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About 10 years ago my mom passed away. It was easily the toughest time in my entire life. I’d just graduated college 2 months before, and suddenly I was managing her estate while working full-time and commuting back to St. Pete to do repairs and sell my childhood home — all while trying (usually unsuccessfully) to collect money from a tenant living on her property. During this time I learned a lot about how to manage money — often by making mistakes.
I realized at the time that I knew next to nothing about investing, or how to manage money. How to budget and not go into debt is one thing, but knowing how to save and invest is a completely different learned skill. With many ways to approach this, it can be more than a little confusing.
Sadly, some of the best education comes from trying things and learning, but there’s a lot that can be read beforehand. The goal is to get to a point where you can understand the terms you’ll see when investing. I always point people towards the same book — Bogleheads Guide. This isn’t a book about doing some hot investment method, but one about how to save and invest money for the long term while reducing taxes and riding things out when returns get rough.
Minimal Investor Course
Here on Minafi, I created a free 10-week Minimal Investor course to help go over the basics of how to invest from scratch.Do you want to learn how to be a Minimal Investor? Sign up to start the course today.
Another great site and fellow Orlando startup is Edukate, Simplified Financial Education to Help Steer Your Retirement. If you’re looking for videos, they’re a good place to stop.
Investing Terms and Broad Strokes
There are a few terms that just knowing about can help understand how to manage your investments. My recommended way to invest is to use a simple three-fund Vanguard portfolio. Just saying that though, doesn’t do justice to the why – which takes a lot more explanation. Much of the rest of this post is understanding why this works and I recommend it.
So what can you invest in? Usually, this comes down to stocks and bonds — but there are a few other categories as well.
Stock — Owning stock is owning a very small piece of a company. It’s usually high risk, low diversity, low fee. You won’t have to pay any ongoing fees (aside from a small purchase fee with your stock brokerage perhaps). Direct ownership in stocks makes up less than 5% of my investments, and are the most volatile. I wouldn’t recommend investing directly in stocks to anyone, ever — aside from a small portion in companies you believe in.
Bonds could be from many places including companies, municipalities, international companies, locations or the treasury.
Bonds Funds — The idea behind bonds is that companies need money, so they sell bonds promising to repay them with some interest. You could buy a bond from a specific company, or a municipality, but most people don’t do that. Instead, you’d buy a bond fund — a collection of bond purchases from various companies. This means that if one company fails, you don’t lose all of your money.
ETF, Exchange-Traded Fund — These could also be called mutual funds. These are single funds you can invest in which are a collection of stocks and bonds, grouped together to avoid risk. If you ever see the DOW or Nasdaq index, those are a collection of funds used to represent the market as a whole. Since these represent a number of companies, if one company goes out of business, it won’t have a huge effect on your investment. These make up 95% of my investments and have a very low fee associated with purchases and holding.
This isn’t everything of course. There are REITs (Real Estate Investment Trusts) which allow you to invest in property without owning it. There are commodities — investments in materials like gold. Not to mention sector investments. These are things like investing in “energy”, or “health care” with the assumption those will be hot.
ETF Fund Types
Any investment you have money in will probably be one of these categories:
Stay away from Active Managed Funds when you can!
Active Managed Funds — These are variable risk, high diversity, high fee. These are a collection of stocks where a human picks out what is in it. Because of the human element, these have a higher volatility, as well as higher fees that are used to pay the people that work on them. I’d recommend staying away from these except in the case where you want exposure to a different sector to add diversity to your portfolio. This, to me, is the same as going with an advisor and putting your trust in them — or picking a stock because you trust the company. These can charge up to 2% of your total invested amount as a fee each year — or $200 per $10,000 invested per year.
Index Funds — These are funds that are controlled by a formula. For example, Vanguard Total Stock Market Index is the biggest fund in the world and is an index fund. These have the smallest fees of anything and can be as low as 0.04% — or $4 per $10,000 invested per year.
Expense Ratio — When you see any fund, it’ll probably have an expense ratio listed. For instance, American Funds Growth Fund of Amer A has an expense ratio of 0.66% or $66 per $10,000. That’s 15x the expenses for VTSAX.
For both Active Managed Funds and Index Funds, you won’t ever get a bill for the expense ratio. Instead, it’ll be reflected in the price of the fund. In other words, if there were two identical funds with different expense ratios, after a year the one with the lower expense ratio would be trading slightly higher.
Load — Load is probably the scariest fee of all. I learned about it when a financial advisor put some funds of mine in a fund that had a load without my knowledge. AGTHX has a load of 5.75, while Vanguard Funds have no load. So what is load?
Load is a fee that the investor pays to compensate the sales intermediary (the broker, financial planner, investment advisor, etc) for their time and expertise in selecting the fund. There’s a concept of “front-load”, where the fee is paid when the fund is bought, or “back-load”, for when the fund is sold.
My advice is that if your financial advisor ever suggests, or you find out you’re in a load fund, then you need to fire them and get out. If you have gains in the fund, I’d wait until you’ve held it a year — but also make sure not to reinvest dividends during that time.
On that $10,000 purchase of AGTHX, there is a 5.75 front-load, meaning that the investor is paying $575 for the privilege of investing in American Funds. $575 + $66 = $641 a year for AGTHX vs $4 for VTSAX. Crazy right? It’d be awesome if AGTHX outperformed, but it doesn’t. For the most part, similar funds in a category will perform about that same.