||Ask Dr. Don
Getting started investing
Dear Dr. Don,
I am interested in investing in mutual funds. I am currently in
college, and have been saving money to put into a mutual fund. However,
I have no idea where to start and don't know when and if it's too
early to start investing.
I plan on this being a long-term investment for my
future, like for my children's college or a down payment on a house.
Please point the way to get me started.
It's not too early to start investing. The earlier you start, the
easier it is to reach your financial goals.
First, decide what your financial goals are. You can
have multiple goals -- most people do -- but you need to be specific
about listing those goals. From a financial planning perspective
it's important because you invest for short-term goals differently
than you do for long-term goals. From a behavioral perspective,
it's hard to reach a goal that you haven't defined.
Investing in financial assets means that you're choosing
between investing in cash, stocks and bonds. The term cash is shorthand
for liquid investments such as money market accounts and investments
that mature in a year or less.
Stock investing is buying fractional ownership of
a corporation. You can own shares of a company's stock or own shares
in a mutual fund that owns the company's stock.
When you invest in bonds you're lending money. With
Treasury securities you're lending to the federal government. With
corporate debt you're lending to companies, with savings accounts
(such as CDs) you're
lending to banks, and with municipal debt you're lending to state
and local governments.
In general, invest in cash to meet your short-term
goals. With long-term goals you can extend your investment horizon
to include stocks and bonds. Saving for the down payment on a house
can be a short-term to intermediate-term goal depending on the price
of the house and how much you are able to invest.
You also have to decide between investing in taxable
accounts or tax advantaged accounts. In a taxable account you pay
taxes each year on the account's investment earnings while in a
tax advantaged account the tax treatment of investment earnings
depends on the provisions in the tax law for that type of account.
Education Savings Accounts (CESA) and Section
529 College Savings plans are two tax-advantaged ways to save
for your children's education.
Individual Retirement Arrangements (IRAs) are also
a tax-advantaged way to invest. You'll need earned income to qualify
for the IRA accounts or CESA and can't exceed income limits to contribute
to these accounts. See IRS
Publication 590, Individual Retirement Arrangements, for more
If you qualify, a Roth IRA would be a good place to
start investing. With a Roth IRA you invest with after-tax dollars
but qualified distributions are tax-free. These accounts allow you
to take qualified distributions prior to retirement for education
expenses and withdraw up to $10,000 for first-time home buyers.
The account has to be established for at least five
years before you can use the first-time home buyer provision without
paying the penalty tax on investment earnings. Talk to a tax adviser
to make sure this approach is right for you.
Just starting out, transaction costs and administrative
fees can really eat into your investment returns. If you have $3,000
to invest and the account has a $35 annual account fee, that fee
will reduce the yield on your investment by more than 1 percent.
Avoid paying sales loads on mutual fund investments
by investing in a no-load fund. Even when investing in no-load funds
you need to know what the fund's annual expense ratio is because
that will reduce the yield on your investment. Contact the funds
directly to set up an account and you'll remove a layer of management
(and expenses) by avoiding the need for a brokerage account.
A common mistake for people just starting out investing
in mutual funds is to think that they need to invest in several
funds. By choosing a diversified mutual fund you don't need to diversify
across mutual funds.
A domestic hybrid fund can be a good choice as an
investor's first mutual fund. A hybrid fund invests in stocks and
bonds. The fund manager allocates between these two asset classes.
selector on Morningstar's Web site can help you shop for mutual
funds. That site also has free investing tutorials that will help
you learn more about investing.
-- Posted: May 31, 2002