How To Start Investing After College – Part the Third of “What To Do After College” Series
On a Financial News Channel far, far away…
Chances are that if you’re not sure how to start investing after college, you’ll start either with a google search or flip on the TV. And you may read an article or watch a show and hear something like the following…
“Apple’s earnings were 3 cents less per share than last quarter”… “Wal-Marts EBITDA is on track to meet yearly projections”… “The discounted cash flow analysis from a group of analysts from Goldman Sachs shows a risk-free rate of 2.27%, which indicates a deflationary yield curve excogitated by experts in the cynosure of US bond markets encomium otiose hizzlefizzlegizzengar“…
When you watch today’s financial news, you can easily become overwhelmed. People in fancy suits are speaking in a language that most don’t understand, or worse, pretend to understand. They make suggestions as “experts”, having no real accountability for what they’re reporting. Google “The best place to invest”, and you’ll see suggestions from the real estate market to Certificates of Deposit (CDs) and everything in between.
However, it really doesn’t have to be this confusing. You do not have the be the Elon Musk of the investing world and figure out how to be wealthy all on your own. Investing in your 20’s is a pretty simple thing to do, believe it or not.
The goal for today is for you to have actionable advice that you can use TODAY to get started investing. I’ll be taking the haze away from what your first investment should be, and you’ll have a perfectly clear idea of how to start investing after college.
Before We Begin – Student Loan vs. Investing
I wanted to clear up what is a pretty common question amongst those who are about to start investing after college: “Should I focus on paying off my student loans, or should I start investing?” Here’s the overarching logic: if the average interest rate on your loans is less than what you expect to earn in the stock market, then invest. If the average interest rate on your loans is more than what you expect to earn in the stock market, then pay off your loans. Now, there are people that will say, “Just focus on the loans, you’ll be able to sleep better at night.” Other say that, “You can’t lose out on early compounding!” There are merits to each argument, but at the end of the day I’m making the assumption that you’re a rational person and you would like to have more money as opposed to less. So if you’re making 10% in the stock market, but only paying 4% on your loans, keep your money in the stock market. 🙂 Kapiche?
A main theme in personal finance is that everyone’s risk tolerance is different. Some of you crazy fucks actually like roller coasters, some of you prefer your feet firmly on the ground, like a normal person. However, in our 20’s we can ride the “roller coasters” of the stock market a lot easier than in our 60’s. Here’s what I’m assuming:
- You’re less than 30 years old (not turning 29 for, like, the 7th time.)
2. You plan to retire around 65 ish. Hopefully before.
3. You understand that more financial risk is more financial reward, and that risk levels out over the years to your benefit.
If these do not match your profile, then take the suggestions with a grain of salt. Don’t write to me saying “I took your financial advice and I lost 30% in a week.” Don’t be a financial chump. Invest longer term, and you’ll see gains.
401(k)icking Some Financial Ass
Ahh, the dreaded moment while reading about personal finance where scary terms are used. Hold my hand if you’re scared, I promise you that you can survive this.
A 401(k) is a retirement savings vehicle that is provided by your employer. Imagine it’s a basket where you can put your money/stocks/bonds. This “basket” has properties that are different from other “baskets” (retirement accounts). The 401(k) is awesome for a number of reasons, but there is one huge advantage that most employers will give you. They’ll guarantee at least a 100% return on your money!
Now, the stock market has an average return of 8% – 10% per year. How can your employer guarantee a 100% return on your money? Well, they have this nifty little tool called “Employer Match”, which means that up to a certain amount, they will match your contributions. For example:
John works at Huge Company, Inc. His employer matches contributions to his 401(k), up to 5% of his salary. John makes 70,000 a year. How much will John have in his 401(k) after one year if he takes full advantage of his employer match? (That’s right, we’re throwing back to 7th grade math)
Well John makes $70,000 a year. If we want that amount that the company will match, we multiply $70,000 x 5% = $3,500. So if John contributes $3,500 in a year, he’ll actually have $7,000 in his account due to his company match. That DOESN’T include the (potential) returns he gets from owning stocks!
Other advantages include contributions that are tax-deductible (they lower your taxes owed) and that (as of 2016) you can contribute $18,000 a year. If you’re company offers any sort of match, this is where you should first start investing after college, no if’s, and’s or but’s.
ROTHin’ and a Rollin’ To a Better Financial Future
After you’ve taken advantage of your company match, the next step is setting up a Roth IRA. Again, this somewhat technical terminology may sound scary, but I’ve got you boo boo, don’t worry. Very simply put, a Roth IRA is another one of those financial “baskets” in which you can put cash, bonds, stocks, and other financial instruments. However, a Roth has special “powers” that make it sweeter than watching your high school bully get a swift kick in the balls. You will have to pay taxes on your contributions, but you will not pay tax on any distributions from your Roth IRA. What does this mean exactly?…
Take Julio. He’s 24 years old, a year out of college, and needs to start investing. His company doesn’t have a 401(k) plan with matching, so he’s decided on a Roth IRA. He takes $5,500 (the most he can contribute in one year) and puts it in his Roth IRA. He then leaves it for 41 years, averages 9% per year, and now has $188,300. He then puts his money in high yield bond and dividend funds, and get’s 3.5% from it every year. That’s $6,600 that Julio gets every year, tax-free!!! And he only made contributions for one year, imagine the effect if he did that for all 41 years!
However, not all is well on the Ice planet of Roth (+2 Star Wars points if you get the pun). There are income limits to Roth IRAs, meaning if you make more than a certain amount of money, you can’t contribute. The limits for 2016 are $117,000 for all the single ladies (and dudes) and $184,000 if you’re ball-and-chained. You also can’t contribute more than $5,500 a year if you’re younger than 50. If you’re older, then you can contribute up to $6,500.
If you’ve maxed out your company match, or you don’t have a 401(k) through your employer at all, then this is the “basket” where you should be putting your money.
What To Buy
It’s all great and fine to talk about what “basket” to put your money in, and that’s a very straight forward argument. Put it where you can take advantage of free money and where your tax burden would be least. I’ve seen doorknobs with enough intelligence to figure that out. However, what exactly do you put in the baskets? There’s cash, bonds, stocks, REITs (Real Estate Investment Trusts), ETFs, Mututal Funds, Index Funds, Options, Foreign Exchange, Futures, and the list goes on and on. I’m not going to bore you in this article with the finer points of different financial instruments. I’m going to make this very simple for you, young person who has decades before they’re going to need their retirement money:
Fancy Speak – You want an index fund or ETF with very low fees that represents a cross-section of low market capitalization stocks.
Regular Speak – You want to pick a fund that’s cheap and includes a lot of small companies.
Forrest Gump – Y’all wanna bye a box o’ companies thatz small and dudn’t cost mor’ n’a pinnny.
Vanguard, T. Rowe Price, and Charles Schwab are all brokerages (companies that place stock trades) that will allow you to open a Roth IRA and buy a fund. Let’s go through what exactly the above directions mean.
Index fund or ETF – Basically this is a financial instrument (share) that you can buy that represents a piece of a giant fund. Someone said to themselves “If I can get enough people to give me money, I’ll invest it all for them and give them each a piece relative to how much they gave me.” Voila, funds were born. You want a fund because it’ll consist of a lot of companies, not just one. The easy reason why you want a lot of companies? It lowers your risk. You want the technical math-y definition as to why you want a lot of companies? Here, have fun!
Cheap – That guy, from the story above, who went around and said he’ll manage money for people? Yeah, he’s not a saint and he’s not going to do this work for free. There will be an expense ratio given for each fund. If it’s more than .5%, don’t bother; it’s too expensive and will drag your returns down.
Small Companies – Ladies and Gents, here’s the deal. I know some of you may stay up all night worried about the stock market. You might be worried about losing even a single dollar. The thought of coming home to the news that the stock market crashed may make you sweat more than a biggest loser contestant in a bakery. But you simply have to get over it. You’re going to have decades to ride out the waves of the stock market (and there will be waves). You’re young, and as such you should be loading up on the appropriate risk while you still can. You’re portfolio can take a 20% hit when you’re 25; the same cannot be said when your pants are up to your chin and you start calling a couch a Chesterfield (ie, when you’re old). Take on the risk now so you don’t have to later. Small companies have inherently more risk than larger companies, and as such reward you with higher returns over time.
How much should you be putting away in these baskets? There are two answers. The first one is “Put away as much as you can afford.” Some people take great pride in putting 50% of their paycheck away and living off ramen for the first few years that they’re out of college. Some people are ok with putting away 5% and retaining some semblance of a life.
The other answer is “What’s important is that you’re putting away money every month.” This is the one that I lean towards. Even if it’s only $50 a month, that $50 bucks not only can mean great things for you in retirement, but more importantly starts a habit. Once you’ve gotten used to having that money taken out, you can start increasing your monthly contribution.
If you’re desperate for a number, I would aim for 10% of your pre-tax income put towards retirement each year. If you can do more, great. If not, try to think of some ways that you can make extra money from side jobs. If only someone could explain to you how to do that…
How To Start Investing After College – The Wrap Up
Here are your key takeaways:
- Use the company match with a 401(k), if they offer it.
- If not, use a Roth IRA
- Pick an ETF or Index fund that has a low expense ratio that’s risky.
- Young people can take on more risk, and therefore should do so for their financial betterment.
Starting to invest after college can be a pretty scary thing. After all, this is one of the first steps you take to being a real adult (not a “I cleaned myself up after a crazy night at Sigma Chi” adult). Not to mention, if you fuck up it can have some disastrous effects on your financial well-being later on down the road. So make sure you follow the key points, and don’t hesitate to comment below with questions or any other ideas you might have!
Keep trying to crack the code,