Investing For Beginners

Frum life is expensive. Just the day-to-day expenses of food, housing, and tuition are immense and much higher than the national average. Paying for weddings, the eventual goal of most frum couples, can seem completely out of reach.

How can a couple save up enough money to marry off their children and then for retirement?

One word: Investing.

THE EIGHTH WONDER OF THE WORLD

Just putting away money isn't enough to get the amount needed. But compounded investing, when done correctly, can be. When the interest keeps being added to the principal, the amount grows larger and larger.

Albert Einstein referred to compound investing as the eighth wonder of the world.

To illustrate: If you invest $50 a month for 20 years at a 7 percent interest rate, you'll end up with more than $26K: $1,200 principal and over $14K interest.

If you invest $50 a month for 45 years, you'll end up with $189K even though you just put in $27K.

One Plus One Doesn't Equal Two

A $20 bill can purchase a drink and a pastry in a local coffee shop. It's not a lot of money, and it's the type of discretionary purchase most people don't think twice about. But if those $20 are invested each week at a 7 percent return, in two years that money will be worth $2,000. In five years, it will be $5,500.

People often say they would love to invest money but they don't have any available. Almost everyone can find the extra $50 a month when they keep this principle in mind. In the long run, those $50 add up to a lot more than the sum of the parts.

HOW SHOULD YOU INVEST?

Individual stocks provide the most glamorous stories and can potentially give the highest return, but they're really just gambling for people who aren't doing it professionally, and often also for those who are. It's risky. Timing the market-picking when to invest in a stock right before it goes up-is essentially impossible for many, and very few people succeed.

If you're a layman looking to put money away, your best bet is a mutual fund or an index fund.

Warren Buffet says, "The goal of the nonprofessional investor should not be to pick winners but rather should be to own a cross-section of businesses... A low-cost S&P 500 index fund will achieve this goal."

And “I believe that 98 or 99 percent-maybe more than 99 percent of people who invest should extensively diversify and not trade. This leads them to an index fund with very low costs.”

The Magic of Diversification

How does it work? A mutual fund diversifies the money of its investors to invest in many different stocks. This way, even if one or several of the businesses that they invest in fail, the rest of the stocks will likely increase in value and you will still profit. The chance of all the businesses in the mutual fund failing is so small that you're practically guaranteed growth, since many of them will probably grow.

Index funds are an even better choice than a regular mutual fund. Index funds are mutual funds that are managed passively. The money is diversified among the stocks of a particular market or index such as the S&P 500, without anyone buying and selling stocks often. Since the fund is passively managed, the fees are significantly lower, and long-term, you're likely to come out with more from an index fund than a regular mutual fund. Over a long period of time, money that's invested in an index fund is likely to average at least 7 percent interest yearly.

Legendary investor David Swensen says, "When you look at the results of after-fee, after-tax basis over reasonably long periods of time, there's almost no chance that you end up beating the index fund."

From a long-term view: $100K invested for 30 years at 7 percent with 1 percent fees yields $574K, with 2 percent fees yields $432K, and with 3 percent fees yields $324K. It's huge amount of growth for very little work.

THE CROCK-POT EFFECT

The best type of investing utilizes asset allocation: dividing your money among stocks and bonds-including more conservative and less conservative investments-to maximize your returns while at the same time ensuring that you'll always have something.

Don't put all your eggs in one basket. Don't only invest in stocks that carry no guarantee. You want to create a mixture of high-risk and low-risk investments to create balance and security while still aiming for good returns.

For this reason, I recommend investing with a target-date fund, which is a mutual or index fund with a set date you plan to withdraw the money. The fund will make annual adjustments to maintain a balanced allocation. As you get closer to your target, the fund will become more and more conservative.

Yes, the allocation may not be exactly what would be best for you in an ideal world, but it's a good system that takes the least effort and is therefore most likely to get done. It's better to set it up and automate investments each month than to lose out on returns by procrastinating and then having to remember and put in all the effort to rebalance annually. And that may not even do better than the more tailored plan, especially if you have to pay someone to do it for you.

Investments are supposed be boring. The goal of a target-date fund is for it to be like a Crock-Pot. You set it, forget it, invest a set amount of money each month, and come back many years later to collect the amount you need.

DIY or Not??

People often ask if this is something they can do on their own or if they should get a financial adviser to choose the fund for them.

There are benefits to having a financial advisor, especially for high net worth individuals, but someone with simple finances can usually take care of it on their own and save, since the fees are higher when using a financial adviser. However, if you won't do it or won't do it properly by yourself, then it's worth it to pay someone to invest the money for you.

If you're the savvy type and want to design your own portfolio so it's exactly tailored for your needs to avoid the fees of a target-date fund, keep in mind that there's no exact rule for how to allocate funds, since it depends on factors such as one's age, when the money will be needed, and one's comfort with risk.

For example, if you start investing in your 20s, you may decide to put 40 percent of the investment money in US stocks, 40 percent in international stocks, and 20 percent in government bonds.

Your age makes a difference because if you're younger, you want a greater risk potential since you don't need the money for a good 20 years. The potential loss from a riskier investment will likely be recouped by the time you need the money. The greater the risk potential is, the higher the growth potential is. As you grow older, however, you'll want to move more of your investments to more conservative stocks, which are unlikely to dip, since you'll be withdrawing soon.