What is the best way for a beginner to start investing?
There are a number of ways to invest in the stock market for wealth creation over the long term. For example, you can buy individual stocks, exchange traded funds, also called ETFs, and mutual funds. I have owned all three.
Mutual funds, the best alternative to investing in individual stocks for both new and experienced investors, in particular, those investors with little money.
When you invest in the stock market you have to invest wisely so you can get a good return on your investment. Otherwise, you could lose a lot of money by either investing in the wrong equities or selling too soon.
Here is an investment strategy for all age groups as well as all risk tolerances
There are two benefits owning mutual funds provide that aren’t available by owning one or a handful of individual stocks.
- professional management
Mutual funds don’t trade like stocks, because they are not traded on an exchange. You buy and sell shares of a fund directly through the fund. The shares of mutual funds are only priced once a day, which occurs shortly after the markets close.
Fidelity offers a number of no-load funds that have no minimum investment requirement. That means you can open an account and invest as little as $1 into a no-load fund. This is ideal for beginner investors with little money who want to start investing for their future.
However, I recommend investing at least $5 each time you invest in a mutual fund since it will take a lot less time to build up full shares in the fund if you invest more than just one dollar at a time.
Keep in mind, the younger you are the less you will have to invest compared to someone who is ten, twenty or more years older than you in order to have a certain amount of money by the time they are age 65.
Waiting until you are 45 years old before you begin to invest is not as good as if you started investing when you were 25.
But, it is better than waiting until you are 50 or 55 years old simply because you have a longer investment time horizon when you are 25, 30 or 40 years old compared to someone who is 55 years old, or older.
You should only invest for the long term and not short term. I consider long term to be a minimum of three to five years. Investing in equities for ten or twenty years would be even better.
Only invest in no-load funds that are rated five stars by Morningstar.
You must know your investment risk tolerance before you invest.
As a new investor, you could simply start out by investing $5 to $25 into one or two no-load funds every payday, just to get the hang of investing in mutual funds.
For example, you could invest $10 into two funds every time you get paid.
This is known as dollar cost averaging.
Dollar cost averaging allows you to buy fewer shares (or fewer fractional shares of a fund) when the market is high and more shares (or more fractional shares of a fund) when the market is low.
Over a long period of time your average cost will be somewhere in the middle of what you paid when you bought shares.
As time goes by, consider boosting the amount you invest in the two mutual funds up to $40, $50 or more each time you get paid.
Keep investing even when the market is dropping because over a long period of time you are likely to come out way ahead compared to only investing when the market is going up.
Of course, you should have an emergency fund equal to six to nine months of income so that when an emergency occurs you won’t have to sell your investments in order to have money to take care of the emergency.
The type of mutual funds you invest in depends on your age, your investment risk tolerance and investment time horizon.
There is no such thing as one mutual fund fits all. For example, I don’t invest in index funds simply because I feel that I can beat the market (the S&P 500 is considered to be the market) most of the time. That is a risk I am willing to take.
Keep reading and I will show you a fund that I consider to be a good alternative to investing in an index fund. But first, let me cover index fund investing.
Investing in an index fund
However, for someone who just wants a way to invest in the stock market, using mutual funds, does not want to have to do any research on the different funds he/she can invest in, an index fund such as the S&P 500 index fund or S&P 500 ETF (exchange traded fund) would be perfect for you.
There are several things you should know about investing in the S&P 500 before you invest in an S&P 500 index fund or ETF.
The good thing about the S&P 500 is that it is well covered in the news media.
The S&P 500 stock index consists of 500 stocks. An index fund will own all of the stocks in the index. In other words, by owning one share of the S&P 500 index fund you will own a sliver of a share of every stock that is in the index.
However, one thing you should know about the S&P 500 is that it can be very volatile at times.
One of the reasons that it can be very volatile is because it is heavily weighed in technology stocks. The largest weight of stocks in this index are technology stocks.
These heavy weights are often referred to as FANG or FAANG stocks. The names FANG and FAANG come from the names of the technology stock themselves.
Their names are Facebook, Apple, Amazon, Netflix and Google.
Any time one or several of these FANG/FAANG stocks has a major move, either up or down in its stock price, that price movement will have a major influence on the overall price of the S&P 500.
On December 21, 2020, Tesla will/did (depending on when you are reading this blog post) be added to the S&P 500. That means all index funds that tracks this index will have to add Tesla to their fund portfolio.
I consider Tesla to be a very volatile stock. When you add this stock along with the FANG/FAANG stocks in the index you are looking at the potential for very large swings, either up or down, in the value of this index as well as S&P 500 index funds.
Younger investors who just want to invest in the market without spending a second studying and/or conducting research about the market may find this to be an ideal investment provided they have a long term investment time horizon and a high risk tolerance.
When owning this index fund, your investment time horizon should be a minimum of five to ten years, due to the potential for high volatility with this index.
However, I do not think that this is the best way for you to go.
Why? Because Fidelity has a fund that is outperforming the S&P 500 index! More about this index alternative fund coming up shortly.
Please allow me to first explain some things that I consider to be very important about the S&P 500 index fund for those who may be interested in owning this index. That way you can make a well informed investment decision.
Some years you could be up by 15% to 30%, maybe even more by owning the S&P 500 index fund. Other years you could be down by 10% to 25%, or more on your investment.
As you grow older and are thinking about retirement more and more, this may not be a good investment for you due to the possible volatility from this fund.
Once you are somewhere around forty to fifty years old, depending on your risk tolerance, you may want to consider adjusting your investment portfolio so that the older you get the less you will be exposed to the volatility that is possible from this fund.
For example, if you are 45 years old and your investments are 100% in the S&P 500 index fund, consider starting to diversify into other funds which are less volatile.
One possibility would be to invest 50% in the index fund and 50% in one or two additional funds for greater diversification.
I just picked the number 50% for simplicity. You could diversify and invest 50/30 and 20. That would mean you have 50% invested in the index fund, 30% invested in a second fund and 20% invested in a third fund.
A combination such as 50/30/20 would likely smooth out the volatility of your total portfolio to some extent.
In other words, by owning just the index fund and having a +18% return one year and a -6% return the following year, your average return over the two years would be +6%.
By diversifying into the 50/30/20 investment mix, you could see a +11% return one year and a +5% return the following year. This would give you an average rate of return for the two year period of +8%.
As you can see, the more conservative portfolio in this example out performed the aggressive portfolio for this particular two year period.
Somewhere around age 45 to 55 you may want to reduce your index fund exposure to somewhere around 10% to 20% in order to cut down the potential volatility in your investment portfolio.
As you get closer and closer to retirement time is no longer your friend. You can not go back in time and change how you invested your money when you were younger.
An alternative investment to owning the S&P 500 Index
I just found a Fidelity fund that is performing way better than the S&P 500 Index. It is the Fidelity Blue Chip Growth Fund (symbol: FBGRX).
According to the Fidelity website, this large growth fund is rated five stars by Morningstar. This fund has been around since December 31, 1987. No minimum investment requirement.
As of 12-14-2020, according the Fidelity website, the returns for this growth funds average annual returns are as follows: YTD +56.18%, 1 Yr +58.66%, 3 Yrs +27.74%, 5 Yrs +23.19%, 10 Yrs +19.37.
This fund owns the FAANG stocks that I mentioned above, Tesla, Microsoft, Salesforce and more. However, it does not own the entire five hundred stocks that make up the S&P 500 index.
I don’t own this fund myself because I am too old. My investment risk tolerance being 69 years old is not as high as it would be if I was 45 years old.
The dividends paid out from this fund are noting to get excited about. That is normal for growth stocks. But, this fund pays a capital gains distribution twice a year.
Investing with the potential for growth as well as additional income in the form of a quarterly dividend check
Would you like to have an investment that provides the potential for growth from stocks investments and also be able to increase your retirement income?
If you plan ahead you can receive a nice supplement to your retirement income in the form of a quarterly dividend from your mutual fund investments.
There are a number of well established companies that pay a quarterly dividend to their shareholders. They include big name such as AT&T, Coca Cola and McDonald’s, just to name a few.
Keep in mind that the stocks chosen for this type of fund are well established companies, and they are not going to give the fund the same amount of volatility you are likely to experience over a number of years by owning a S&P 500/growth index fund.
In other words, I consider the types of funds that pay a quarterly dividend to be more conservative compared to an growth/index fund. That is a good thing for those of you who are older, like me.
For someone who does not have a stomach for volatility in their investments, I feel that it would not be OK to invest most or all of your money into an equity income type of fund.
For example, you may want to go with 20% to 25% index fund and 75% to 80% equity income fund portfolio mix. Or, you could go all in by just owning the equity income fund.
Younger investors should be investing in equity income funds and letting the quarterly dividends paid by these corporations reinvest back into the fund. This will result in something similar to compound interest.
For example, the dividends this year may add up to one additional share of the fund you own. Next year the dividends will be based on the additional share you received the previous year, not counting any additional investments you make, and this may result in the dividend you receive buying one and a third shares, instead of one share.
The following year the dividends could end up buying two shares, and so on and so on every year that they are allowed to build up in the fund.
It is very important to keep in mind that dividends are not guaranteed and a corporation can reduce or stop paying a dividend at any time, for any reason.
Somewhere along the line, your investment risk tolerance will probably decrease. You may want to be out of the index fund that you invested in years ago and move that money into a fund(s) that pays quarterly dividends.
This will boost the number of shares you own in an equity income fund so you will be able to receive larger dividends.
I invest in the Fidelity Equity Income fund (symbol: FEQIX).
In addition to investing in the Fidelity Equity Income fund, I also invest in the Fidelity Strategic Dividend and Income fund (symbol: FSDIX).
Both of these funds pay a quarterly dividend.
Some time, maybe at your age of 65, 67, or 70 you decide to take the dividends out and receive them in cash every quarter. You can do that to give your retirement income a boost.
I chose to invest in both of these funds for greater diversify. These two funds have different investments in their fund portfolios, which is why I decided to invest in both funds.
Another nice thing about these funds is that they have no minimum investment requirement. That means you can invest a very small amount of money into either one, or both funds.
For example, you can invest just $5 into each fund every payday, every week, every month or any other time frame you like.
One of the investment strategies you could use, depending on your investment risk tolerance and age, is allocated as follows. 50% index fund or the Fidelity Blue Chip Growth fund (but not both because they are somewhat similar in fund composition), 25% Equity Income fund, and the remaining 25% invested in the Strategic Dividend and Income fund.
NOTE: Any time you see Index fund anywhere on this blog post you may want to swap it out and replace it with the Blue Chip Growth fund.
Adjust the allotment in each fund according to your own risk tolerance and of course your age.
Investing in the Asian markets using mutual funds for even greater diversification
One other way to diversify your investments is to invest in countries located outside of the United States using no-load mutual funds.
The Fidelity fund that I use to invest in countries located outside of the United States is the Fidelity Emerging Asia fund (symbol: FSEAX).
It is good to spread out your investments into other countries, in my own opinion, since some years the US stock market may be down but the stock market of other countries may be doing better. It could also be the other way around.
With the addition of this fund to my portfolio, I get the best of both worlds, Asia and the US.
Now your asset allocation will change again. The simplest way to go is to go with 25% in all four funds.
Another choice is choosing between one fund, any two funds, or any three funds.
I would not go overboard with the Asian fund asset allocation. You probably should not go over 20% to maybe 30% in this one fund simply because this fund is investing outside of the US.
Asset allocation when approaching retirement age
For example, you could go with 20% index fund, 20% Asian fund, and 30% into each of the two other funds. I like this asset allocation, and I think that it gives you a well rounded portfolio, even up to age 50 or maybe even 55.
Consider eliminating the index fund from your portfolio completely around age 50 or 55. Or, you can sharply reduce the amount of exposure you have in any growth and/or index funds rather then eliminating them all together.
For example, maybe just keep a 2% exposure in these types of funds, up to or even in retirement.
Place the money into the two dividend income funds that I mentioned to give you a higher number of shares. Let the dividends keep building up in those two funds until you are 65, or until a time comes when you would like to start taking the dividends in cash.
Use the information I have provided here to do you own research by simply going to the Fidelity website and inserting the symbol for each of the funds I provided in this blog.
Be sure to scroll down the page provided for each fund on the Fidelity website and click on all of the links found a short distance down from the top of the page. That will give you lots of information you can use to make a wise investment decision.
Maybe you will want to start off with small investments into one or several of the funds provided here. That way you can judge for yourself if the investments you make are good for you.
Of course, you should only invest in any mutual fund for the long term, which is usually for a minimum of three to five years, with the exception I mentioned above.
Dollar cost average into the fund(s) to keep from buying at the top of the market. That helps to reduce your investment risk tolerance.
Be sure to read the prospectus for each of the funds mentioned here before investing. Always do your own due diligence before you invest in any security.
This should not be considered to be investment advice. The information contained in this blog post is for informational purposes only.
P.S. If you think your friends would find this information beneficial, please share it with them. Thank you.