With many things in life, participating in them can be done at various levels. For example, you might enjoy challenging yourself with word-search puzzles -- or you might level up gradually or quickly, tackling New York Times crossword puzzles (especially the tricky Saturday ones).
It's the same with investing. You can invest very simply just via your bank -- perhaps buying certificates of deposit (CDs). But they generally lag many other investments in returns, especially in this ultra-low interest rate environment. So consider leveling up to other ways to invest. Here are three signs you're ready.
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1. Level up to the stock market when you know what to expect
The stock market is, for many people, the best route to long-term riches. The table below demonstrates that, offering data from Wharton Business School professor Jeremy Siegel, who calculated the average returns for stocks, bonds, bills, gold, and the dollar, between 1802 and 2012:
|
Asset Class |
Annualized Nominal Return |
|---|---|
|
Stocks |
8.1% |
|
Bonds |
5.1% |
|
Bills |
4.2% |
|
Gold |
2.1% |
|
U.S. dollar |
1.4% |
Data source: Stocks for the Long Run.
Clearly, stocks are the best performers. That's true over a shorter period, too: Between 1926 and 2012, Siegel found that stocks grew at an average annual rate of 9.6%, versus 5.7% for long-term government bonds.
But before jumping into stocks, know what to expect. For starters, expect volatility, and know that no returns are guaranteed. A bond or CD can offer a certain interest rate that's pretty much guaranteed, but in any given year, the stock market might rise or fall by 3% or 30%. Over the long run, though, it has always gone up.
The best way to invest in stocks, for most people, is via one or more low-fee index funds. Some (of many) worth considering are the SPDR S&P 500 ETF (SPY), Vanguard Total Stock Market ETF (VTI), and Vanguard Total World Stock ETF (VT). Respectively, they will spread your dollars across 80% of the U.S. market, all of the U.S. market, or most of the world's stock market.
2. Level up to individual stocks when you're ready to spend the time
Broad-market index funds will deliver roughly the same return of the indexes they track (less associated minor fees). If you would like to try to do better than that, aim to invest in some individual stocks, which have the potential of growing at a faster clip than the overall market.
However, this individual stock investing strategy will take more time and energy than just plunking dollars in index funds. Ideally, you'll spend some time reading up on investing in general and then about lots of different companies. You'll do well to develop some skills along the way, such as learning what dividends are and how they work, along with how to read financial statements
Dividend stocks are a great way to ease into individual stocks, as dividends tend to be paid by companies that are relatively steady growers. It's true that when a company faces very tough times, it might cut back or even eliminate its dividend, but it will try hard not to.
You can simply add some dividend-paying stocks to your portfolio along with shares of index funds. Here's how it might work: You might have a portfolio worth, say, $400,000, with half in index funds and half in a bunch of dividend-paying stocks. (Note that broad-market index funds will pay dividends, too.) If the overall dividend yield for the whole portfolio is 3%, you're looking at receiving $12,000 in dividends annually -- and dividends tend to be increased over time.
3. Level up to growth stocks when you're comfortable studying companies
Once you're comfortable with stocks and you're getting used to studying contenders for your portfolio, reviewing their financial statements and following their news and developments, you might consider adding some growth stocks to your mix. Growth stocks belong to companies growing faster than average, and the best of them can multiply the value of your investment many times over. Costco, for example, has grown in value more than sixfold over the past decade, averaging annual gains of more than 20%.
Not every growth stock will perform as expected or hoped, though, so The Motley Fool's investing philosophy recommends buying 25 or more stocks and aiming to hold them for at least five years. That will give even overvalued stocks a decent chance to grow in value and will give you a greater chance of having some companies among your holdings that turn into amazing long-term performers.
Remember to keep learning as you go, as you might keep leveling up. Some other good books in this regard include The Little Book That Still Beats the Market by Joel Greenblatt and The Little Book of Value Investing by Christopher H. Browne.
