Laurie was feeling really good about herself and rightly so. She had spent the better part of the past year getting a solid grip on her spending, paying off her high interest credit card debt, and building up her emergency fund. She'd also made the very critical decision to participate in her employer-sponsored retirement plan. She should feel on top of the world, but instead she feels overwhelmed. She's finally saving money but she doesn't know even where to begin when it comes to thinking about how to invest that money wisely.
Laurie isn't alone. In fact, Laurie is like most people. Investing can seem very overwhelming. The good news, however, is that a keep-it-simple plan is most often the best plan. For money you don't need to spend for five or more years, your basic choices are stocks, bonds, and real estate. How do you know which to pick? Well, here's a rough guideline for you:
If you are under the age of 50 and you don't need to spend your money for five years or more, stocks can be a very compelling place to invest your hard-saved money. While there's definitely no guarantee that history will repeat itself, stocks have historically had the highest investment return of all of these categories over the long-run. Over the past 80 years, stocks have generated an average return of 10.5 percent a year. That compares to bonds at 5.5 percent and real estate at 3.5 percent (after adjustments for annual expenses like property tax, insurance, and maintenance / upkeep).As you can see, stocks have produced the biggest bang for your buck. That said, before you get decide to invest your hard earned money in stocks, there's something else you should know: Investing in the stock market is a bumpy ride. This means you'll need to be prepared to put on your mental seatbelt. While stocks have gone up an average of 10.5 percent a year over the past 80 years, stocks didn't go up 10.5 percent in each and every one of those years. In fact, stocks actually lost money during those 80 years. As such, before you invest in the stock market, you need to mentally prepare for the inevitable years where you will lose money. It's the financial equivalent of taking three steps forward and one step back. But there's good news: The more time you have on your side, the higher the odds are that you'll end up making money when you are ready to take out that money you invested in stocks. This is why we say stocks rock if you have at least five years on your side. And, of course, the more time you have on your side, the better.
So do you need to go out and try to pick the next Starbucks or Google to invest in stocks wisely? Many folks think picking individual companies is the best way to invest in stocks. We're here to tell you that unless you want to pick stocks for a living, day in and day out, you're better off investing in a basket of stocks -- which is called a mutual fund. There are two types of mutual funds, "active funds" and "index funds." With active funds, a professional money manager goes to work each day and decides what to buy and sell. With an index fund, the basket of stocks is essentially stable, and the companies in it change less frequently. While there are some wonderful active mutual funds out there, there are also some not-so-wonderful ones. In fact, over the past 10 years, index funds have done better than 80 percent of active mutual funds. This means if you want to go with active mutual funds, you'll have to commit to really doing your home work to find the best active managers -- the same way you would if you decided to invest in individual stocks.
So what's a woman who has better things to do with her time than pour over the financial pages to do? If you want to keep your financial life simple, go with index funds. It's a great low cost way to start out investing. The classic index fund is the S&P 500 index fund (which is like a financial smoothie composed of 500 large American companies). Another equally good index fund is a "total market index fund" which includes all those big companies plus some small and mid-sized ones.
Finally, remember to take personal responsibility for your money. Your investment choices will largely depend on how old you are now, your time horizon, and appetite for risk. If anything doesn't make sense to you, don't do it. If you have questions, talk to your financial institution. Armed with some basic facts and common sense, you can invest like the best.