Ok, you know you need to be saving for retirement. But when it comes down to it, how in the world are you going to actually learn what you need to know to start?
The good news is that you don’t have to know everything, just a few key things to get you in the game.
I’ve talked about the three steps you need to take to start saving for your retirement. There, I told you to invest in a Target Date Fund. In this article, I want to do a little more explaining. You always want to understand what you’re investing in, even if it’s just a basic understanding, and if you’re going to follow my advice, I want you to start learning how this works.
So, What is a Stock?
Owning stock or shares of a company is essentially owning a small piece of that company. When the price of that stock goes up or down, it’s reflecting the behaviors of the people buying that stock. So if the price is going down, that means that people that own that stock are selling it, so it’s perceived to not be as valuable. When the price goes up, it’s perceived to be more valuable.
Ever heard about needing to be diversified when it comes to your investing or retirement? The reason that term is so important is that it’s really dangerous to have a whole lot of money invested into one stock.
Let’s say a company went under. What would happen to the value of those shares of stock? They would plummet to the point of being worthless and if you have a lot of money invested in that company, that means that you just lost a whole lotta money.
Really scary stuff.
Especially when you consider that a lot of times, a company will issue stock to its employees as part of their benefits package.
But what happens if that company fails?
If that employee had all of their retirement in the company stock, they just lost all of their retirement in addition to losing their job. It’s a double whammy.
So when you diversify, you invest your money in many different categories and many different companies. That way, when one goes down, it’s a relatively small hit.
Mutual Funds
You and I don’t have the time to research the best companies to invest in right now. We don’t have teams of people working for us to know what’s a good investment, which companies are hot, and which ones we need to sell and get rid of.
We would need teams of people and it would need to be our full time job.
So that’s where mutual funds come in. A mutual fund is a group of stocks that are bundled together. By investing in one mutual fund, you’re investing in a lot of companies. This means your risk goes way down. Even if one of those companies fails, there’s a lot more stocks in the fund to not let it hurt you as bad.
Actively managed funds mean that there’s a person that’s in charge of picking the stocks for the mutual fund. This person has that team of people to help them make wise decisions when choosing what goes into the fund.
But because there are people that are working behind the scenes, it costs more to invest in this fund.
The term for that cost is the expense ratio.
Actively managed funds always carry a bigger expense ratio on the fund.
Which brings us to our next type of mutual fund:
Index Funds
Index funds are my preferred way to invest.
Ever hear of the S&P 500? What about the Nasdaq?
That’s when you hear the people talking on the tv about how bad or good the day was for the stock market and they say something like “The Nasdaq lost a bajillion points today” and it sounds like that’s really bad but you don’t really know what they’re talking about.
Those are indexes. Basically, it’s just a group of companies whose stock prices are bundled together. When we look at a group of companies like the S&P 500, we’re able get an idea for how things are going with the stock market.
So the standard for how we’re doing in the stock market starts to be measured against an index like the S&P 500.
When a person is managing an active fund(remember, that means that they have that team that are picking the stocks), they judge how they’re doing against the index.
There’s a ton of research out there that dives into the amount of times an active manager is able to take their mutual fund and actually beat the stock market.
The catch is that it’s super hard to consistently and reliably beat the S&P 500 index.
So this guy named Jack Bogle came along and invented the index fund.
If the goal is to at least do as well as the S&P 500, why not just buy the exact same stocks as the index?
On top of having a mutual fund that is invested in exactly the same companies as the index, you no longer need to pay for managers or teams to actively research and pick their own mutual funds. Therefore, you are really able to keep those expense ratio costs down.
It’s the ultimate, if you can’t beat em, join em, in finance. So instead of spending a lot more money trying to beat the market, you can join the market and keep costs really low.
I love index funds because it is such a time saver. I have my money invested in the market and I know that I don’t have to worry about doing worse than the market does. It takes a minimal amount of time to manage, and I’m keeping costs really low.
So, which funds should I invest in?
I want to point out just four funds to you today.
The Target Date 2050(VFIFX)-This is the target date fund I’d use if I wanted a one stop shop for my investing. I talked about why it was a great choice here. It actually includes all of the following funds in it, but they do all of the balancing work for you. Excellent choice for beginners. It’s not a bad choice for me either, but I do like to have a little more control.
The Vanguard Total Stock Market Index(VTSAX)-This fund covers the US stock market as a whole and it is the heart of the target date funds. Since I have a pension when I retire, I consider that to be a really conservative part of my retirement, so I am much more invested in the total stock market index so that my money can grow more aggressively.
The Vanguard International Stock Market(VTIAX)-Financial experts recommend that part of being diversified should include investing in international companies. This is smart because then you aren’t just invested in US stocks. You should invest about 25% of your retirement savings into VTIAX.
The Vanguard Total Bond Market(VBTLX)- This is a bond index fund that is invested in the US bond market. Investing in bonds is considered to be much more conservative. Even when the stock market takes a hit, bond funds tend to stay pretty steady. For this reason, with the target date funds, they steadily increase the amount that you’re investing into this bond fund the closer you get to retirement. Since I have 30 years until I will retire and I have a pension as a major part of my retirement, I don’t invest in bonds now. I’m not really worried about being conservative now because my investing timeline is so long. But you need to invest in a way that feels comfortable to you.
If you’re just starting to wrap your head around investing in these individual funds, go for it. If you’re still not quite sure, investing in your target date fund for your retirement timeline is a super great idea.
Action Steps
So have you taken any action yet? It’s time to get in the game! Go back and check out this article on getting started. Remember, it doesn’t have to be super sophisticated now. Go with an option that gets you most of the way there and works great. If you’re still interested in learning more, make adjustments as you go, but you can do this.
Still have a hangup? Let me know because I’d be happy to see how I can help.
Disclaimer: All investing is subject to risk. I am not a financial professional. The ideas contained in this blog are strictly for educational purposes. You assume full responsibility for any actions you take.
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