My Personal Finance Class Essay

At the end of the school year, my Personal Finance teacher gave us an assignment to write an essay, which I wanted to post because I think it will be helpful for others who want to get started investing themselves. Below is the prompt and my response (I even mentioned my blog, thinking it would impress my teacher :) I hope you find it helpful!

Imagine you have a friend who knows almost nothing about investing that comes to you for advice on how to get started. This friend just graduated from college and was hired by a company that offers a 401K that matches up to 3% for all employees. Prior, the friend had only ever worked part-time and only has a basic checking account. Explain how you would you advise this friend?

From the time your get your first job, developing a basic understanding of how to invest will provide a foundation for wealth building. Here are some simple steps you can take to educate yourself and start investing for your future. 

First, read and learn the basics of investing. There are great books and websites with valuable information available to you. Websites like Investopedia, Yahoo Finance, Motley Fool, and even Khan Academy offer lots of great information for beginners. I would also recommend following my blog, investingforteenagers.com. While you’re not a teenager, my blog offers practical and simple advice for beginners on how to start investing for your future. Lastly, the stock market game is also a great way to learn the fundamentals of investing. However, one warning, in stock market game your timeline is only a few months, which encourages making risky decisions to maximize your short term return. In reality, your goal should be to invest long term, a decade or more, and not beating people on a leaderboard in the short term. Overall, know that there are strategies that spread your money over many different investments and greatly lower your risk so you do not have to stress about losing all of your money.

Once you have a good understanding of the basics, open a few accounts that will allow you to start investing. First, open a basic savings account as an “emergency fund” for unexpected expenses, and then a brokerage account. Brokerage accounts allow you to invest money in stocks, bonds, mutual funds and other investments. Charles Schwab, Fidelity, and Vanguard are popular brokerage companies, which provide customer services and have user friendly apps. Also open the 401K with your employeer and invest at least 3% of your paycheck to take advantage of the company’s dollar for dollar match.  Since your employer matches up to 3% of your 401(k) contribution, that is essentially free money. For example, if you make $1,000 a month and contribute 3% of your paycheck, that’s $30. If your employer matches up to 3%, that’s another $30, doubling your investment to $60. I also recommend opening a Roth IRA (individual retirement account). Because you have already paid taxes on your income, the money you invest in a Roth IRA and everything you earn grows tax free forever. 

Once your accounts are active, you can start choosing how to invest your money. I recommend making simple choices, especially early on, and diversifying your investments, which will limit your risk. Diversification is when you spread your money across many different investments so that if one fails, it won’t impact you significantly. Buying mutual funds and ETFs (electronically traded funds) make this easy. The first investment I would make is into diversified index funds, like the S&P 500 ETFS, which invest in the 500 largest companies in the U.S. This is smart because buying one share of an S&P 500 ETF instantly diversifies your money across 500 reputable companies, making it so that if one company were to fail, it won’t impact you too much. Historically, the S&P 500 has returned 10% per year on average (https://www.fidelity.com/learning-center/trading-investing/sp-500-average-return). There are years when the stock market goes down and you lose money, but that is why it is critical to keep your money invested long term, because the average return over long periods of time has been positive. Investing some money in bonds and gold is also smart because when the stock market goes down, bonds and gold normally stay stable or increase in value. Another advantage of starting early and investing for the long term is compound interest. Compound interest is when you earn interest on the original money you invested and the interest it has already earned, which makes your wealth grow more over time.

Once you feel more comfortable, you can invest in individual stocks, too. But it is important that you do your research and understand the company’s long term potential. Many of the most successful investors, such as Warren Buffet, suggest that you only buy stocks you are willing to hold long term. Long term can be defined as ten or more years. If you are buying an individual stock, it should be a solid company that experts say has lots of potential for growth in the future. Buying individual stocks are risky because if the company does poorly, the stock price will go down and you will lose money if you have to sell. Individual stocks can also go to $0 if the company goes out of business, in which case you would lose your full investment. The S&P 500 will never go to $0, neither will investments such as gold. 

In conclusion, diversifying your money over several different investments and holding your investments long term, lowers your risk and increases the likelihood of positive returns. If you take the time to educate yourself and learn the basics of long term investing and diversification, you won’t have to worry about losing all of your money, even if the stock market crashes, because you will be set up for long term success. You will also take advantage of compounding interest, which over many decades will help your diversified investments grow significantly in value.