What to invest in when you are just starting out?
With the low interest rates everyone is in the search for better returns. And the longer the rates stay that low, the greater the urge to find that holy grail that will pay higher rewards.
It probably explains why recently I have been asked similar questions by different folks:
- Do you have any recommendation on what I should invest in?
- Do I even have enough money to be active on the stock market?
- And how does it even work? Don’t I need to be rich to start investing?
Time to earn more
After years of seeing absolutely no return on their savings and their disappointment in their banks’ saving and investment products, it appears that many have decided to take their financial future into their own hands. They are transitioning from a passive saver to an active investor. But as they are just starting out, let’s call them junior investors.
Rather than seeing their money rot away in some low interest account or following their local bank’s financial “advisor”, they now want to take control of their financial future. I’m sure there are some good advisors out there, but there are simply still too many who don’t cut it. Many local bank advisors are surely working to help their clients, but others are merely in financial advisory for the salary and commission. If they were that outstanding, they would work in wealth management or a hedge fund and not for a mediocre salary.
Too frequently, a significant chunk of their salary is based on selling their bank’s products without your best interest in mind. But let’s leave financial advisors alone, as many probably do a good job.
For any investor, regardless of where they are in their investment career, investing should be a personal choice and not determined by an “advisor”. And while choosing the right investment might initially be a bit daunting, with experience it becomes easier, pleasurable, and a passion.
So what should the junior investor invest in when starting out? Well, I think Warren Buffett said it all: ETFs.
ETFs for beginners – What are Exchange Traded Funds?
ET what, you might think. What sounds mysterious and complicated, particularly even more so when spelling out the abbreviation - Exchange Traded Fund – is a really simple and useful investment vehicle; particularly for the junior investor.
Exchange Traded Funds (ETF) make away with much of the nitty gritty research aspects that are fundamental to investing. You will still need to do some digging in, but much less than when investing in single companies. In fact, if you know one particular industry well enough, ETFs might be just the thing for you. No research needed on what the management is capable of or the company’s ability to beat rivals. In fact, rivalry matters little as you want an entire industry to do well. The better a sector performs, the more your ETF will gain in value.
For example: If you work in the food and beverage industry, you might be familiar with the opportunities and dangers feeling comfortable enough to predict the market potential of alcohol and burger sales in the near future. Rather than picking one company you choose to invest in an industry.
If you were to compare ETFs to a horserace: Instead of placing your money on one horse (one company), you are placing your money on all horses in the race (ETF).
But what if instead of an industry you want to invest in a certain country? ETFs offer that option as well, allowing you to invest in a pool of US, Chinese, or German companies (or any other country for that matter).
ETFs are pools of companies, industries, and nations
ETFs are, in fact, a very simple concept. An ETF is a reflection of a pool of companies, whether this is a certain industry or a certain country. In order to capture the performance of that pool of companies, a price of the ETF is constantly calculated and, similarly to shares, can be traded at any time.
Regardless of who chooses the pool - a bank, hedge fund, or some other financial institution - ideally the companies included in the ETF are of interest to you. Thus you are able to make a sound decision on whether the industry or geographical area that the ETF covers is indeed a good investment.
Coming back to our food and beverage industry example: you might find an ETF comprising McDonalds, Burger King, Starbucks, Coca Cola, PepsiCo, Anheuser-Busch InBev, Diageo, Yum Brands, Chipotle Mexican Grill, Greene King, Dunkin Donut, Dominos, Whitbread, and Compass.
Thus, even if McDonalds was to sell fewer burgers and fries (sure, today they also sell salads and coffees), the others might sell more pizzas, tacos, beers, donuts, or pies. If you had invested exclusively in McDonalds, the stock might go down in a particular quarter, but with a pool of companies their performances balance each other out.
The pool of companies will determine the overall performance of your ETF and thus give you a lot more safety and stability, and fewer worries than if only investing in one company.
Are ETFs expensive?
Contrary to actively managed funds, ETFs are very cheap to invest in. As the price of an ETF is based on the underlying companies, their costs are usually less than 0.5% instead of the few percentage points you’d be paying a fund manager attempting to outsmart the market.
Only very few actively managed funds that you can invest in through your bank ever outperformed the overall market. In other words, if you had invested in the market as a whole by buying every listed company and left them for some time, you would have earned more money than if you had paid someone trying to predict market movements.
Most ETFs either pay or reinvest the dividends paid out by the companies forming part of the pool of companies in the ETF. Frequently those dividends are paid on a quarterly basis adding another financial advantage.
Thus, not only are they significantly cheaper than actively managed funds and pay you dividends, they also give you greater safety as your investment is diversified (a pool of companies rather than a single company).
Better still: Instead of being dependent on your bank’s advisor, you also get to be a real investor with less research required than when investing in a single company.
What is the minimum amount needed to invest in ETFs?
To many investing in the stock market or bonds appears to be something only the wealthy can do.
Yet, the reality is far from it.
Just as you don’t need millions or hundreds of thousands to start investing in shares, buying ETFs does not require you to have massive amounts of cash. You could invest as little as a few hundred or a couple of thousand.
The only two rules are:
Never invest money that you need tomorrow, never invest money that you might need in the next few months. Only invest money that you don’t need at the moment or the imminent future. Don’t put yourself in a position were you are forced to sell, because you invested money from your emergency or your child’s college fund.
Remain patient as with any other investment. The market will fluctuate. Even really well chosen investments are prone to price changes. So whatever happens: Don’t panic, relax, and wait for the market to bounce back up.
So there you have it, Exchange Traded Funds, ETFs, offer a great opportunity for those only starting out to invest. They are a relatively safe investment vehicle enabling to test the waters of the investment world.
One last advice: When entering the investment world, go with one of the big established firms offering ETFs, such as Vanguard.