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Financial independence. Ah, yes. Has a nice ring to it, doesn't it? To be a person of independent means, to live on one's investments, to retire, to retire early. To one person, financial independence may mean just enough cash coming in to support a beach bum lifestyle, to another it may mean a $2 million portfolio that supports round-the-world cruises and his-and-her golf carts. Whatever it means to you, this seminar can be the first step down the road to your financially secure future. We will teach you how to save, what to do with your savings, and how to outperform more than 75% of professional mutual fund managers (surprisingly, it's not that hard!). Along the way we'll try to point out which side roads are dead ends and which detours might lead to washed-out bridges.
We're glad you've made the decision to join us as we tackle the mysteries of the investment world together. Here's what we have planned:
In Lessons 1 and 2 you will learn why it really pays to save and invest and how to start getting your financial house in order. (Sharpen your pencils!) You'll also begin to get a little perspective on what to expect from investing. Lessons 3 and 4 teach you what kinds of investments are most appropriate for beginning investors and help you decide which is best for you. Lessons 5 and 6 take some of the mystery out of investing accounts such as IRAs and brokerage accounts. Lesson 7 teaches you how to ride out the inevitable storms in the marketplace.
Lesson 8 looks at where you can go from here and gives you a list of resources you can use to continue your investing education.
The seminar is designed to get you started on a lifetime of investing with a simple plan that will work reasonably well for most people. It's not a cram course in all aspects investing, and it won't immediately turn you into a financial whiz. But when we finish, you will be on the road to a lifetime of successful investing. Where you go from there is up to you.
What Is an Online Seminar Anyway?
Just to be sure everyone is clear on the concept, here's how this seminar works. It's self-paced, which means you can bear down and complete it in a day or two, or you can take a few months. We've parked all the lessons and homework assignments in one area where you can access them at any time. Each lesson is broken down into convenient sections focusing on some key points with links to places on the Web (including the Motley Fool site) where you can go for more in-depth treatment of topics that are of particular interest to you. There's a lot of homework. Sorry, but no pain, no gain! The homework is where you'll take what each lesson teaches and apply it to your own specific situation. What you get out of this seminar will depend largely on what you put into it.
Step One Is Saving Money
Easier said than done, eh? It's that old conflict between immediate gratification and delayed gratification. Immediate gratification is fun, but delayed gratification is far more satisfying over the long run. You may have to trust us for a while on that one, but once you try it, I think you'll agree. The thing about investing in the stock market is that it supercharges your savings. Over the last 75 years, the market has returned an average of 11% per year. (Savings accounts, bonds, etc., cycle around 3% to 7% annually. We will use 5% as a representative rate.) So let's see what that supercharged stock market rate does for delayed gratification:
In 10 years, a $300 DVD player will be worth... nothing. It will
probably be taking up space in your basement while you download movies from the 'Net. If you keep the old VCR and put that $300 in a bank account, in 10 years you'll have a grand total of $488 (assuming a 5% annual interest rate). Not an exciting prospect? OK, put the $300 in the stock market and earn an average of 11% a year for the next 10 years and you'll have $851. (And yes, that will buy more than a newer model DVD player.) In 20 years, the $2,000 you might have spent on a trip to Cancun could be worth $5,300 in a bank or $16,000 in the stock market. In 30 years, $4,000 for that titanium bike you covet could be worth $17,000 in a savings account or $91,000 in the stock market.
More to the point, $2,000 invested every year in a Roth IRA over a 40year career earning the average annual market return of 11% will become over a million bucks (tax free!). In a savings account at 5%, it's just $240,000. It comes down to a simple trade-off: Do you want to have stuff now or money (and maybe even better stuff!) later? (We call this the "Stock vs. Stuff" dilemma.) You can buy stuff or you can put that money away and watch it grow. The big payoff comes to those who are willing to take on a certain amount of risk (more about that in a later lesson) and put some of their savings in the stock market rather than opting for the safe, boring interest a savings account offers. So how can we do that? We're glad you asked! Read on.
Step Two Is Investing It Foolishly
Here are the returns investors have historically received for different types of investments, with inflation included for context:
Investment S&P 500 Small company U.S. Treasury U.S. Treasury U.S. Treasury Inflation 1926-2000 Average Annual Return 11% stocks 12% Bills (short-term) 4% Long-Term Bonds 5% Mid-Term Bonds 5% 3%
Notice one thing. The top two categories, each a different segment of
stock market.that's why the Fool is a proud proponent of informed participation in the U. We prefer to participate in the growth of the stock market. Albert Einstein is reported to have said. have returned far more than the fixed-rate investments.the stock market. Savings: This is the one factor you can control most easily. It comes down to one thing: The market is where you make the most money over the long term. Check out this table to see how much more you might earn when you reinvest your profits year after year. So why do people invest in stocks? Investors take on the additional risk because they know there is the possibility of earning far more than they could with a risk-free investment like cash or bonds. The Power of Compounding When asked what was the most powerful force in the universe.) Interest-paying bank accounts and bonds can't compete with stocks over the long term. In . but we'll use the more conservative long-term rate for our examples. "compound interest. Stocks are riskier." Investing. and then reinvesting your returns year after year. does astonishing things to your balance. About all you can do is adjust your plans to give your investments more time to grow. When you finish this seminar. (Here's a nifty table that demonstrates just how much difference a higher growth rate makes over time. you will know how to match the growth rate of the market (which will beat most mutual funds and professional money managers).) How fast your cash piles up depends on three factors: time. It's never too early and rarely too late to begin! Growth rate: We'll tackle this in an upcoming lesson. plus a small guaranteed return (interest). but you aren't even guaranteed to get your original investment back. which over the last 75 years has averaged a return of 11% per year. So don't put off learning about and starting investing.S. Not only do they not have a guaranteed return. But Fools aren't that fond of interest per se. and savings: • • • Time: You have very little control over this. Government bonds and bank accounts are risk-free. You know you will get back what you invested (your principal). growth rate. And that's the secret -. (That return was quite a bit higher in the '80s and '90s.
Then. Stock!" Assignment 1: . investing in stock. What We've Covered So Far • • • • We introduced the topic of financial independence and described what you should expect to get out of this seminar. Lesson Resources • • • Table illustrating the power of compounding.it's not like we haven't given you enough to do. illustrating how modest amounts of money can grow to large amounts over time. If you need motivation. The main point: For long-term investments. "Stuff vs. we will look for ways to wring more money out of your (yeah. stocks are the best place to be. check out our "Power of Saving" table. But you might want to keep them in mind for after the seminar. Danko Learn to Earn by Peter Lynch Homework You've managed to make it through the first lesson. may we recommend a few books that many of us have found both useful and inspiring? You don't have to read them now -.the next lesson. yeah. Stanley & William D. We discussed the importance of saving and offered some examples of how not buying some stuff today can lead to piles of wealth tomorrow. we're going to take a little time to examine the consequences of choosing to spend money on stuff vs. All together now. Table illustrating the power of saving. we know) already impossibly tight budget. We rhapsodized over the power of compounding. but now it's time to really start learning by putting what you've learned into action. Table illustrating the power of growth. For further study. • • The Millionaire Next Door by Thomas J. We helped you set some expectations by showing you the returns of stocks and bonds over the last 75 years.
way too many shoes! -. Now write down the cost and. how many shares of Cisco could we have bought three years ago with our $500. so try to avoid purchases made within the last year. condo. But it's not. but the stock has split six shares for one since that time. houseboat. unused item. Your list may look something like this: • • • Mondo-screen TV (for watching PBS. or whatever dwelling unit you call home.$200 every year for the last 10 years! (No snickering! Some of us just like shoes!) Let's start looking at the choice we didn't make when we bought our TV. Ballparking it is fine for this exercise. Just curious -. and make a list of purchases you made several years ago that you really just don't need or could have done without. your $500 would have bought about nine shares at $58. So. we could have purchased approximately 50 shares of Cisco (ignoring commissions -. if possible. We didn't choose to buy stock in Cisco or eBay or Kodak.. apartment.300 TV? (What.Part 1: Walk around your house. Fools look at stock investing over the long haul.about $10 at a discount broker).$500 in October 1998 Lunch every day at McTaco Hut when leftovers would do -$1. at the beginning of 1998 you could have bought Cisco Systems for about $9. It's sitting in the living room.68 per share. and what would those shares be worth today? Stroll over to the Historical Quotes page at Yahoo! to determine how many shares your $500 would have bought at the beginning of 1998 and the value of those shares today. Cisco traded at around $26 per share. of course!) -. In late February 2001 (when this lesson was being prepared). When you look up historical stock prices. the year you bought that unloved..495 every year for the last five years Shoes. let's see. so let's call it an even $10 per share. it's not high definition?) (Note that the historical price for Cisco has been adjusted for subsequent stock splits.06 per share.300 that could have been sitting nicely in our brokerage account. so your nine shares would now be 54 shares. With our $500. you usually get "splitadjusted" prices that reflect splits and can therefore be compared . In reality. Using our example. log cabin. So 50 shares x $26 = $1.are those Frasier reruns really better on a $1. Remember.
It's not critical to master now. This is where we get personal.11 = $684 Next time you're thinking about whipping out your credit card to buy something.000 portfolio Time Left to Save 3 years 6 years 30 years . If this talk about stock splits is confusing you. Or. Be realistic. if you don't have any favorite companies. Assignment 2: We're going to start a project here that you will use throughout the seminar. so write neatly and put some thought into it. remember that stuff loses value.) Now take your list and run that Cisco exercise for each purchase and see what that purchase would be worth today if you had instead invested in a favorite company.000. put the credit card down and step away from the store! 'Nuff said. but stocks often gain value. All of them. Make a chart like this: Goal Trip to Europe College for Kenny Retirement Cost $10.just get them down on paper. don't worry about it and move on. Fool. What are your savings goals? Need a down payment on a house? College tuition for your little ones? Planning a trip to Australia in a year or two? Thinking about retirement? Part 1: List your goals. it would look like the stock had actually fallen in value from $58 to about $26. stock. when instead it rose from roughly $10 to $26.11 = $616 $616 x 1.000 per year/4 years $1. but be ambitious.directly with today's price. Stuff vs.000 $5. If the Cisco price weren't split-adjusted. Don't worry about how to reach the goals yet -.11 = $555 $555 x 1. just multiply the purchase price by 11% (the stock market's average return) for each year: $500 x 1. Also write down how many years you have until the expense hits and approximately how much money you think you will need.
here's my list.This homework has no wrong answers. Whoa! Health Rider (remember them?). I wasn't a very sophisticated investor. It's embarrassing.80. In 1996. but I'll share it. This could have been a good purchase -. 9. So my $250 would be worth $500 bucks.50 a share -. Glass-topped dining table. Checking Historical Quotes and picking a random day in March of 1996. I sold the table and four chairs at a garage sale last summer for $35. I had a perfectly good oak table. But teachers should never assign work they wouldn't do themselves. Bopping over to quote.I bought it from a classified ad in the paper. Clicking on "Historical Quotes" for Jan. 1994. Christmas 1995. Assignment 2: .551. Some others: Bike in January 1994 for $300. It comes straight from your own experience and your life. I see that SPYs sold for around $67.50. tells me I could have bought GE at around $9. Today. I would have been better off in a bank CD. Suppose I had invested that $250 in the S&P index using S&P Depositary Receipts (SPY) (more about them in a later lesson). giving me 33 shares for my $300. I didn't plan it that way. But I hated it within a week (glass is cold and loud and usually covered with fingerprints) and. 1996 -. more important. $400.15.$250. I see that shares are selling for $135. So 33 shares bought in 1994 times today's price of $47 = $1.fool. Here are my answers: Example Homework Answers Assignment 1: OK. so at least I didn't pay full price. Entering GE (for General Electric) in the quote box gives me a quote for today of $47.com and entering SPY in the quote box. I actually bought Iomega stock at that time at (split-adjusted) $3. well. so I've volunteered my life as an open book so that you can see just how one goes about doing these assignments. a 16% increase in five years. Oh. you can't win them all. IOM sells for $4.exactly half! Hey.
used $10.000 $18.Goal Cost When needed ---------------------------------------------------Trip to Europe College for Kenny Retirement New roof SUV. I can tell you right now that the SUV will be partly financed. but not planning is a disaster. Get started! .000.000 portfolio $3.000 $5. we will be refining that list and working on ways to reach our goals. even though I know it would be better to pay cash! We all know that no plan is perfect.000 3-5 years 4 years 15 years 1 year 2 years As we go through the lessons.000/yr x 4 $1.
What Do I Want? (Stuff vs. but that's not so. but you can break this task down into manageable steps by asking yourself three easy questions: • • • Where am I? What do I want? How will I get it? Where Am I? Before you jump into the stock market. you can make your own "stuff vs. and you will not end the seminar with absolutely. you absolutely. we're only covering things that money can buy. definitely will know how to define your goals. maybe a little bit. the next step is to get your financial house in order and learn about investments appropriate for beginners. Once you nail down how you spend your monthly cash. You need to know how you currently spend your money. but that's another . compare investment types. stock" decisions to increase the money available to spend on stock.LESSON 2 Welcome back! Now that you've started thinking about your goals. This may seem like a hopeless task. let's do some hard thinking. Eternal love is a worthy goal. (Remember. a chalet in the Swiss Alps? Perhaps you just want to feel in control of your money. didn't you?) that will guide you through that process. and how much (if anything) you owe. it is vitally important to take stock of your personal financial situation. not even a little bit! OK. perfectly completed financial plans. This short seminar will be a mere moment in your financial life. a trip to Cancun. We have a detailed homework exercise (somehow you knew that. That said. But first. regardless of the pay? Are you saving for a car. It's time to put your financial house in order. and make investment decisions. Stock) A house to call your very own? Enough wealth that you can pursue work you enjoy.
Fool. can you increase your income? Get a part-time job? Get a better-paying job. We'll get into specific accounts and investments in later lessons.000 on eating out? A family can do that easily these days.) Grab your list of personal goals from Lesson 1's homework and let's refine it a bit. To make sure it's you. but first.seminar. This is where today's homework comes in. You don't have to give them up. you need to free up some cash to save and invest. let's think about different types of savings. But first.000 on shoes last year? $2. you'll be paying off your debts at a furious rate. Your Savings Options OK. if you aren't satisfied with how much you can put away. Finally. The next step is to start thinking about where to put that money. by the time you've finished all your homework. Some might just be reduced instead of eliminated. hard cash you can free up for investing. Are your goals realistic? ($1 million in three years won't cut it unless you are pretty close already!) Now. but set your sights high. Ask yourself how important that morning latte is. and pleasures are a great source for cash to invest. which of those goals are really important to you? Do you really want a Ferrari and an SUV? Go for the attainable. The Foolish Cash Uses Tally helps you see where your money is going: $1. It's really the opposite of investing. How Will I Get It? Someone's going to end up living in your dream home. Maybe skip the grande mochas for a month and buy a couple of shares of Starbucks instead. use that cash to pay down high-interest credit card debt and any other consumer debt before you start investing. sucking your money into a black hole that often just gets bigger and deeper. but you do have to think about them seriously. Scrape up cash everywhere you can. or at least a raise? Maybe it's time to dust off the resume or go for additional training. . Here are a few suggestions on how to approach debt and interest. and you'll have a general idea of how much cold. Debt is the biggest thief of investment capital we know of. Single? What's your bar bill? Everyone has their pleasures. One thing is certain: You won't reach those goals if you don't plan for them and put that plan into action.
You need to treat short-term and long-term savings very differently if you expect the money to be there when you need it. that family reunion cruise. If you are in doubt about this. Of course. Short-term money should also include an "emergency fund. .Not all savings are alike. you have some flexibility here. such as retirement savings. but we don't advise taking chances with essential expenses. Time Frame Short-term (up to 3 years) Mid-term (3-10 years) Long-term (more than 10 years) Investments to Consider Risk-free investments Mix of risk-free investments and stocks Stocks Short-term expenses are major expenses planned for the next three years -. As the time for the expenditure draws near. the cash for his freshman year college tuition might get moved out of stocks and into a bond that matures in three years. The only appropriate investment for short-term money is one that does not risk your capital such as bank savings accounts and certificates of deposit (CDs). you simply switch cash from stocks to a riskfree investment. we think that there is only one good place: stocks held directly or through a mutual fund. or short-term bonds that mature when you expect to need the cash." in case you ever find yourself sans paycheck. Lots of folks will leave the money in the market until Junior is dragging his footlocker down the stairs. perhaps college tuition. You could get hit with another year like 2000 and find your tuition fund 20% short. Years like that aren't predictable. depending on how much time you have and how much risk you are comfortable with. but they hit often enough to keep us on our toes and out of the market with our must-have money. revisit Lesson 1. money market accounts. Money for mid-term goals can be in risk-free accounts or stocks (or a combination of the two). A single person with generous parents will need less in emergency cash than a single parent of three small children. Here's one way to define the appropriate investment types for your personal schedule. For long-term money.a down payment on a house. So if Junior is 15. but a cautious benchmark would be three to six months of living expenses.
you should profit handsomely. Remember that you needn't charge full-blast into stock investing. You can ease into it.and not just in their early years. If you find great companies and remain invested in them for as long as they remain great companies (ideally. Real success is measured over years or decades. Success: • • • If you keep reading and thinking and questioning and learning throughout your investing career. Over the short term. But carrying through with it can be easier said than done. The stock market might not gain much new ground for several years -. Expect to miss out on some great bargains because you waited too long. But over the long term. You'll make mistakes. Mistakes: • • • Don't expect to have a pristine trading record. you're likely to get better at it as time goes by. You can move some of your • .that's happened before. anything can happen. Expect to sell some stocks too soon and some too late. Be prepared with some perspective. Remember not to judge your results on a short-term basis. Take the time to reflect on your decisions and purchases and learn from any regrettable moves. You'll have some down days and even some down years. you may find that some unexpected developments set your heart beating faster. Here's what you can expect from the stock market: Volatility: • • • Stocks can zip up or down quickly. As you begin actually investing.Setting Expectations It's one thing to have a plan. The upside of mistakes is that you can learn from them. decades). the stock market has steadily advanced (just not in a straight line). Expect to buy some that you never should have bought. Even the best investors have made a bunch of mistakes -. not weeks or months.
But when the Dow is at 10. A 100-point drop was a big deal when the Dow was at 1. If your moolah is invested in stocks for just a few months. many investors get anxious. Don't Panic During market downswings. Anything can happen in the short term. remind yourself of this. Here's when you might have cause for concern.000. • • • When the market tanks When a stock they own tanks When people around them are panicking None of these are particularly good reasons for panicking. (Don't worry. When you haven't learned that it's the percentage of the market drop that counts. stocks in great companies and the market as a whole tend to rise in value. 100 points is just 1%. though: • • • • When you don't know why you own the stocks you own. This is often the worst time to sell.money into stocks incrementally. To keep your blood pressure down during market slumps. People tend to panic. not the points. any money you expect to need within the next five (if not 10 or more) years should be out of stocks and perhaps in CDs or money market funds. When you have a short time horizon. An informed investor should have a good handle on her investments. As we mentioned earlier. Only do what you're comfortable doing. then go ahead and begin hyperventilating right now. We can help you learn how to evaluate companies. in which case you should hang on. Here are some pointers on the fine art of avoiding panic. If you have no clue why you ever bought shares of Rubber Chicken Catering Co.. Even stock in wonderful companies can temporarily freefall.. From decade to decade.) When you don't understand the long-term upward trend of the market. you'll have a lot of trouble determining when it's the right time to sell. wondering whether they should follow the crowd and bail out on some of their investments. Or it might be due to some serious trouble at the firm.000. Did CHEWY shares just take a nosedive? It might be due to some fleeting market misunderstanding. (ticker: CHEWY). .
So far you are: • • • • • • • Tallying your current uses of cash Making some "stock vs. Well-informed Fools will rarely panic.e. Lesson Resources • • Foolish Cash Uses Tally (i. only to quickly unload at the first sign of trouble. All that trading will only make your broker rich. as they present good buying opportunities.) What We've Covered Let's do a quick review of how you will get your financial house in order. (If you're like us. stuff" decisions to free up cash Managing your necessary debt to pay the lowest interest rates possible. . Read up on investing. and start building up savings Defining your savings goals Defining the timeframe in which you expect to need your savings. on a hot stock tip. but fortunately.• When your investing is mostly influenced by fear and greed. so that you keep your wits about you through market ups and downs. Budget) Quick Tips on Paying Down Credit Card Debt Additional Resources • • • The Motley Fool's Investing Basics The 13 Steps to Investing Foolishly The Motley Fool's Credit Card Debt area Homework You're getting a lot of homework for this lesson. Expect occasional market slumps and surges. You don't need to finish it all overnight. this is a self-paced seminar. you may find yourself licking your chops at some falling stock prices. The more you learn. thus freeing up more cash for investing/debt payoff Using this cash to pay off high-interest debt (if you have any). the less you'll panic. Don't be one of those people who eagerly snap up shares of companies they've never heard of. Preparing to invest while developing realistic expectations. pay off any other consumer debt.
coffee. Take all the time you need to really think through how you want to change your spending habits and what you want your goals to be. breakfast. Any time you make a cash purchase. lunch. Make a list of stuff that you might be able to do without in order to free up cash for investing in stock. dinner. You need to have your goals and plan in place before you start investing. Assignment 1: Get started on your Foolish Cash Uses Tally (i. Set up general categories for the items on which you spend money (newspapers. though.Definitely get started now. For the first assignment. Assignment 2: We've shared our "stuff vs. groceries. It does . but you only have to do it once. what's your plan for paying it off? Formulate a stepby-step plan and write it down. This is tedious. Begin analyzing your spending and making some decisions. Then stick to it. stock" thinking to help you examine your past spending decisions. to see where your dollars really go. Make sure you include your cash expenses in your calculations. Once you've done that. consider it completed if you've broken out and tallied several months' worth (ideally three to six months) of expenses. For about a month.and keep it up for the rest of your life. Assignment 3: If you have debt. either. there's no right or wrong answer. if not fascinating. gas) and then tally the spending within each category.) It should actually be eye opening. (And it's not that painful. but you'll probably find yourself surprised by how worthwhile it is.e. movies. you'll want to start thinking of ways to reduce some expenses in order to generate additional funds for savings and investments. This can look like a painful and boring exercise. but not before you start learning about investing. keep a 3x5 index card or a small notebook with you at all times. budget). Sample Homework Answers Assignment 1: As with most of our assignments in this seminar. Assignment 2: Getting Foolish with your money means making better choices. record it. Start the saving process now -.
also list the date you're scheduled to complete your payments. student loan. right near my gym) that only charges $15! That's $396 in savings for my Roth IRA (or 20% of my annual contribution). right near my home). but it will help you to pay less interest on that balance. but focus any payments beyond those on the creditor . and it turns out it stops one block from my office. but on cold or rainy days I drive in and park for $8. Rank the debt in the order in which you want to pay it off. my quality of life is just as good. Here's how I've been maintaining a happy lifestyle while socking away some savings: • I'd been paying $48 for my monthly haircut (a sorta fancy place. This won't reduce the principal balance that you owe. Maintain the minimum payments on all your debt. and my hair still looks great! I generally walk to work (which I love!). They're sitting in my hall closet. which means you will end up paying less to the creditor. I've now found a new place (definitely no frills. which is even closer than the garage.50 a day. and that's the direction I want to go. outstanding balance. car loan). but that's still stuff out and stock in. and minimum monthly payment. Recently. Since they were used when I got them. Debt with the highest interest rate comes first. interest rate. I'll save around $250 in parking expenses this year. I'll probably only be able to get about $75 for them.not mean living your life in a dank basement eating cold soup! It just means making some adjustments in your spending habits and focusing on long-term plans as well as today's needs and desires. list every creditor. I looked into the schedule of the bus that goes right past my home. and still have the used set I started with. I spent about $300 doing this last year. Use this "Tips on Paying Down Credit Card Debt" link to see if you can reduce the interest rates that you pay on any of your debt. and I haven't cut out any fun at all! Assignment 3: On a sheet of paper. • • So. and for those debts with a fixed term (mortgage. I'm a little more than one-third of the way toward my annual Roth IRA contribution. I bought new golf clubs last year.
charging you the highest interest rate. Paying down one debt at a time (while remaining current on all bills) can make the task of eliminating all your debt more manageable. . such as overdue utilities. When you have paid off your high-interest debt. which would take precedence. start pouring this money into your investments! (Low-interest mortgage and student loan debt should not keep you from investing. When this debt is paid. move down your list to the debt with the next highest interest rate.) This assumes that you do not have any pressing debt.
and which were overpriced at another -. We present to you. Disney.trying to guess where the market was going or which companies were better buys at one moment. McDonald's. the closest thing yet devised for getting the full value of the stock market into every man. investors could participate in the successes and failures of the 500 biggest companies in America. Instead of hiring expensive well-dressed managers to actively buy and sell stocks -.LESSON 3 So far you've seen the value and importance of defining your goals and designing a financial plan to reach them. Most major American companies that you can think of are part of this massive index." an investor in this index fund would automatically match the market's return.this mutual fund would simply buy all the stocks in the S&P 500. could also be the last. Wells Fargo. Johnson & Johnson. He suggested creating an extremely low-cost mutual fund that would not even attempt to beat the returns of the entire stock market (as measured by Standard & Poor's 500 index). Schwab. Xerox. woman. We're going to give you the one-stop shop for a lifetime of successful investing. Hershey. That way. Sears. Since the S&P 500 index is widely regarded as "the market. a man named John Bogle presented a then-radical idea to the board of directors of the newly formed Vanguard Group (a mutual fund company). or child's investment account. PepsiCo. In case you're curious. What's an index? It's a list of companies that represent some aspect of the market. Coors. we look at what should certainly be the first stop for all investors -. Wrigley. An index could . Whenever you read or hear the words "index fund. Intel. Toys R Us..an investment that. In 1975. Safeway. Texas Instruments. Boeing. Sara Lee. the S&P 500 includes companies such as AOL Time Warner. Cisco. Marriott. Pfizer. Ford.. Exxon Mobil. Walgreen. Wal-Mart. Waste Management. Lockheed Martin. Gillette. index investing. In this lesson. for most investors. Oracle." what's being discussed is a mutual fund that buys just the stocks that are listed by an established stock market index. Let's back up a second now in case we're getting ahead of anyone. Gateway. Motorola. and Yahoo! And that's just a small part of its holdings.
the index goes down by the same amount. or index shares. Now known as exchange traded funds (ETFs). Like the first index fund. Instead of owning a share of a company or a mutual fund.) So when you hear that the Dow gained 120 points. for example. When you buy shares in a mutual fund. this approach to index investing works much like a mutual fund.2%. When the average value of the companies in the index goes up. they quickly became known as Spiders and trade on the American Stock Exchange . Now. that means that the average of the prices of the 30 companies that make up the Dow Jones Industrial Average went up 1. Dubbed SPDRs (for S&P Depositary Receipts). To back up further still. you own a share of that block of stock (known as a "depositary receipt"). the American Stock Exchange introduced a new kind of index investment. So if you buy even one share of the Vanguard 500 Index Fund. Then. the index goes up by the same amount.attempt to measure the whole market. some part of the market. or 1. (It can get more complicated than that. you are a shareholder -. When the average value of the companies goes down. to make investments with that money. but essentially the value of the index rises and falls with the value of the companies that comprise the index. the first index share was based on the S&P 500 index. but eventually it dawned on the industry that John Bogle was really on to something -. in 1993. let's make sure everyone understands that mutual funds are companies set up to receive investors' money.S.2%. onward! The Vanguard S&P 500 index fund chugged along for years. except that the shares are traded on an exchange just like stocks or closed-end mutual funds An index share represents partial ownership of a huge block of stock that duplicates the composition of a particular market index. but you are also an indirect owner of the companies that the fund has invested in. you own a tiny piece of the 500 of the largest companies in the U. spawning an occasional competitor and getting modest attention.especially since most actively managed funds continued to lose to the overall market year after year. and then having received it. The index's value is generally the average value of these companies. you own a piece of every company that makes up your fund's index. If you buy an index fund.an owner -of that fund. but it's always a group of companies with something in common. a specific industry. or a foreign market.
and. and more are planned. and thus better choices for most investors. You've got to hire somebody (usually a team of people) to do all that guessing and stock picking for you. less than 10% of U. stock mutual funds that have been in business for at least 10 years have actually beaten the S&P 500 over the last three-year. Actually. according to Morningstar.com.you own both the index share. They have ticker symbols so that you can easily get quotes on their value and see their performance history. a small piece of every company in that index. but they can be harder to find. monkeys randomly selecting stocks have fared better than professional money managers. trying to outguess the market. not beat it. and 10-year periods." and in a later lesson we will discuss the pros and cons of each. And then. five-year. We will refer to both index funds and index shares as "index investments. better performers than most actively managed mutual funds.) Odd as it seems. the market.under the ticker symbol SPY. you've got to hire another bunch of people to advertise the myth that the . costs serious money. But. on many occasions. Today there are dozens of index shares available. aren't you supposed to aim high? How can an investment that aims for mediocrity be such a good idea? Why It's Not Easy Being a Mutual Fund Manager You might think that just throwing darts at the newspaper stock listings would produce market-matching or market-beating results for at least half of those who try just by sheer luck. too. either by trying to determine which way the entire stock market is heading or by picking the companies expected to go up the most.) Once purchased. Its goal is to match the performance of the index. ironically. Index investments. Index shares can be purchased from any broker just like stock. Their price rises and falls with their index. on top of that. The crucial thing that distinguishes an index investment from a managed mutual fund is that the index investment simply owns all the stocks that make up the index rather than attempting to pick the best stocks. are. The problem is. indirectly. with their firm ambition to match. gee. (Index funds have tickers. index shares function just like shares in an index fund -. (We're not making this stuff up -check this out. not beat.S.
Why Do Managed Mutual Funds Do So Poorly? Let Us Count the Ways Expenses First.) By comparison. Just to cover that expense fee. Don't get on that boat. your balance would have been a shade over $135. That's the average amount that a fund charges its shareholders every year to cover salaries.5%.a very difficult task. the majority of investors who have attempted to beat the market using mutual funds with money managers at the helm have failed to attain the average returns of the market. So what does this mean for you? By far.particular guessers you've hired have particularly good crystal balls so that people will give your guessers lots of money to invest. the stock market as measured by the S&P 500 index provided an annualized return of 17. glossy brochures. expense ratios have been rising.18%.000.000. . During the study period we mentioned above.000! And that gap continues to widen. they have to beat the market by 1.5%. Had you invested $10. The amount of money this has cost them is staggering. there is the expense ratio of the average fund. making beating the market -. but year after year. and TV ads.000 in 1984 in an average mutual fund. With all these people. High expense charges are the biggest handicap for fund managers. (Over the last couple of years.12%.7%. and the expense ratio for Spiders is 0. it adds up. This means that for a $10. But that's not the only problem these poor fund managers have to face. the market-matching account would be more than twice the size of the average mutual fund-matching account. versus just $18 for the year to the index fund or $12 for Spiders.7% underperformance for the average mutual fund. After 25 years. That might not sound like much. From 1984 to 1999. compared with just 15. That's a 2.000 investment. you'd fork over $150 per year to the average mutual fund (one that doesn't perform as well as an index fund). and the average currently stands at 1.or even matching it -. But had you matched the markt with an index fund. But those costs severely handicap the poor money managers. the costs can add up pretty quickly. the average expense ratio for a managed mutual fund was about 1. by the end of 1999 your account would have stood at a respectable $93. That's a difference of $42.2%.0% for the average diversified mutual fund. the Vanguard S&P 500 Index Fund expense ratio is 0.
6% of annual underperformance." Any stock sold at a profit results in capital gains. but major selling only takes place when the index is changed. No matter who you are. which are taxed. low-return investments are where the funds park their cash waiting for the "right" time to buy.6% lost to cash inefficiency kick in. all S&P 500 index funds will buy proportionate shares of Company XYZ and sell the stock it replaced. when Company XYZ is added to the S&P 500. selling or buying to keep their holdings in the right proportion to each other. Index funds have much less turnover each year than most managed mutual funds. but index funds are very tax efficient.5% loss to expenses. though. They might do a bit of balancing on a daily basis. That's right. even fund managers who are skilled (or lucky) enough to have picked stocks that matched the market's performance are 2. This practice. . and 0. Taxes And then there are taxes.Turnover Many funds buy and sell their holdings at a rapid pace. but few of them manage to get the cash into the market at the optimum time. Currently this turnover of stocks occurs at an average rate of 85% per year. buying and selling stocks is not free.7% loss to turnover. The transaction costs involved in buying and selling so many shares every year result in an additional 0. All that buying and selling generates "taxable events. This doesn't come out of the fund's stated returns like the factors discussed above. but it does come out of your pocket (unless you are investing in a tax-advantaged account like an IRA or 401(k) plan. Treasury bills. the average fund buys and sells almost as many stocks as it owns (typically. known as "market timing. For example. and they think they need these reserves to buy into the market when it is underpriced.8% behind.) Mutual funds range from pretty good to abysmal when it comes to tax efficiency. There are always trading costs involved. 0." is expensive. Add it all up and you see that after the 1. and bonds? Those safe. Remember how the market outperforms CDs. This doesn't happen too often. They feel that they need some cash on hand to cover a potential imbalance between cash flowing into the fund and cash demands when investors sell.7% of your money disappearing into some broker's pocket every year. This holding of cash reserves by mutual funds results in another 0. Cash Reserves Fund managers typically hold about 8% of their portfolios in cash reserves. many billions of dollars worth of trading).
an investor stands a better chance of earning a million dollars as a contestant on Survivor. Consider this example. that number drops to -.000 mutual fund investment made in 1950 with returns mirroring the S&P 500 would be worth over half a million dollars today. and low expenses. such as Vanguard. There are plenty of pretty much identical funds with very low fees.) Some index funds charge high maintenance fees and/or commissions (loads). You can authorize a regular automatic withdrawal from your bank account and the money will go straight into your fund. The have low annual expenses.000.Did you get all that? We sure hope so. They typically have no loads or sales commissions. If the fund is not meant to be tax efficient. before you start shopping for the yacht. Without paying attention to costs. rather than the returns of average mutual funds. from a recent speech by outgoing SEC Commissioner and friend of the individual investor. conservatively a little under 2%. Just avoid those funds." The Pros and Cons of Index Funds Pros: • • • • They outperform the vast majority of managed mutual funds.index funds can capture most of the gains the stock market generates because that's what they are designed to do. They have virtually no cash reserves. that figure is reduced to just $230. . very low turnover.000. Arthur Levitt: "A $1. remember this much -. Matching the returns of the stock market. But if not. So you can add small amounts to your holdings regularly without paying sales fees. But. (You may need to buy into an index fund directly from its company. After you figure in the compounding costs of mutual funds. plus they don't have hotshot managers guessing what the next hot stocks will be. there's still a bit of math to do.if you can believe it -.just $65. You don't even have to lick a stamp. means a lot over time. Cons: • • Not all index funds are available from every broker or fund company.
no-brainer place for long-term investment money. index investments represent the best.thereby generating commission charges and taxable gains. This can be a real eye-opener. Index funds and index shares can essentially match the performance of the stock market at a very low cost to you." Its value rises and falls with the index on which it is based. They charge you a lot in fees and sales loads. For anyone who isn't yet ready to select their own individual stocks in which to invest or anyone who has no interest in picking individual stocks.What We've Covered So Far • • • • • • • • • Index funds are not actively managed. You will find a fairly comprehensive list in our Index Center. They simply own the stocks that make up a certain index. as opposed to trying to beat the market. Index funds typically have no loads or sales commissions. Total market index funds outperform the vast majority of managed mutual funds. Index investing is a monument to the wisdom of fully participating in the stock market. Mutual fund managers face an uphill battle trying to outperform the market average. Lesson Resources • • • Index Funds. and they buy and sell very frequently -. then pick a few that look interesting and call the company to get their average annual return for the past five and 10 years compared to the average annual return of their underlying index. The performance of an index investment is not dependent on a money manager selecting the "right stocks. So you can add small amounts to your holdings regularly. Index shares are purchased from a broker for the broker's standard commission. . they keep a sizable portion of their money in cash.com More on Mutual Fund Fees From Morningstar The Truth About Mutual Funds Homework Assignment 1: Compare historical performance among several index funds. Check out how they have performed for the last few years.
62% 15.13% 17. .29% Assignment 2: Pick a broker or a fund company and investigate the index funds available through that broker or company and what it would cost you (if anything) to buy an index fund through the brokerage. S&P 500 Index Dreyfus Basic S&P 500 Index Vanguard Total Stock Mkt. be sure to ask if they apply to future deposits as well as the initial deposit. back to the fund's start. Ask about all costs associated with the fund. and commissions. loads. I clicked over to the Fool's Index Center as the starting point for a source of information on index funds.35% 15. If there are loads.2% or less. That gave me the following funds: • • • • • • • • • Ssga S&P 500 Index Fidelity Spartan US Equity Index USAA S&P 500 Index Vanguard S&P 500 Fidelity Spartan Market Index Schwab S&P 500 Select CA Inv. Last 1 Year Return (2000) Last 3 Years Returns (1998-2000) Last 5 Years Returns (1996-2000) Last 10 Years Returns (1991-2000) Last 15 Years Returns (1986-2000) Last 20 Years Returns (1981-2000) Last 25 Years Returns (1976-2000) -10.91% 18. There are no absolute solutions to this homework. I narrowed down the list to funds with an expense ratio of 0.02% 11. The "answers" below should be considered as examples. Sample Homework Answers Assignment 1: We thought we'd have a beginning investor go through the homework assignments.93% 15. including expenses. The fund companies should have comparable index returns for each fund.Here are recent average annual returns for the S&P 500 index to get you started.
So rather than calling them on the phone. I therefore chose three and five years as my comparison points. I visited www.com and found the following information: AVERAGE ANNUAL RETURNS Vanguard S&P 500 5 Year 18.33% 17.) • • • Wilshire 5000 Total Market Index Vanguard Total Stock Mkt USAA S&P 500 Index Since USAA S&P 500 is restricted to military personnel.000 or less.68% (Note: The Vanguard Total Stock Market fund has not been around for 10 years. (Note: Initial investment requirements are lower for IRA accounts. I found myself in need of a good starting point. It turns out that Vanguard has a very nice website that contained all of the information I needed. I used the Fool's Discount Broker Comparison Table to choose a broker.vanguard.92% 5 Year 16. leaving me with two funds. Looking close to home.35% S&P 500 5 Year 10 Year 18.77% 5 Year 16. I am sure there are many other sources with more . Anyway. I eliminated it.68% Wilshire 5000 Total Market Index 3 Year 10. Assignment 2: Again. these are only two of a very large number of funds to choose from.46% Vanguard Total Stock Market 3 Year 10. I narrowed the list even further to those requiring an initial investment of $3.31% 10 Year 17.) Both funds compare well with the average annual returns of their underlying indexes.Since I don't have a lot of money sitting around. leaving me the following funds to choose from.
The commission to buy a no load mutual fund through Ameritrade is $18. I then visited their website to look for costs associated with buying an index fund. Out of the list. I randomly chose Ameritrade.) . (Note: You can also buy most no load mutual funds directly from the mutual fund company for no commission.comprehensive lists. but as a beginner. I honestly didn't want to have too many choices.
Mutual fund managers have been gnashing their teeth over their inability to beat the average return of this index.the Vanguard S&P 500 Index Fund that we discussed in the last lesson. so owning different indexes can possibly smooth out your returns from year to year. That's the theory anyway. but if you want some possible protection from market volatility.there are about 9. five. For beginners though. If you name a measurement of the market or some segment of the market. There is no evidence that after a few decades you would end up with more money in your account if you decide to diversify beyond the S&P 500.LESSON 4 LESSON 4: BEYOND THE S&P 500: SELECTING YOUR INDEX INVESTMENT Introduction Index funds have gathered a lot of attention over the last couple of years for good reason.000 small-company stocks). and the Dow Jones Industrial Average (the 30 stocks that make up the Dow). adding some smaller. But index investing is by no means confined to the S&P 500. The S&P 500 has outperformed more than 90% of all domestic equity mutual funds over the past three. the Wilshire 5000 (pretty much the entire stock market -. and ten years. specialized indexes is not a bad idea. started by John Bogle at Vanguard all those years ago -. against which their performance is usually judged. small-caps have tended to flourish when the big companies were slow. International markets also don't always move in lockstep with the U.000 publicly traded companies. but the "Wilshire 8. There is a case to be made for buying more than one index. The advantage of adding a small-cap index or an international index is that historically. The best-known index investment is the very first one. market. then somebody has probably slapped an index fund or an index share on top of it: the Russell 2000 (an index of 2. just to name a few of the big ones. we suggest sticking with one of the broad-based indexes while you study your other choices. .S.723" just doesn't sound right).
but this proliferation of products threatens to turn a simple investing decision into a mass of confusion. the lower expense ratio that index shares offer will offset your commissions fairly quickly.Which Index Investment Is Right for You? Even if you limit your choices to broad-based indexes. Spiders (the S&P 500 index share. The American Stock Exchange Index Share website lists many more. Our Index Center will give you an overview of some of the more popular indexes. but for any given large purchase. Take a quick look at each page. remember) have lower expenses than the Vanguard 500 fund. but if you tend to make large deposits (more than $2. each with its own index share. If your style of investing tends toward making frequent small investments. Index Funds or Index Shares? Index Funds . For large purchases. but Spiders are traded like stock and incur a commission each time they are bought or sold. The S&P 500 has been the best performer over time and we suggest that it is a good choice for almost anyone.000).S. you will definitely want to go with a fund to avoid monthly commissions. the more costeffective index shares are versus an index fund. Still. As a general rule of thumb. the lower annual fee will wipe out the effect of the commission in a year or two. Funds don't charge you to buy more shares. market and will let you participate in the economic growth of our country. the differences are not great. While we wouldn't want to discourage anyone who has a passionate desire to own the Russell 3000. those commissions could be a deal killer. there remains the question of whether an index fund or an index share is best for you. but if you plan to make frequent small deposits. we think that dithering over the choice of indexes is a serious waste of time. the larger each purchase is. Both indexes track the U. Another good choice would be the "Total Martket" index (often based on the Wilshire 5000 index). Whew! Index investing used to be pretty simple. you still have a number of products to choose from.
Lower management fees.35% 0. Some may charge high maintenance fees and/or commissions (loads).50% 0. Cons: • You pay a commission each time you buy -. Index Shares (or Exchange Traded Funds) Pros: • • Can be purchased like stock from any broker (setting up a brokerage account instead of a mutual fund company account gives you more flexibility later if you want to move into stocks).funds are great when adding small amounts frequently.18% 0. with some info on them. Where to Find Index Investments Here's just a smattering of some of the many index funds available. $3.500 Vanguard 500 Index Schwab Total Stock Market Index Inv.500 Annual Fees 0. this would be a deal killer. Automatic investing -.Pros: • • Usually no commissions -.40% Phone # 800-373-9387 800-435-4000 800-662-7447 800-435-4000 Schwab S&P 500 Inv. as of mid 2000: Ticker Name of Fund Symbol PEOPX SWPIX VFINX SWTIX Dreyfus S&P 500 Index Initial Deposit $2.if you are investing small amounts frequently.500 . $2. You don't even have to lick a stamp.you can authorize an automatic withdrawal from your bank account and the money will go straight into your fund.000 $2. Cons: • • Not all funds are available from every broker or fund company.
. Total Market Ticker SPY DIA QQQ IVV IYY Index Tracked S&P 500 Dow Jones Industrials Nasdaq 100 S&P 500 Dow Jones Total Market Index (These ETFs all trade on the American Stock Exchange.can deliver great results to the long-term shareholder.or at least they should keep costs low.any index fund -.) A Final Word: Watch Those Fees! Watch carefully what some companies are selling as "index funds.nearly eight times as much! When Morgan Stanley sells you an index fund.000 Market Index Wilshire 5000 Index Portfolio $1.20% 0. on the other hand.VTSMX WFIVX Vanguard Total Stock $3. We deserve the other 1. runs an S&P 500 index fund (buying the exact same stocks as Vanguard's fund) with annual costs of 1. because index funds keep costs so low -. "You should be happy with only 98.55-0.000 0.S.5% of your money still in your pocket every year." Just say "no thanks" to that. Full-price brokerage Morgan Stanley Dean Witter.82% of that money keeps working for you." The real point of investing in index funds is not to try to pick the "hot" index (or the "cold" index before it gets hot). Most index shares have similar expense ratios.18%.5% for doing such a great job. The Vanguard 500 Index Fund has annual costs (the expense ratio) of roughly 0. That means that when you put your money into the Vanguard 500 Index or an index share. Putting your money into an index fund -.70% 800-662-7447 888-200-6796 A Sampling of Index Shares These can be purchased from any broker simply by specifying the ticker symbol.5% -. it essentially says. about 99. Name Spiders Diamonds Cubes iShares S&P 500 iShares U.
Easy homework this time. would simply be. Many banks offer index funds with high expense ratios and sales loads! The Wells Fargo S&P 500 Fund. We know of no case where the rationale for paying a load held up outside of the salesman's spiel.you still don't want to pay a big commission.75% load. that's 5. When you buy an index fund with a 5. Which One Is Best for You? American Stock Exchange's Index Shares Morningstar's EFT Center Homework Assignment Congratulations! Believe it or not.71% every year thereafter! We have just three words to say about funds with loads (sales fees): Don't buy them. the choice is simple -matching the S&P 500 is a no-brainer. "Pay this load 'cause my income depends on it.2%." Don't do it! Stick with index shares or companies like Vanguard or the many other low. Decide which index investment best suits your situation. you're halfway done. but for a beginning investor. What We've Covered So Far • • • • • Index investments are proliferating like mutual funds did in the '90s. which. use the information you gained in the last two .75% upfront sales load. low.000 at one time. for instance.75% of your money gone right there! And then Wells Fargo has the audacity to take 0.And it can get even worse.71% annual expense ratio and a 5. They expect you to pay someone to sell you a fund with an expense ratio four times that of their competition that is guaranteed not to perform as well. Don't buy funds with loads or annual expenses over 0. Index shares are more cost-effective for those who invest more than $2. An index fund is best for those who make small frequent investments. Lesson Resources • • • • The Motley Fool Index Center EFTs or Index Funds. If you feel a fund is the best choice for you. low cost providers of the world. (But use a discount broker -. has a 0.) Investigate fees associated with any index fund carefully. if honest. At least we hope it will be easy.
Sample Homework Answer Vanguard's Wilshire 5000 looks good to me. In this lesson we discuss the various types of accounts available to you.). option accounts. our grandparents drove their Chevy Impalas to the bank to do business and manually recorded their banking transactions in their savings vehicle of choice -. Once upon a time. But what kind of account -.and where? The next two lessons cover exactly that. and in the next lesson we'll go through the steps involved in actually setting up an account with a brokerage or mutual fund company. with money market accounts. and it's no more difficult to open. of course. but there's nothing romantic about the passbook. What's an investor to do? Get educated. The annual expenses are higher than some of the other choices I checked though. you need to know what kind of account you want.a passbook savings account. and the transformation of financial service institutions into one-stop shops. But before you open an account. the Internet. There . we have a virtual buffet of available choices. We might romanticize the car. Nowadays. margin accounts. bank CDs.homework assignments to select the fund you prefer. In many respects. etc. so I'm going to plan to switch to either the Vanguard 500 Index Fund or Spiders in a year or so. LESSON 5 LESSON 5: WHICH TYPE OF ACCOUNT IS RIGHT FOR YOU? Introduction Now that you know what to invest in as a beginner (and possibly forever) you need to get your money into an account so that you can buy into the index of your choice (S&P 500. the advent of the computer. It has the lowest minimum deposit and I can make additional monthly deposits at no cost. discount brokers. 11 types of IRA accounts. a brokerage account is just a more versatile bank account. Total Market.
So far. Understanding the types of accounts available will help you decide which will work best for your investing goals. you fork over your money for a specified period of time (three months. Find out exactly how substantial the penalty is in your specific case. you'll receive interest on your CD. they vary according to . brokerages. and CDs. plus accrued interest.are lots of choices -. It may be only a few months' worth of (fairly paltry) interest.). You won't get rich investing in either. If you park your funds in CDs. six months." Don't let the language scare you off -. one year. etc. Withdrawing early will get you a ticket on your windshield in the form of the dreaded "substantial penalty for early withdrawal. they are relatively safe and easily accessible. you get a certificate specifying the interest to be paid. One step up from savings accounts are money market accounts and CDs (certificates of deposit). you receive your original principal. and mutual fund companies. remember that you're committed for the term of the CD. Both are pretty safe. you can retrieve your money.S. either. two years. Money Market A money market account is a mutual fund that invests in securities such as U. When you redeem the CD. the length of the contract.if you run into an emergency and need your cash. short-term corporate debt. Because money market accounts stick to short-term.enough to drive you bonkers if you don't approach the subject with some basic facts. or if you decide to move it into the fast lane and go for a higher return. Instead. and the amount deposited. but you won't get poor. At regular intervals. so good. Yields are not fixed like they are with CDs. CDs and Money Market Accounts Let's start by assuming that you know about savings accounts and you want to do better. CDs With a certificate of deposit (CD). In exchange. low-risk securities. Both pay higher interest rates than traditional savings accounts and are offered by banks. Most bank CDs are insured by the FDIC. Treasury bills.
and brokerage accounts -. credit cards. or brokerage house. Any of the three types of institutions may offer money market accounts. mutual fund accounts. not investment income) during the year and meet certain income and age requirements. At the time of this writing. but all three are expanding their services. often comparable to a CD. and the lines between them are blurring as each organization tries to be all things to all people. and you decide which . In addition. Some banks and brokers will also offer financial planning services and mutual funds. and brokerages. Most investment accounts -. taxpayers who receive taxable compensation (meaning income from work. without the potential penalties. Retirement Accounts: IRAs An Individual Retirement Account.S. Brokerage accounts often "sweep" any cash in your account into a money market account every night so that it earns interest. Other than the tax consequences.can be designated as IRA accounts. It can be opened through a bank.. the next question is. Nothing beats earning while you're learning. is a personal retirement savings plan for U. they were hovering in the 4-5% range. many money market accounts offer check-writing capabilities. where? Your choices are banks. efficient havens for your cash.including bank accounts.short-term interest rates. mutual fund. Until you've decided which long-term investing methodology is for you. although certain risky kinds of investments may be prohibited. money market accounts are safe. or IRA.. CDs. mutual fund companies. you can open a brokerage account and earn interest in a money market account until you're ready to invest. Beyond Banks Once you know what type of account you want to open. an IRA account functions exactly like a regular account. You get a reasonable rate. Some mutual fund companies offer brokerage accounts. making them ideal holding places for money earmarked for short-term goals and emergency funds. and checking accounts. banks still have a monopoly on drive-through tellers. As far as we know. Even if you aren't ready to make your first investing decision.
That's OK though. married or not. These include SEP-IRAs and . and the income limits are somewhat higher. a Roth IRA should be the first investment account you open. you can sometimes make a partial contribution -. Traditional IRAs allow your money to compound tax-free. index shares. (If you make a bit more than that.") Annual contributions to Roths are limited to $4. the only people who should opt for the traditional IRA are those who don't qualify for a Roth.000 per year. we're pretty sure you will wish you had paid the higher taxes upfront and gone for the Roth. you will often see that described as a $8.) The traditional IRA has two advantages. For those who qualify. Contributions to a traditional IRA may or may not be tax-deductible. but you will pay far more in taxes during retirement. contributions to traditional IRAs are limited to $4. you may be tempted to choose a traditional IRA for the immediate tax savings. money market accounts. Roth IRAs are the Holy Grail of retirement investing. reducing their current taxes. but withdrawals are taxed as regular income. you can't deduct what you put in.000 limit for married couples. Self-employed people can choose from a variety of investment accounts with higher limits than IRAs. In our opinion.000. mutual funds. and the contributions are not tax-deductible like those to traditional IRAs can be. because when you retire (and under other limited circumstances).000 and couples making up to $150. but IRAs are never joint accounts. the withdrawals are not subject to federal income tax at all. and individual stocks. Looking back.investments to buy. depending on your income and eligibility to participate in a tax-qualified retirement plan through your employer. In other words. As with a Roth. Individuals contribute to their own personal account. bonds. Folks with low incomes or those who are not covered by an employer retirement plan can deduct their contributions from their income.see "IRA Contributions. (By the way. You can invest in CDs.000. If you are eligible to deduct your IRA contribution. and that's a legitimate choice. Quick Overview of IRAs The Roth IRA is fully available to individuals making up to $95. but everything that comes out is tax-free (as long as you follow a few rules).
the following might not be the absolute best route for you. we suggest investing in the order listed below. In most 401(k) plans. To make the most of the tax advantages offered through various retirement plans.the best part -. contact the 401(k) administrator at your company and ask that one be added.you can have a SEP-IRA or Keogh plan in addition to a Roth IRA. you absolutely should commit yourself to deferring every dollar you can up to the amount that your employer is willing to match. you're probably already familiar with such plans. It's free money and it grows tax-deferred -. You'll frequently find an index fund among your choices -. all the earnings on those contributions compound untaxed until the money is withdrawn from the account. your employer will give you money for doing so.if not. most or all of which are mutual funds. This tax deferral adds an enormous kicker to the compounding effect of those deposits during the employee's career. Find out if your employer provides matching contributions. offered through your employer. the employer permits eligible employees to elect to contribute a percentage of their pay (pre-tax) to a retirement account established on their behalf. They offer higher limits than other IRAs and -. but if not. You don't pay taxes on the money that goes into a 401(k). We've heard of many Fools who have been successful in getting an index fund option added to their choices. With a 401(k). and since each person's situation can be slightly different.Keogh plans. you're offered several investment choices. Max out each option that is available to you before moving on to the next. Besides getting to invest with untaxed dollars. Retirement Accounts: 401(k)s Another popular retirement account is the 401(k). If you are self-employed. If it does. There's a good chance that if you participate in a 401(k). although you will pay regular income taxes on withdrawals made during retirement. you owe it to yourself to get familiar with them as soon as possible. Note that these are general guidelines.grab it. . Many employers match a portion of the money deferred by their employees.
Almost any type of account can be designated as an IRA account. Roth IRA 3. Mid-term money can be in either a risk-free account or in stocks. Company-sponsored 401(k) with matching funds 2. Company-sponsored 401(k) with no matching funds or retirement plans for the self-employed 4.most will offer many types of accounts. Take full advantage of one if you qualify. Roth IRAs are the best thing for investors since discount brokerages. participate fully up to the amount the employer will match. The differences between brokerages. That's free money! Lesson Resources • • • • • • • • Short-Term Savings Center Retirement Plan Primer All About IRAs All About 401(k)s BankRate.1. you need a risk-free account. Comb the Web (or your local . banks. and mutual fund companies have blurred -. If you employer offers a 401(k) plan with an employer match. Traditional IRA (if you don't qualify for a Roth) 5.com About Interest Rates BanxQuote The Motley Fool Investment Tax Guide (featuring a large section on retirement accounts) Homework Assignment 1: Scavenger hunt! For your short-term savings and emergency fund. Regular brokerage account What We've Covered So Far • • • • • • Short-term savings should be in a risk-free account such as a CD or money market account.
I want to buy and sell stocks." proceed to the next question. B BRO. MFC. If the answer is "No. BRO = Brokerage Company. some MFCs BRO. I would like to open an IRA. I have some mid-range goals and would like to put that money in a CD account. For both types of accounts." check the right side of the page for the financial institution that is best suited to your needs. MFC. I need only limited check-writing capability and want my money to return the highest interest rate available. and a location convenient to my home. if you prefer) for the best rates on CDs and money market accounts.newspaper or yellow pages. B B. but feel free to use any Internet search engine. Either online or via some phone calls. I want to buy mutual/index funds from a variety of companies. 5 . I want to buy mutual/index funds from a specific family of funds. It's easy to do online. BRO. since several sites have been set up to compare rates. MFC = Mutual Fund Company 1 .com are two good ones. BankRate. BRO BRO MFC TCBY . I want to invest small sums each month directly into a mutual/index fund for low or no fees I want to eat creamy dessert treats and not gain weight. confirm the CD rates and terms. 6 . cash machine access. 7 .and longrange savings? In the following list. including the exact penalty for early withdrawal. 9 . Assignment 2: Which type of financial institution is right for your mid. 3 . If your answer is "Yes. 8 . answer the questions on the left.com and banx. B = Bank. Find three institutions that offer high rates for each type of account. confirm the minimum deposit required. MFC BRO MFC. 2 . 4 . I want unlimited check-writing.
Composite for the location box. I then selected an 18-month CD. I didn't like it that they were not upfront about the penalties. I found the early withdrawal penalties in three clicks (under "Truth in Savings").com I selected U. so at banx. Sample Homework Answers Been prowling the Web? What an amazing amount of stuff out there -. Assignment 2: 1. Yep. I sent them an email. had the best rates (annual percentage yield: 6. Here's mine. Go back to the investing goals that you wrote down in Lessons 1 and 2. and sometimes just downright frustratingly difficult to find." Write down which type of account you think would work best for each goal: money market. E*Trade Bank in Arlington. or mutual fund company. which offered 5. I have kids heading to college soon and I really do need . CD. Virginia. well. I care more about a good rate than about having this money in a local bank. They have something called a Share Certificate that also looked pretty good.000 -. The minimum is $500 and the penalty for early withdrawal is only a month's interest. so I went back to banx. Assignment 1: I have a son starting college in two years. preferably high-interest account. done that)." so I tried customer service -. 2. Well. I didn't see a category called "Penalties" or "Downsides. looking for early withdrawal penalties or some other downside. I was surprised. Add a column titled "Account. a local (sort of) bank.S.sometimes beautifully organized and at your fingertips.9%.but still no good. also with a $1. No (been there. so his first year's tuition needs to be in a safe. I clicked their logo and went to their site. Maybe I'll just stick with them.I can live with that. brokerage. NetBank looked good.0%) and a minimum of $1.com and went through the same procedure with NetBank.000 minimum. but just to be fair I also checked out my local credit union.Assignment 3: Now apply what you've learned to your specific situation. I hope your experience was good.
Assignment 3: Here are my goals from Lesson 1.3. I want to trade. What I really need is a good place for Kenny's college money. This is my wake-up call to convert that to a money market account! . 8. No. so checking and ATMs are not an issue. it's safe to say that I already have one or two brokerage accounts. No. since I can stagger their maturity to coincide with the tuition bills. Stocks -. That means I need to look for good rates on CDs.no. No. but that's already covered. 9. I am content to put my small sums in a money market account until I have enough to buy some stock. used $18K 2 yrs Money Market I hate to admit it. to get some of their money out of the market. Mutual funds -. 6. with appropriate accounts added: Goal Cost When needed Account Trip to Europe $10K 3-5 yrs Brokerage College for Kenny $5K/yr x 4 4 yrs CD College for Tory $5K/yr x 4 4 yrs CD Retirement $1MM portfolio 15 yrs Brokerage New roof $3K 1 yr Money Market SUV.to short-term money. 7.yep. 5. but I've been letting my short-term savings languish in a savings account at the credit union. yes! OK. All of my banking needs are taken care of by my credit union. what have I got here? This being the real world and me being an instructor for the seminar.nope. That's mid. 4. Well. All my bills are paid by CheckFree. Mutual funds -. check-writing is of little importance to me.
Since you probably aren't inclined or able to run down to the New York Stock Exchange each time you want to make a trade. How much of a fee? Well. and what kinds of accounts you need to get started. Since opening a brokerage or mutual fund account may be a first-time experience for you. your broker does it for you -. Full-Service Brokers . starting with: How do you go about actually opening an account? And with whom? What Is a Broker? Simply put..LESSON 6 LESSON 6: HOW TO OPEN AN INVESTMENT ACCOUNT Introduction to Brokerages Welcome back! You've learned about the importance of saving and investing. You can start the process right here online. we'll go through the process very carefully.. the best investing choices for beginners. a broker is a middleman. Now all that's left is to put your money where your mouse is and set up an account.for a fee.
more and more people have turned to discount brokers. Comparing Brokerages There are. In exchange for making trades for you -. two factors to consider when choosing a discount broker: fees and services Fees . simply because we feel that you are the best captain of your investing ship. It's hard to go wrong in choosing one. Still. and are known as "full-service" brokers.com. pioneered by Schwab. that varies according to the firm. and the information flow was choked off before the individual investor ever got near it.) How much of a discount do you get? Well.and various online tools for stock research if you want them. but you can buy or sell stock for $10 or less per trade these days. the fees were hefty. as the historical returns of "managed funds" have shown. In general. On our website. we have a discount brokerage comparison table that allows you to see some sponsoring brokers' services and fees side by side. don't pick entirely blindly. broadly speaking. These brokers still exist. Another good resource for comparing brokers is Gomez. (Discount brokerages actually originated offline several decades ago. the men were men. there really isn't that much of a difference between most brokerages. and earn the hefty fees they charge.and for throwing in some "expert advice" -. Many. Discount Brokers With the advent of the Internet.the only thing worse than no advice is bad advice!) What you get instead is the ability to make trades easily and cheaply -. don't serve you as well as an index fund would. Keep in mind as you compare brokerages that while all the apparent differences and details can seem overwhelming. the returns that you get from using "expert advice" don't come anywhere near justifying the expenses you run up for it. And. Some of them do a bang-up job for you.brokers would charge hundreds of dollars even for relatively small trades. though. Do a little research until you find an appealing brokerage that offers all you need. You don't get much (if anything) in the way of advice.In the bad old days. Just about any broker will place and execute your orders and send you monthly statements. we don't think much of most full-service brokers. (Which is good -.
you can cross off any brokerages with minimums higher than that.. If not. But if you trade twice a month.e. The Fool's Discount Broker discussion board is a good place for getting the skinny on various brokerages. you need to know: • • • How much do they charge per trade for a market order? (Don't worry about "limit orders" until you are farther along your investing road. the difference between $10 and $25 trades amounts to $360 per year. Is there an account minimum? Is it lower for IRAs? Is it lower if you agree to an automatic deposit plan? If you're flush with funds. Are there any account maintenance fees (especially IRA fees)? What about account closing or transfer fees? Compare the fees that you're likely to be charged at any brokerages you're considering.) The answer might range from $7 or less up to $30 or more. Just remember that people are far more likely to post about bad experiences than good ones! . If you only plan to trade once or twice a year. but do they also allow you to make trades over the phone -. You may also want to take a look at what customers have to say about their brokerages. Are their account statements easy to read? You may be able to view sample statements on their website. But if you've got just $1.Before deciding on a broker. this factor might not be a deal-breaker for you. the difference shouldn't matter too much.either by using a touch-tone keypad or by speaking to a human being (and how much more do they charge for these services)? Do they have local offices near you (if that's important to you)? Do they have a reasonably good reputation for customer service (i. perhaps some contenders will fax or mail you samples.000 to invest. Services • • • • All online brokers offer Web-based trading. if you need to speak to someone do you have to be put on hold for seven hours)? You can assess this for yourself just by calling or emailing each contender and asking any questions you have.
their commissions are usually significantly higher than online discount brokerages. While most mutual fund companies offer brokerage services. Narrowing down your list of brokerage contenders and picking The One. . (Hint -. a mutual fund company is a good choice if your plan is to invest only in index funds..e. Making a Choice This is the tough part. perhaps you could invest in your desired index/mutual funds through the company. But you should know what they are beforehand and compare what different companies charge. and you have no plans to branch out into stocks in the near future. The Vanguard 500 Index Fund has traditionally kept expenses extremely low and has returns at the top of the pack.there is no perfect broker!) Check out a bunch of brokerages. (At the very least. a fund company will be your simplest choice. it makes little sense to go with a mutual fund company if you have plans to invest in individual stocks as well. Questions to ask mutual fund companies: • • • • Does the fund you're interested in have loads (i.Mutual Fund Companies As we learned in Lesson 3. overall.) If you feel that an index fund is for you. While services and fees can be very important. but also open a separate brokerage account for stock investing.is it lower for IRAs or if you set up an automatic deposit plan? Are there IRA account maintenance fees? What are the account closing or transfer fees? Some fees are a necessary part of doing business. commissions) or any other fees associated with it besides modest annual maintenance fees? What is the account minimum -. We can't make that decision for you. we think it's wa-a-aay more important to get your account open and put your money to work than it is to torture yourself over choosing the perfect broker. but we know that this is often the place where people get stuck. especially if you are inclined to add small amounts to your account on a regular basis (an excellent idea!). Since you can find discount brokerages that will let you invest in mutual funds for free.
and remind yourself that you can always switch if a better deal comes along. simply call the company (many phone numbers are listed on this No-Load Index Funds Chart) to ask for an account application or go to its website where. If you're getting butterflies in your stomach. pick one with no transfer or accountclosing fees. Remember to ask for an IRA application if that's the type of account you want to open. you don't have to invest right away. Remember. and then pick one. enclose them in an envelope with a check to initially fund your account. In the DBC. Fill out a form and send them your money. Kinds of Brokerage Accounts A brokerage account application will want you to choose among different types of accounts.google. So let's review the options here. If a broker you like isn't listed there. and you'll probably be earning more in the money market account than you got in your savings account. opening a brokerage or mutual fund account is just like opening a bank account. Opening the Account Opening an account is not. in most cases. sign them. Cash Account This type of account asks you to deposit cash (doing so with a check is .make sure you understand the fee structures. look over the various services and features of interest. Although IRAs require some additional paperwork. To set up an account with a mutual fund company. You can put your money in a money market fund and let it rest a while before it's put to work in an index fund or stocks. and you'll receive confirmation of your ability to start trading in pretty short order. Try www. and that takes you to its website.com and enter the broker's name in the search box. you can print out the application forms. you'll be able to download an application. Either way. rocket science. as they say. It's not even backyard astronomy. you can click on the broker's icon. once you get to the site. it's a good bet that any Web search engine will pull up its website. Another way to open a brokerage account is to go through our Discount Broker Center.
say. etc. and can result in you losing all the money you put into them. It's not much more complicated than that.fine). or you might have to scrape together additional cash to deposit into the account. 20% of the value of your holdings is pretty risky. while below typical credit card rates. mutual funds. The interest rates that brokers charge. Although we don't recommend using margin. you can borrow from your broker in order to invest in additional stock (or even just for your personal use). (Very few stocks ever get to zero value like options can -. If your holdings head south for a while. bonds. a short timeline.) Even options on good stocks can be bad investments. In general.just don't avail yourself of the margin loan provision.) We generally counsel strongly against using margin -. you might sell some of your holdings at deflated prices in order to cover your loan. That's fine. In other words. the cash and securities in your account act as collateral for a line of credit available to you from the brokerage. make the return that you need to earn on your investments much higher than if you're investing with your own cash. you may find yourself making hefty interest payments while waiting for your investments to recover. then you'd better earn a good bit more than 9% on your investments in order to make the borrowing worthwhile. Most brokers won't let new investors open option accounts. Margin Account In a margin account. IRA Account . we're not fans of trading options because they have relatively high fees associated with them. a margin account may be required by your broker in certain cases. Cash accounts are ideal for beginning investors.and often do. we think that borrowing more than. Even if you're a seasoned investor. (Alternatively. which is a much riskier business than trading stocks. You can spend decades investing in a margin account without actually going "on margin." Option Account This type of account allows you to trade options. You can open a margin account -.at least for beginners. and then you can use that cash to buy stocks. with a margin account. so you don't need to worry about this one for a while. For example. if you're being charged 9% margin interest.
We don't counsel against this one! In fact, we think it's a great idea. The popular Roth IRA is the best option for anyone who qualifies. The process is simple, and is laid out for you in our IRA Center. Most of the tax-related work is done for you by the brokerage. (Note: Check to see if the broker charges an IRA account fee. Some do, and the service they provide is worth paying for, but some don't, and why pay if you don't have to?) Be sure to specify whether you want to open a Roth IRA or a traditional IRA. The application form for each will be a bit different. Mainly you will have to specify beneficiaries who will get the account in the case of your death. Remember, both mutual fund and brokerage accounts can be IRAs. Which Account Is Right for You? By all means, if you qualify for a Roth IRA, that should probably be your first choice. The tax advantages are so great that there just isn't any reason not to. After you've maxed out your Roth account and any company retirement plans, a plain cash account (or margin account if your broker requires it) is your next choice. Once the Account Is Open You generally go to the broker's website and log on with your account number and password. You can then check quotes, view your portfolio and account balance, and, if you like, make a trade. You can also view a history of prior trades over a given time period. If you've never placed a trade over the Internet before, you might want to choose a brokerage that offers phone trading -- just in case. A phone trade will cost more, but you also get to pick the brain of the broker. After that, the next time you trade, the online form probably won't seem so intimidating.
Once You're Up and Running: Kinds of Orders
If you're new to investing, an overview of the kinds of stock orders you can place is in order. Don't let all these details intimidate you, though. After all, you're just beginning. You might not actually buy or sell any stock for a while as you learn more. Still, you'll likely run across some of the following terms, so a few explanations might prove handy.
Market Order: This is for immediate execution at the best price available when the order reaches the marketplace. This is the most common type of order and is nearly always filled, since no price is specified. This kind of order is used often by Fools of all experience levels and it's a good one for beginners, too. Limit Order: This is an order to buy or sell only at a specified price (the "limit") or better. Limit orders are used by investors who have a maximum or minimum price at which they're willing to trade. Fill-or-Kill: This order is sent to the floor for immediate execution. If it cannot be filled immediately, it's automatically canceled. Day Order: This order terminates automatically at the end of the business day if it hasn't been filled. Good 'til Cancelled (GTC): This order remains in effect until cancelled by the customer or executed by the broker. It doesn't typically remain in effect forever, though; many brokerages cancel GTC orders after a month or two. All or None (AON): This is a limit order for which the broker is directed to attempt to fill the entire amount of the order or none of it. An all-or-none order differs from a fill-or-kill order in that, with an allor-none order, immediate execution is not required, but the broker can't break up an order for, say, 1,000 shares by buying 750 when that's all that's available, then waiting until another 250 comes on the market, possibly at a higher price. Stop Order: This becomes a market order when a specified price is reached or passed. Buy stops are entered above the current market price; sell stops are entered below it. For example, you might place a stop order to have your shares of XYZ automatically sold if the price falls below $40 per share. Stop Limit Order: This is similar to a stop order, but it becomes a limit order instead of a market order when the price is reached or passed. If you place a "sell 100 XYZ $55 stop limit" order, then if XYZ drops to $55 per share or below, the order becomes a limit order to sell 100 shares at no less than $55. These are the major types of orders. Note that some of them can be
combined. Also, understand that as a beginning investor, you can do just fine simply placing market orders.
What We've Covered So Far
• • •
• • •
Brokers mainly exist to execute your trades. There are full-service and discount brokerages. Full-service brokerages offer recommendations and handholding, and for that they typically charge you up to $100 or even several hundred dollars per trade. Since we think you should be making your own investment decisions, we favor the more no-nonsense discount brokers. They typically charge $10 or $15 or less per trade and offer an ever-increasing array of services -- including published research reports featuring recommendations. Compare a bunch of brokerages and review their fees and services. Understand that all discount brokerages are more similar than different. Don't get stuck trying to choose from among them. Choose one and get an account application. (You probably want an IRA or cash account, although you might need to open a margin account.) Fill out the application and mail it in with a check and you're ready to go! (Or ready to just leave your funds there in a money market account, earning more than they would in a bank, while you learn more.)
• • • • • • • • •
Discount Broker Center Ten Ways to Size Up a Broker Discount Brokerage Comparison Table IRA Center Mutual Fund Comparison Table Fool FAQs on margin Special article on margin Fool FAQs on options Gomez online brokerage ratings
If you've got the dough to invest, you know which broker you prefer,
Here's a of choosing a new broker. Send it in with a check to open your account. Check out as many ads as you can.Ten Ways to Size Up a Broker -. we take a page out of Nike's playbook and urge you to Just Do It! Remember that time is your greatest ally in long-term investing. I started with the Discount Broker Comparison Chart.000 in a regular brokerage more expensive discount brokers. Pick your new brokerage and fill out an account application. You can do whatever research you want.opening the account does not rush you into a trade. purchase as little or as much as you wish.watch TV. But fear not -. Sample Homework Answers I've promised to help exercise for me to go account at one of the report on my process a friend set up a Roth IRA. and pick at least three brokerages to investigate further. The article linked above -. or use the Discount Broker Center to get a list of reputable brokerages. (And by the way. let this lesson be the impetus for you to take that next step. She has $1. The comparison table in the DBC is a terrific guide for questions to ask when checking out any broker. Don't have any cash at the moment? Open an account with no minimum and set up a schedule of regular deposits. All brokerage and mutual fund companies are perfectly respectable places to keep cash. That means that every day wasted is. We're serious. a few more words on picking a broker -. Most offer money market rates on cash right up to the day you invest it. There are other places to start and lots of other brokers not listed on the chart. well. but I'm . CNBC or any of the financial channels will offer a wealth of ads for brokers. It's just that you really can't get started investing until you've opened an account. a day wasted.is useful as well. Any more excuses? Assignment: Only one assignment today: If you're ready.and you're ready to take the plunge. so this is a great through. congratulations on taking this momentous step!) For the undecided.
and looking on down the chart. Unlike IRA account maintenance fees. you need to be a long-term investor. she's really only putting $980 to work.if she contributes $1.or you might find a better deal just watching ads on CNBC. I saw that Datek had no transfer-out fee. trading commissions come directly out of your account. For an index investor. Your daughter dyes her hair green? Do nothing.99 per trade. that gap will grow. Since this is an IRA account. One final stop was the Discount Brokers discussion board. Don't take this as a recommendation! You might find other broker services and features more important -. (Trust me.HOW TO NOT FREAK OUT WHEN THE MARKET'S FEELING FRISKY Introduction: Just Do Nothing To be a successful long-term investor.000 and spends $20 of that contribution to make her first investment. She met the minimum for it.not interested in checking out every broker in the world. Over the years. The market zooms up beyond all rational expectation? Do nothing. which can (and should!) be paid by check from non-invested funds. I really like that. Trading commissions at Datek are $9. And I also like that Datek doesn't have an IRA custodian fee. but better her than you. The market tanks? Do nothing. LESSON 7 LESSON 7: PERSPECTIVE -. What works for you is what matters. But that's just me. The broker I checked on this chart was Datek. Why. the secret of success is: Do nothing. There I found several good comments on Datek. it is pretty important to pay low commissions. you wonder? Because IRAs have contribution limits -.) . It will drive her crazy.
" Dealing With Paper Losses Panicking and selling when your account is down is the one sure way to turn a "paper loss" into a real loss.Doing nothing is very hard. umm. Ask yourself: What is the "real" consequence . But patience is the critical skill. The inability to do nothing has probably been responsible for just as many wrong moves as all the boiler-room shysters on Wall Street put together. you need to know when to hold 'em and when to fold 'em. but if your goal is to match the market -and beat more than 75% of managed funds -. Here's why you need to ignore him.. He will rub it in. but doing nothing works every time. But if they didn't correctly call the market bottom (and when the market's down. (A paper loss is when your holdings have fallen in value. the next time isn't so bad. they lost money because the market has never been that low again. Note that this isn't necessarily true when it comes to investing in individual stocks. But doing nothing is the secret to successful index investing. Your friends and co-workers might call you an idiot and you may even feel like an idiot at times.. Next is learning to ignore those friends and co-workers -. Until you sell. you don't have a real loss. For individual companies.) The first time you go through a market retreat is the worst. he's probably... Doing something rarely does.especially that guy who sold and went to cash the last time the market was higher than it is now.you don't need to worry about that. First. everyone's predicting it will just drop farther) and get back in before the end of the year. how to put this nicely. although many times doing nothing is the best thing you can do. Focus on the long term. read "The Perils of Market Timing. One of the hardest things for some new investors to learn is patience. If this paragraph doesn't make perfect sense to you. when's he getting back in the market? Folks who sold everything and went to cash just before the Asian monetary crisis in the summer of 1998 probably felt pretty smug. But more important. he's probably not being completely forthcoming about all aspects of his "brilliant" move. After you experience the recovery. but you haven't actually lost any money because you haven't sold anything. So here are some tips to get yourself through your first big market drop.
while your account is in the paper loss territory. wars both hot and cold. well.000 last year. but remember. you won't have the same potential for upside return as you would with some of the high flyers. which should be many years down the road.000 this year instead of the $30. Expect some slumps. since 1926. the U.000 or $50. And that's the whole point of starting out your investing career with an index fund. Your index fund holding may be worth $20. Remember. natural and man-made disasters. inflation and deflation. what really matters is what it's worth when you sell it. yes. remember that life and economic growth goes on. a successful investor has to keep investing in perspective.000 it was worth last year? • • • Am I likely to lose my home? Will my car be repossessed? Will my dog scorn me because I have a paper loss? (If so.S. During that time we've had major and minor depressions. your very real life is unaffected in any way by paper losses (you weren't counting on this money for the mortgage payment. stop checking the ticker on a daily basis and get on with the business of living a Foolish life. and Pee-wee Herman. and you have every reason to realistically expect the paper losses to turn into paper gains. So. . stock market has posted an average annual return of 11%.000 or even a lot more. check the local pound.of my S&P 500 index fund being worth $20. it might be worth $40. Lots of lovely pooches are waiting to give you a warm face licking no matter how much your brokerage account is worth!) While we don't mean to trivialize the real pain that can come with a paper loss. right?). So. The market managed to survive and thrive through all of that. but you also won't have the same downside risk. you do have a real loss on your hands. political turmoil. With an index fund that mirrors the return of the S&P 500 or the total market. At that point. even if it wasn't thriving every moment or every year.000 now after being worth $30. If your loss is in a specific Internet penny stock that just went bankrupt. Investments rarely go up in a straight line.
226. (Notice that we aren't talking about individual companies here. Now. which the index doesn't show). For all practical purposes. If you stuck it out. Total gain for the year: 27. if you have patience. your investment would have been up 22. but the market as a whole as represented by index funds or index shares. The risk that an investor takes on when he invests in a market index is the risk that the value of his investments will fluctuate.3% (28. Another name for that kind of risk is volatility. we don't mean the risk of losing all your money. We aren't even talking about the risk of losing some of your money. It's never a smooth uphill climb.) Say you had invested $1. we know of no way to get high returns from the stock market without taking on some risk. When you draw that story out over a year or more. Volatility means that at any point in time.6% and worth $1.6% if you include dividends. that's volatility. the value of your investment may be below or above its starting value or some intermediate value. your $1. This chart shows how 1998 looked to an investor: . But let's look at just what we mean when we say risk. Wild as that ride was.Risky Business: Volatility Unfortunately. though. Scary word.up just 1% for the year and a 17% drop from the July high. living through the long down stretches can be excruciating.000 investment would have been worth $1.273. when we talk about risk in the context of index investing. Wow.000 in a broad market indicator like the S&P 500 on the last day of 1997. one of the better years on record.011 -. it was actually less painful than some other market drops because the recovery was fast. and then in October it would have started a steady climb to end the year at $1. what a run-up! But just seven measly weeks later. By the middle of July 1998 (seven measly months later). eh? Fear of risk is probably the main reason many people never achieve financial independence. your investment would have bounced around some in September.
. the long-term trend is up. Notice two things -. Even the Great Depression makes little impact when viewed from a long-term perspective.first.But let's look at another chart: This one reflects how the S&P 500 has grown since 1926. all of that up and down business in 1998 barely shows as a blip. second.
Even though the long-term performance of the S&P 500 has averaged 11% per year over the past 75 years. just to get her feet wet. tech stocks aren't the worst of it. but growing economies. there have been stretches where the return over a 10-year period has been negative. This happens occasionally. and that kind of return. in our books. is enough to ensure your future financial independence.) Investments to Avoid Speaking of catastrophic risk. That's why we emphasize investing only with long-term money. but over the long term they consistently reflect our increasing standard of living.no.not specific companies.at least not with too much money. But it's not required at all. applied to some serious savings. Want to talk about catastrophic risk? Let's look at tech stocks last year -. There's no reason for a beginner to take on the risk of individual stocks -. And that's what we suggest that beginners invest in -. Want to see your money evaporate? Try these: • Penny stocks (stocks trading for less than $5 per share) . The Last Word on Risk Volatility can be painful. let's don't. It can be instructive for a beginner to plunk just a little into a stock or two."Alternate Choice" Risk Another kind of risk is that the market will underperform some alternative investment choice such as a fixed-return investment like a CD or bond.human and business productivity. but it's not the same as catastrophic risk. In the short term. and in other seminars. Boiled down to basics. Onward and Upward Why is the long-term trend always up? Because markets reflect the efforts of individual people to better themselves. the markets can fluctuate wildly. (Of course. There are no guarantees in the stock market. we would love to discuss investing in individual stocks with you. You can beat more than three-quarters of professional mutual fund mangers simply by investing in the market as a whole. The S&P 500's 17% loss over seven weeks in 1998 is quite volatile enough for our purposes. That's what The Motley Fool does best! You can learn much more about that on our website. We aren't going to be getting into tech stocks or analyzing specific companies in this seminar. that's what the long-term chart tracks -.
futures. you can find out more about them by simply clicking on the links above.• • • • • • Options Day trading Futures and commodities Technical analysis Margin investing Shorting Haven't heard of shorting? Not up-to-date on the latest in technical analysis? Good. Don't let paper losses freak you out. Expect volatility. Lesson Resources • • • • The Dangers of Some Advanced Investing Techniques The Perils of Market Timing The Growth of a $1000 Investment in the S&P 500 in 1998 The Growth of a $1000 Investment in the S&P 500 from 19262000 Homework . Left alone. Markets and stocks move up and down. margin. But they are power tools and can be very dangerous in the hands of a novice. if you want to. Steer clear of penny stocks. But beware! What We've Covered So Far • • • • Muster the courage to do nothing if you're investing in index funds for the long haul. either. you can look into these highly risky ways to lose all your money if you don't know exactly what you are doing (and sometimes even when you do). Shorting and margin investing are legitimate tools for serious investors. If we've piqued your curiosity simply by mentioning these more exotic investments. Then. day trading. and shorting. Know what to avoid. Stay that way -. options. they'll likely turn into paper gains eventually. at least while you're an inexperienced beginning investor.at least until you have managed to become a competent investor who can beat the market with your own stock picks. commodities. technical analysis. Don't let market ups and downs alarm you.
at a thrift store! Read Stocks for the Long Run by Jeremy Siegel (this should be your first choice!) Sample Homework Answers Assignment 1: The market goes up and the market goes down in its own sweet time. but in this case. Start with 1998.what if it is in one of those downward blips when I want to retire?!" . Remember the 1998 chart? All of that volatility? What happened when it is put into context? Assignment 2: This can be another thought exercise. Pick a point on the left side of the chart and note the level of the market and the time. Go shopping -. But the long-term trend is always up.Assignment 1: Spend some more time with the two charts we have presented in the "Lesson Resources" section. but you're invited to make more of it. a new investor who provided feedback during the development of this seminar. Now pick out 1998 and look closely at it. Some possibilities: • • • • • Run in circles. (This is fine as long as you don't call your broker screaming. and shout." Stop checking your portfolio every day. but it still goes down over short time periods -. think long term. Keep going until the end of the year. Imagine yourself moving forward in time. One of our in-house Fools. Think of three things you will do when your index fund drops more than 10%. Watch the way the market moves and imagine yourself as an investor experiencing that rise or fall. look at the broad trend. scream. 1926-2000: Study this one too. "Sell! Sell!") Sit quietly in a dark room with one candle burning as you repeat: "Think long term. commented: "It's all well and good to know that the market goes up over 75 years.
But those times are rare. But what do you do about that? Right. If I find myself tempted to check my portfolio. The rest of your portfolio has time to recover. Unless you know one is coming. Assignment 2: • • • • I will invest any spare cash that has been accumulating. The picture isn't completely rosy. or 20. Pick a low point and back up 10 years.). (You can't buy low and sell high if you are afraid to buy low. There have been times when the market has been stagnant for a decade and you would have been better off in CDs. wait.. I will teach my kids how to balance a checkbook in Quicken. No guarantees. I will eat chocolate instead (no.I'm sure a lot of people wonder about that. so it is not affected. See? Even when the market goes down. but good odds. NOTHING! You've already moved the money you will need for the next three to five years out of the market. it doesn't usually retreat that far when looked at from a long-term perspective. But look at this long-term chart. the odds favor sticking with the market. LESSON 8 . It can be a huge blow to one's retirement plans if the market decides to drop the year before your planned retirement date..) I will use the time I used to spend on my investments to work out more often.
And the better you'll probably do. Moving in and out of stocks frequently. The more you know. Perhaps you want to beat the market. where you look for undervalued stocks (essentially trying to buy a dollar for 50 cents). You now understand how you can match the market's overall performance by investing in an index fund. there are many approaches you can take. you've got more work to do. the more comfortable you'll be with whatever investing strategies you use. and discuss more -. Growth stock investing. Investing in more dynamic and volatile small-cap stocks. Buying and holding for years or decades. "Drip" investing. Investing mostly in stocks that pay high dividends. If so. Buying high and selling higher. For many people.LESSON 8: WHAT'S NEXT? LEARNING MORE AND MOVING INTO STOCKS Introduction: Learn More You made it to the home stretch! By now you've gleaned a lot of food for thought. Perhaps you're different. though. Value investing. . look them up in the Fool's glossary): • • • • • • • • • • • Dollar cost averaging. We won't go into these in detail here. Buying low and selling high. You've possibly opened a new brokerage account. where you invest directly in companies. Investing mostly in blue-chip stocks (the IBMs and CocaColas of the world). that's all they'll ever need to know. where you invest consistent sums into certain investments regularly.essentially. many of which can prove successful for you. learn more. Instead. Different Styles and Approaches Know that there's no exclusive sure-fire way to invest. question more. You've learned what to expect and what not to expect from a bunch of different kinds of investments. but just to open your eyes to what lies beyond the land of the index fund. For starters. bypassing brokers and their commissions. where you buy fast-growing companies. you need to read more. let's list some in an oversimplified fashion (if any of the following terms are unfamiliar to you.
on average. The more you read. Forbes. Being very diversified. Focused investing. Moving Into Individual Stocks To beat the market.and books by Peter Lynch. the more you'll develop a sense of which make sense to you and which are within your comfort level. check out The Wall Street Journal and Investor's Business Daily. Well. 15. (And remember that the overall market returned.such as the Uzbekistan Molybdenum Mining Co.) 20-YEAR AVERAGE ANNUAL RETURNS (1981-2000) Wal-Mart 31% . possibly overdiversified. the more you'll learn. For newspapers. you can do very well investing in companies familiar to most people. At your local library or bookstore. Uncommon Profit -. Fortunately. or TransOptiDynaPlex Technologies. all kinds of things. either -. You needn't invest in small companies you've never heard of. you'll probably want to move into investing in individual stocks.7% per year during this period. This list might frighten you. Different articles will offer different insights. Don't expect to understand every part of every article immediately. Take a gander at the following list -. check out Philip Fisher's Common Stocks. Business Week. It's just meant to show you that there are a lot of approaches out there. that doesn't mean having to strain to overhear some hot stock tips in elevators. Investing in a bunch of different ways -. Learn More If you're interested in reading and learning more. where after considerable research. you're probably wondering what you should read.it's pretty amazing. We haven't even listed them all above. We describe these and a bunch of other recommended books in FoolMart. Believe it or not.diversifying your portfolio with a little of this and a little of that. Some good magazines include Fortune. you put all of your eggs in just a few baskets. and SmartMoney. such as Rule Makers and Rule Breakers.• • • • Investing using some Motley Fool strategies. The more you read and learn. owning perhaps several dozen stocks. but don't let it.
Look at your life. pay attention to healthcare-related firms. If you're a nurse. and firms coming out with new technologies. think about computer hardware or software companies. Visit the company's website and look for its investor . you're seeking answers to these two questions: • • Is this a high-quality company? Is this a good price at which to buy into this company? To begin researching a company. Think about products or services that you use and like a lot -. If you shop a lot. look around. Make lists of companies and industries that you know and understand well -. If you're a geek.Tootsie Roll Coca-Cola Schering-Plough General Electric Merck PepsiCo Pfizer Sara Lee Disney Johnson & Johnson McDonald's Philip Morris Texas Instruments Procter & Gamble Ford 28% 21% 21% 20% 20% 20% 20% 19% 18% 18% 18% 17% 16% 16% 15% Finding and Evaluating Companies Finding Companies To find companies to invest in. Basically. you'll need to study them.that many people use and like a lot. you can: • • Call the firm. and ask for copies of recent annual reports and financial statements.perhaps ones related to your field of employment or your interests and pastimes. Evaluating Companies Once you've made a list of companies you're considering investing in. In other words. begin noting which stores are packed and which products are selling briskly. say you're thinking of investing in its stock. you should be trying to assess their quality and price. networking enterprises.
stocks can be quite . where it will likely store recent annual reports and financial information. Understand.in a mock portfolio. too.COMPANY-NAME-HERE. try www.com.• • information area. www.com/. You may have pretendinvested in a solid company.marketguide. compare the company's current stock price to its earnings (via the P/E ratio). See how quickly revenues and earnings are growing. that short-term results aren't too meaningful.freeedgar. Get a feel for how comfortable you are (or aren't!) when a stock suddenly drops. Of course. At Fool. To assess quality. visit our Fool's School. In the short run.com. To assess price. Mock Portfolios and Investment Clubs Mock Portfolios While you learn. We have lots and lots of help when it comes to evaluating companies. Look up information at sites such as http://quotes. and determine whether it's becoming more or less profitable over time.com.) Look up its financial statements online at www.fool.com doesn't get you there. there's much more to evaluating companies. for example. IBM also offers a good guide to financial statements. you can create an online portfolio and then track its progress as often as you'd like. only to see its stock temporarily tank over the next six months. start by pretending you've bought some -.wsrn.google. This can be a great way to learn some tough lessons without having to pay for them.hoovers. and make sure that inventory levels and accounts receivable aren't growing faster than revenues and earnings. See how your mock portfolio picks respond to unfolding news. compare how much cash a firm has to its debt. Don't let the complexity scare you off.com. For more information.com. and www.com. revenues. It's something you can pick up gradually. www. and before you actually plunk your hard-earned dollars into your first stocks. And Merrill Lynch has one. though. Assess how much profit the firm is wringing out of every dollar of sales. (If simply typing in www. cash flow. and/or other measures.
or in our investment club primer. Learn more about investment clubs at Fool. so you might end up sending $15 to Coca-Cola every month. you'll have to specify that you want the share(s) registered in your name. bypassing brokers (and broker commissions!). along with $20 to General Electric and $25 to Home Depot. that means you'll be sent a stock certificate. You can regularly invest small amounts in stocks together. The share must be in your name. Band together with some of your friends or colleagues (they don't have to know any more about investing than you do) and you can all learn and invest together. They permit you to buy shares of a company's stock directly from the company or its agent. Note: When a stock is registered in your name. Then you can open a Drip account with the company. you have an instant group of learning buddies that can research companies together.if you don't have a lot of money to invest (and in many cases.or not! There are many successful clubs that do everything except actually pool their money. Drips are direct investing plans offered by hundreds of major companies.better known as "Drips" -. you'll have to buy at least one share through a broker. with more companies introducing them every day. They've been growing in popularity in recent years and hundreds of major corporations now offer them. and buy additional shares directly through the company (or its agent). you can cover 36 companies. Investment Clubs Another great strategy for a beginning investor is to start or join an investment club. even if you do!). as is typically done.volatile.com's online club nook. the company expects you to already own at least one share of its stock before you enroll. With a club. If you've got a group of 12 and each of you studies just three companies a year. consider dividend reinvestment plans -. not the brokerage's name. With traditional Drips. These days most shares of stock are . too -. Drips and Low-Cost Investing Once you know what companies you want to begin investing in for real. these plans make it easy to invest small sums regularly. so if you're not already a shareholder. In addition. Better still. paying the commission.
our online Drip info area. operate in much the same way. If you've found one or more very promising stocks trading at . jump in. though.com/. Investing Without a Silver Spoon: How Anyone Can Build Wealth Through Direct Investing. So if you send in $15 to Coca-Cola one month and the shares are trading for $60 each.com. BuyandHold was executing trades twice daily and ShareBuilder once or twice a week. Last time we checked. Ease into it. except they don't require you to own at least one share before enrolling. so read up on them at http://www.registered in your brokerage's name to simplify record keeping. but with extra-low trading fees. it frequently takes weeks and some paperwork before you can buy or sell stock. you'll get 0.BuyandHold. either. Once you're ready for individual stocks. That's a big difference. and they have some advantages over traditional Drip plans.netstockdirect. too. such as $2. Low-Cost Investing There's a new breed of online investing service available that shares some characteristics with Drips and works a little like a brokerage. Buy just a few shares of one or two companies to start. These are attractive options that Foolish investors should consider. you don't have to mail it back in. You don't have to wait for the perfect time.com. as it means that when you're ready to sell. That means that you don't get a copy of the certificate. There's a lot more to know about Drip plans. Two good examples are www. And they permit you to buy fractional shares of stock. You can buy your very first shares through these plans..) A new variety of Drips. (Not holding the certificate can actually be an advantage.25 of a share. They permit you to get started investing with as little as $20.99 per trade.ShareBuilder. One terrific aspect of Drip plans is that they let you have any dividends reinvested in additional shares of stock. direct stock purchase plans (DSPs). or wade in slowly.moneypaper. With Drips.. www. or check out our book. You don't have to immediately plunk every dime you've got in stocks. but you most assuredly still do own the stock.com and www.
well-known companies can be terrific long-term performers.smartmoney. It's often a good idea to create and track a mock portfolio as you learn more about investing. www.fortune.forbes.com. Whatever your next steps are. www. Many enormous. At the end of this lesson. here are the resources specifically mentioned in the lesson: • • • Some recommended magazines: www. I've listed a host of resources well worth your investigation. What We've Covered So Far • • • • • • • • If you want to do better than the market-average returns an index fund can give you.reasonable prices. When you start studying a company.com. where you can look up financial statements .com. consider investing a little in them now and more later. You can learn a lot by joining or forming an investment club. we've got valuable information for you. You don't need to find obscure companies to do well. There are also a lot of different investing approaches and styles. Lesson Resources As you learn and begin investing. You can start small.com. with Drips or extra-low-cost investing services. know that there's an incredible amount of information and resources available to you at Fool. where you can check out books recommended by Fools FreeEdgar.com FoolMart. You can find possible stocks to invest in by looking around and examining industries familiar to you. There's a lot more to learn about investing. if you're investing in individual stocks. determine whether it's a high-quality firm and whether it's trading at an attractive price. you'll need to consider investing in individual stocks. In addition to that mongo list. though.
com.where you'll learn to save a lot of money.com. www. of course.com. And check out our Fool Perks. www.hoovers.fool.netstockdirect.com and www. too. (Remember -most of them exist online.com. Investing Without a Silver Spoon: How Anyone Can Build Wealth Through Direct Investing The Fool's online Drip info area.com. where you can learn more about how to study and evaluate companies IBM's guide to reading financial statements Merrill Lynch's guide to understanding financial statements Create a mock portfolio at the Fool The Fool's Investment Club information area The Fool's Investment Club primer The Fool's Drip investing primer. Start by reading about companies that interest you and pretty soon things will start to fall into place. www. invest it intelligently.com and www. etc. Assignment 2: Create a mock portfolio.marketguide. pretending that you've bought some shares of several companies that interest you.fool.com Homework School's Out! You're embarking on a brave new adventure -. as you might be able to sign up for some free trial subscriptions there. and build a secure financial future for yourself and your loved ones.) Don't worry if much seems to fly over your heard.wsj. and www.com. It's very preliminary.smartmoney. Congratulations! Assignment 1: Find a few copies of our recommended magazines and newspapers and read some articles that look interesting to you.fortune. but it'll help you begin watching how stock prices move .moneypaper.ShareBuilder. at www.wsrn.com The Fool's School.com. www. www.com Low-cost Drip alternatives: www.BuyandHold. Websites specializing in Drips: www.• • • • • • • • • • • companies file with the Securities and Exchange Commission (SEC) Other stock research sites: http://quotes.
and one on why a company's valuation matters so much in investing. and our news and commentary area. There I scrolled around a bit and stumbled onto a bunch of interesting articles. Assignment 3: Click into some of the Fool areas mentioned in the lesson that interest you (such as our investing strategies area.com. Assignment 2: I did this by heading to http://quote. I found an interesting article introducing me to the Rule Maker Portfolio. investor extraordinaire.wsj. too. Sample Homework Answers Assignment 1: I headed to The Wall Street Journal online (at www. www.com) to see what interesting articles I could find there. at http://www. There was a collection of pieces on America's "Most Admired Companies. At SmartMoney magazine's site. under "Track Your Stocks.and how their value grows (and shrinks).fortune. I moved on. I found some intriguing headlines -. Explore our discussion boards. our personal finance area.choose the ones that interest you most. And an article titled "Conquering Vertical Limits" that discussed how good companies might become great ones. I was introduced to a company new to me: IMS Health. Next. too. of course.for example.) Start reading and learning." I clicked on "create portfolios. In the latter article. It seems like one worth keeping an eye on and learning more about." which included an interesting article on Warren Buffett.smartmoney. There.fool. I read about Wal-Mart's recent earnings and how the company feels it's faring fairly well in a "difficult" economic environment. (There are many others -. But when I clicked on it. Finally.com. I learned I needed to subscribe and fork over some money. an article covering Home Depot's 20% profit drop. I headed to Fortune magazine online.com. Not willing to do that at this point. where you can get many questions answered. I poked around The Motley Fool a little." Then I followed the . our retirement area.
But we've got so much information here that I suspected I could find something new to me.steps. That's probably not of great interest to the majority of people. adding companies and removing them. as I've hung around its neighborhoods for about six years now. where you can learn about some important coverage that most people neglect: disability and long-term care. where you only add companies that you've researched carefully and have decided to pretend-own. you can tweak it endlessly. etc. Assignment 3: I can't pretend to be a stranger to the Fool site. And a host of other spots I listed in the Fool Resources section. (Note: If you're just beginning.) Once you create a portfolio. though. Cheers! . and entering a bunch of ticker symbols for the stocks I'll own in my portfolio. so let me point to a few other spots in Fooldom. I recommend our newly renovated Tax Center and our Insurance Center. you might start one portfolio filled with companies you're interested in and then gradually build another mock portfolio. I poked around and found an interesting new discussion board on renewable energy. giving my new portfolio a name.
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