financial advisors, but the Asset Backed Commercial Paper (ABCP) fiasco up here in Canada really reinforced that view. Basically what happened was that sub-prime mortgage derivitives were sold to investors on the advice of financial advisors as being just as secure as government bonds but with better returns. Then the ABCP market seized up and people who bought it specifically to avoid risk are unable to sell it and may end up taking a loss.

The problem is that the investors didn't understand what they were buying, they just took their advisor's advice. The advisors didn't really understand what they were recommending either, they just saw that it was rated AAA and paying an extra percent or so over other bonds, and thought that was a good opportunity for their clients. But the rating agencies didn't understand it either and gave it a AAA rating anyway.

Bottom line, if you don't know enough to understand what you're buying you can get burned whether you have an advisor or not, and if you do understand what you're buying, you don't need an advisor.

But if you're going to get a financial advisor, make sure you pay for it. An advisor who charges by the hour is going to be relatively unbiased; one who is "free" is actually just a salesman getting paid commision for directing you toward specific funds.

[stusser]

Almost nobody saw the subprime mess coming; you need to lower your standards a bit. An advisor can still offer real value without being as smart as Robert Schiller.

[Lunch of Kong]

http://www.infomarketingblog.com/images/This_Stock_And_Bond_Business.jpg

[Shadarr]

Almost nobody saw the subprime mess coming; you need to lower your standards a bit. An advisor can still offer real value without being as smart as Robert Schiller.
Nonsense. A lot of people who had a vested interest in perpetuating the bubble fooled themselves and others into believing there was a new paradigm. You don't have to be as smart as Shiller, you just have to be smart enough to know to listen to people like Shiller. I've been reading the financial reports from Phillips Hager & North (where I have my mutual funds) and they were saying for several quarters that a stock market correction was coming, risk premiums were too low in the bond market, they wouldn't invest in any mortgage-backed ABCP or CDOs because they were too opaque.

I don't buy for a minute the line that "nobody could see this coming". That's bullshit. Lots of people predicted this, they just weren't listened to until after the fact. Some of them made out like bandits shorting CDOs, some of them merely prevented losses by positioning their portfolios defensively. But from a basic logic standpoint, there is no such thing as risk-free higher returns. An efficient market simply doesn't allow that. If you're getting higher returns and you don't know why, you should get nervous.

[stusser]

Thanks for the strawman. I didn't say nobody saw it coming. I said almost nobody saw it coming. That's why almost all of the banks are going under, and almost all subprime, non-conforming, and alt-A loans made in the past 3 years will default. Not all, almost all.

[Rimbo]

Almost nobody saw the subprime mess coming.

Bullshit.

[Shadarr]

Banks are going under because the system is broken in a way that promotes long-term destructive behavior for short-term gain. Everyone from mortgage brokers up to VPs and CEOs had financial incentive to keep making loans they knew would default. Some of the "quants" may have genuinely believed they were smarter than the market, but I'm sure a lot of them just looked at their bonuses and the company stock price and didn't worry about the consequences. Informative link (http://captaincapitalism.blogspot.com/2007/12/banking-christmas-carol-part-1.html).

[stusser]

Thanks for the informative link, but you're full of shit. Rather than regurgitate random blogs, why not try to draw some conclusions yourself? I read patrick.net every day too so I stay on top of this stuff, but if you don't watch yourself the endless negativity and schadenfreude can pull you right in.

Nobody "made loans that they knew would default". That's crazy talk. It wasn't malicious. They aren't villains, they're people. Stupid^H^H^H^H^H^HIrrationally exuberant people, OK, but just people. They mistakenly believed that there was no bubble, that housing would continue to appreciate indefinitely, that the po' folks who signed up for those crazy no money down liar loan ARMs would have the ability to refinance, and the money train would keep tootin'. They were obviously incorrect in this belief.

Or do you really think wachovia bought golden west in 2006 because they wanted to fuck over the lower class? No, they bought it because they thought they were right.

[spiffy]

Thanks for all the help, folks. I'm going to look into all your suggestions.

[Aeon221]

Or do you really think wachovia bought golden west in 2006 because they wanted to fuck over the lower class? No, they bought it because they thought they were right.

Any other bank and I'd agree with you. But Wachovia? Those sadistic fucks would do anything just to increase the suffering of humanity.

[Shadarr]

I don't think it was necessarily malicious, I think it was just a result of the system. They had an incentive to create as many loans as possible and no incentive to make sure those loans would be paid back. And I do think there was deliberate fraud in a lot of NINJA loan applications. I know of people who got approved for a mortgage where the mortgage broker counted the estimated rent from a suite as employment income in order to get the loan approved.

I'm sure there were a lot of people who had nagging doubts or even flat-out knew what they were doing wasn't sustainable, but they were making so much money and everyone else was doing it so they couldn't not go along. The longer a bubble lasts the less people worry about risk.

As far as corporate mergers, I think a lot of it is driven by executive self-interest. The people who benefit from all the various aquisitions and spin-offs are generally the executives and the ones brokering the deal, not the shareholders.

[Bill]

Another tool you can use to learn is a virtual stock market. Something like www.investopedia.com (http://www.investopedia.com) allows you to start with some arbitrary amount of money that you can virtually invest in the stock market.

Unfortunately, it's sort of like playing poker with play money--it doesn't hurt if you lose so you're more likely to go "all in" on some wild bet. So if you do decide to play around with this I recommend doing what some friends of mine did, which is to make it a competition with a "buy in" of $20 or $50. Having real money on the line makes you less likely to take wild risks. Also create a "player" that just has something like an index fund so that you can see if any of you are really any good at this investing thing.

Most likely you won't be :)

[King Lupid]

interesting article

http://www.portfolio.com/executives/features/2007/11/19/Blaine-Lourd-Profile

as i am in the biz, here is my disclaimer: i submit this for information and entertainment purposes only. my posting this should not in any way be taken as a recommendation or endorsement of any kind.

[Ex-S Woo]

I guess that goes back to the hanging dilemma that everyone in the industry knows by now : that the vast majority of actively managed funds do not outperform the market. .It's just that everyone thinks that they know more to be in that top few % that can beat it :)

Still, it's pretty odd how sensationalist and groundbreaking that article reads like even though any intro book would cover the exact points that this article goes over.

interesting article

http://www.portfolio.com/executives/features/2007/11/19/Blaine-Lourd-Profile

as i am in the biz, here is my disclaimer: i submit this for information and entertainment purposes only. my posting this should not in any way be taken as a recommendation or endorsement of any kind.