If you feel like your finances are broken, you're not alone. Even though it's hard work, making the effort to fix them is a step forward that many people never take -- and it will make a huge difference in your quality of life for decades to come.
This week, I've been taking a look at five steps you can take to get your finances back into shape. If you've gotten rid of all your bad debt, then you know how liberating it is not to surrender a huge portion of your income just trying to catch up. And if you've successfully set up an emergency fund to handle those unexpected expenses, then you're in terrific shape.
Now, it's time for the fun part: investing. With the right tools, you can become an expert investor sooner than you think. Yet if you'd prefer to wade in, rather than starting out over your head, you may feel most comfortable using two of the best financial innovations in history: mutual funds and exchange-traded funds (ETFs).
Why funds make a great start
Personally, I'm a big fan of investing in individual stocks. There's no better feeling than doing your own research and discovering a company with real potential -- potential that will not only make the company successful, but could also make you rich.
But as I'll discuss in more detail tomorrow, there's a lot involved in picking individual stocks. It's easy to get frustrated if you read about the market jumping 200 points on a particular day -- only to discover that the stock you picked fell. And it takes work to dig out the details on the way a company works, and what it has to do to beat its competitors and thrive in its industry. Moreover, most 401(k) plans don't let you pick individual stocks.
Funds, on the other hand, don't necessarily take a lot of thought. Once you figure out a simple asset allocation strategy -- that is, how much of your money you want to put into different types of investments -- it's a piece of cake to set up a fund portfolio that reflects that strategy.
Where to start
For instance, say you're in your 40s and looking to invest for a long-term goal like retirement. Turning to the experts over at the Fool's Rule Your Retirement newsletter, you might want to divide up your assets like this:
- 35% in stocks of large-cap U.S. companies.
- 30% in shares of smaller U.S. companies.
- 25% in international stocks.
- 10% in bonds.
The next step is finding mutual funds or ETFs that own those investments. If you choose the simplest low-cost index-tracking funds, you'll find yourself heavily weighted in the biggest companies in each particular sector -- meaning ExxonMobil (NYSE: XOM ) and Microsoft (Nasdaq: MSFT ) for large-cap U.S. stocks, and companies such as HSBC (NYSE: HBC ) and BP (NYSE: BP ) among international stocks.
On the other hand, you can also find actively managed funds that are good for beginners. For instance, a fund like Scout Small Cap (UMBHX) will let you start an automatic investment program with as little as $100 to start, and owns shares of promising small companies like Fossil (Nasdaq: FOSL ) and Lincoln Electric (Nasdaq: LECO ) . Just steer clear of funds that have high expenses, and you'll do fine.
What about ETFs?
The big difference between mutual funds and ETFs is that while you can buy shares of a mutual fund directly from a fund company, you need a brokerage account to buy an ETF. But with brokerage firms like Charles Schwab (Nasdaq: SCHW ) and Fidelity offering commission-free ETF trading, it's easier than ever to get started with ETFs.
Whether you go with mutual funds or ETFs is more a matter of personal preference in most cases. Just be aware that certain ETFs will force you to pay a commission, which can increase your trading costs substantially.
Don't stop thinking about tomorrow
The other nice thing about ETFs is that once you set up your brokerage account, you'll be ready when you decide to move on to buying individual stocks. That's tomorrow's topic in this series on how you can fix your finances in just five days.