Last week, a young reader wanted advice on investing for themselves after college. That prompted a different question about investing on behalf of someone younger: What would be your advice on someone investing for their child? Is there a good long term low risk investment choice?
It'd be the same for anyone considering investing: do your homework first. Plunging money into anything you don't understand is a fail waiting to happen. Just ask anyone who got greedy during the housing bubble.
Second, you need to determine what exactly you're investing for: so the kid will have savings later? College? First house downpayment? Remember that different investment choices make sense for different goals, for example 529s & certain IRAs have tax benefits for education savings.
On the other hand depending on the child's age and when you'll want him or her to use the cash, you might want to buy stocks, which can be riskier but provide better returns over the long-term, or bonds or money market funds which have the goal of protecting your principal (the amount you initially invest) and could make sense if you want access to money in the shorter term shorter term.
I have to warn you, though, that I think looking for a long-term/low risk investment might be misguided. You always need to invest to your own sensibilities and risk tolerance and keep in mind the length of time before you'll want to cash out of your investment.
Remember, though, that as a general rule the longer the investment horizon, more risk you can afford. You can stand to have significant equity positions (stocks) in a portfolio if you're not planning on using that money until 10 years from now, because of the likelihood that long-term gains in the market will more than make up for short-term losses. But if you're trying to stash away some cash for something you want to buy next year, putting that money in the market would be foolhardy.
Today's question from tweeted to me by @JNeedHisScrilla (love that handle):
What is the best direction to go for a first time investor with limited funds?
That's a tough question to answer, because like choosing a mate or a place of worship,choosing a smart investment strategy is intensely personal. Where you put your money, and how much of it you put there, should reflect your own goals, resources and time frame. There are as many reasons for investing, and kinds of investments, as there are people with things to spend money on.
But here are some common reasons first-time investors get in the game and things you should consider:
- To save for a first home. Usually, putting your downpayment savings into stocks or mutual funds doesn't make sense because of the risk of losing money. But if you're young and not planning on buying for 5-7 years, you might be able to weather a downturn and still see a return on your principal before you have to touch that cash. You probably still want to keep those holdings separate from any other investments.
- To save for retirement. This is likely to be the first introduction to investing that most young professionals will get. You start your first job and they hand you your benefits packet and that includes information on the company's 401(k) plan and an enrollment form. Read that information from first word to last, and then enroll at the maximum level you can afford to. If you're working and not in your company's 401(k) or other retirement plan, there's really no point in thinking about any other kind of investing.
- To save for a business. To build capital for a business. The same rule as saving for a home downpayment applies: don't put money into the market that you're going to need over a short time frame. But if you don't think you'll be hanging out your own shingle for at least five years or more, this might be an option.
In any event, the best thing you can do before you begin investing is to learn as much as you can about investing. Do you know the difference between equities (stocks) and fixed income investments (bonds)? Do you know what a mutual fund's expense ratio is (and do you even know the difference between funds and individual stocks?). Before diving into any major endeavor, you need to know as much as you possibly can to mitigate your risk.
Good luck.
photo courtesy of freedigitalphotos.net
