Money Money Money!
So you have a little bit of money, and you want a lot of it . You have read the first article of this series but those “safe” investments just are not going to grow your money fast enough! Unfortunately, being a graduate student means that you do not have the dough to finance your own oil drilling expedition. Instead of hitting the Vegas Blackjack tables, some of my classmates have written in questions on how to get involved in more legitimate aggressive investments. I am definitely not a professional financial advisor. However, I hope that being a graduate student, I can comment more relevantly on the specific financial issues that graduate students face. My answers are based on a handful of business classes and my own experience creating and managing my own portfolios.
I’m a typical graduate student with limited funds for investing. Should I invest in stocks or mutual funds?
Mutual funds are a better choice than individual stocks if you do not have a lot of money to invest. The general rule of thumb is that it takes at least $50,000 in order to have a well-diversified portfolio of stocks without eating up all your money in transaction fees (fees paid to the brokerage for each buy or sell transaction). Each mutual fund will generally invest in many stocks (or bonds), so you do not have to buy each stock for yourself. The two main reasons mutual funds are great is that they can help you diversify and many don’t have fees to buy and sell them.
Well, you could be the guy who invested only in Google (GOOG) and got fabulously rich, or you could be the guy who only invested in Enron which went bankrupt. Having many different stocks or different types of investments spreads out your risk. It is just common sense not to put all your eggs in one basket.
Of course, that leads to the question of how many baskets is enough? Two? Ten?
That is the tough part. I could tell you how to model each stock/investment as an equation and calculate the amount of decrease in risk each new investment will bring, but I do not know many personal investors who actually bother doing that. Just try to have holdings in different companies and different industries, small companies and big companies, investments which will rise even if the economy or dollar falls (hedge funds), fixed-income (bonds, CDs, etc.) as well as equity (stocks or mutual funds) holdings. If you have got all that, you are pretty well set, and you can also try diversifying to international holdings.
Since some investments rise in value while others fall, the main goal of diversification is to smooth out the volatility of the overall return from a portfolio. Diversification sacrifices some of the upside potential, but this should be more than offset by the benefits of a lower level of risk.
How do I choose a brokerage firm and mutual fund?. Do I need a financial advisor?
Choosing Brokerage Firms
If you plan on investing in many mutual funds, I highly recommend Vanguard for your mutual fund account. Mutual funds sometimes have a buy-in fee (which can be thousands of dollars), but Vanguard has the largest selection of “no-load” funds (no buy-in fee). However, Vanguard’s brokerage services are ridiculously expensive, so if you plan on buying individual stocks, I would suggest also opening a separate brokerage account at a different firm. I have my brokerage account at Charles Schwab. However, I do not recommend Schwab for the average graduate student because it is only a good deal (on price per trades) if you have a large account or can link to your family’s household account. There are many discount brokerage firms (if you do not need the personal attention and advisement of full-service brokerage firms). I think the most important features in a discount brokerage firm are the fee structure (the price per trade can vary depending on the type of trade e.g. limit, stop, stop limit, market order), if they have an annual fee, and ease of use. Research tools are a bonus though you can always do your stock/mutual fund research at another site such as www.finance.yahoo.com.
Choosing Mutual Funds
I do not have a financial advisor and generally pick mutual funds on my own. In looking at mutual funds, you should look for a lower (management) expense ratio or MER (the cost to keep-up the fund – such as the fund manager’s fees or administrative costs). As I mentioned above, you also want to watch out for the fees to buy and sell the fund as well as the minimum amount required to buy in. Many brokerage firms offer fund screeners where you can search by category, fund ratings, minimums, expense ratios, etc. to help filter through the numerous mutual funds out there. http://screen.morningstar.com/FundSelector.html?tsection=toolsfsel is a tool offered by Morningstar, a well-known investment research firm. The Mutual Fund Education Alliance is the not-for-profit trade association of the no-load mutual fund industry. They also have a tool for searching for no-load funds at http://www.mfea.com/FundSelector. http://biz.yahoo.com/funds/ is a great place to find mutual fund information and includes a list of the top performing funds in each category. You should also look at the prospectus for any mutual fund you’re considering investing in. The prospectus describes the fund’s goals, holdings, etc.
Another way to use mutual funds is to round out one’s portfolio by picking them for specific purposes. For example, one could buy an inflation protected fund since inflation has been rising over the last year. The idea of such a fund is that it generally stays around the same price, but the yield is adjusted for inflation. So, it is not something you would trade in and out of, but hold for the long term. Almost every brokerage firm should have one, such as VIPSX (a Vanguard fund) or ACITX (a Schwab fund). Bear funds, such as BEARX, are good hedge funds if you want protection against stock market declines. Broad market index funds will track the market such as SPY(also cutely termed spyders), which tracks the S&P500 and QQQQ, which tracks Nasdaq.
There are a range of tax-advantaged mutual funds including tax-free munipical bond funds. These generally have lower returns in exchange for a lower tax burden. However, I do not recommend them for graduates students since we are in a low tax bracket anyways. These should also never be held in a retirement account (e.g. IRA, 401K) because you would just be wasting the tax advantage.
Hopefully this bird’s eye view of mutual funds and portfolio building will pique your interest to further explore the various ways to invest your hard-earned money. Everyone’s financial situation is different. For some of you, this article will be as elementary as pipetting basics. While for others, this might not even be financially feasible. Your investment plan should be geared towards your own needs and personality.
So if you are stuck inside, and you do not feel like doing that maxiprep, I hope that this information will help you to try your hand at the stock market.