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Grow Your Own Money Tree: 27 Investment Tips for Young Adults to Help You Grow Y

Grow Your Own Money Tree

27 Investment Tips for Young Adults to Help You Grow Your Money

By C.J. Carlsen

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Copyright

Published by C.J. Carlsen at Shakespir

Copyright © 2016 by C.J. Carlsen.

All rights reserved. This book or any portion thereof may not be reproduced or used in any manner whatsoever without the express written permission of the publisher except for the use of brief quotations in a book review.

Disclaimer

This text is intended to be used for informational and educational purposes only. It is not intended to be a substitute for personalized advice from a professional advisor. The information in this text is in no way considered legal, financial, or professional advice. While best efforts have been used in preparing this book, the author makes no representations or warranties of any kind and assume no liabilities of any kind with respect to the accuracy or completeness of the contents and specifically disclaim any implied warranties of merchantability or fitness of use for a particular purpose. Neither the author nor the publisher shall be held liable or responsible to any person or entity with respect to any loss or incidental or consequential damages caused, or alleged to have been caused, directly or indirectly, by the information or programs contained herein.

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Table of Contents

Introduction Error: Reference source not found

Part I: Getting Started Error: Reference source not found

Part II: Planting the Seeds Error: Reference source not found

Part III: Getting Down to the Roots Error: Reference source not found

Part IV: Fertilizing the Soils Error: Reference source not found

Part V: Growing the Money Tree Error: Reference source not found

Part VI: Closing Error: Reference source not found

Introduction

I remember it like it was yesterday.

I was 8 years old, walking around the mall with my mom. I caught a glimpse of Toys ‘R’ Us out of the corner of my eye. I was instantly magnetized, and took off towards the store. I saw the Gameboy system I had longed for in the window.

The game you could play anywhere. I wanted it. What 8 year old didn’t want a Gameboy!? I was determined to get it.

I tugged at my mom’s sleeve. It took some convincing, but she finally agreed to let me go inside. I walked around for a few minutes, but I knew exactly what I wanted. Once I built up the courage, I said to her, “I want a Gameboy!” I was blunt about it. But I didn’t care.

“Sorry son, we can’t afford it.”

“Please, please, please.” I begged, to no avail.

Finally, she dropped the bomb. “Honey, we can’t get it. Money doesn’t grow on trees.”

Ugh, foiled again.

“Money doesn’t grow on trees.”

How many times have you heard this growing up? If your childhood was anything like mine, then it was a lot. It was my parents’ way of saying money is not an unlimited resource.

It must be earned.

You don’t walk up to a tree, collect money, and go home. It takes hard work. This is the lesson my parents taught me. That, and it was another way for them to get me off their back every time I wandered into the toy aisle.

Money isn’t easy to come by. If you could pluck $20 bills off a tree, then you wouldn’t be reading this book.

But…what if your parents were wrong?

What if you could have your own money tree? And what if that money tree could support you for as long as you live?

You have the power to grow your own money tree. A money tree that will provide for you for decades. Growing your money tree will take time and require patience.

It will not be easy. You have to plant the seeds of money. That is the first step. That is what this book is for. You are provided with the seeds here. But I can’t plant your tree; that’s up to you.

Growing a money tree requires you to understand the basics of investing. These fundamentals provide you with the fertile soil you need to plant the seeds of your money tree.

In this book you learn 27 tips that will help you start investing. These practical lessons are presented with one goal in mind: to help grow your money.

Do you want to achieve financial freedom? Do you want to retire years before your peers? This book will help get you there.

The best time to plant a tree is 20 years ago. The second best time is today.” – Chinese Proverb

Without further ado, let’s dive in!

Part I: Getting Started

Money Tree Tip #1: Investing is not as risky as you believe.

Millennials are the most fiscally conservative generation since the great depression. Think about that. Our generation is as risk averse as the one that experienced the great depression.

An article in Time Magazine told a story of how more young adults choose to keep their savings in cash. They found cash was actually the preferred savings method for most millennials.

In addition, a study by the Brookings Institution found millennials keep 52 percent of their savings in cash. To put this in perspective, all of the other age groups studied keep about 28 percent of their savings in cash. UBS says this is “directly counter to traditional long-term investment allocation advice.”

Millennials are conservative, especially compared to our older counterparts. We saw the burst of the dot-com bubble in the early 2000s. We witnessed the burst of the housing bubble, and subsequent stock market drop in 2009.

In addition, we carry trillions of dollars in student loan debt, making us all the more hesitant to invest. This is why UBS named us the most fiscally conservative generation since the great depression.

Many people fear investing. There is a perception that the market is extremely risky. This perception is only strengthened when the markets go down. We’ve seen people lose money from their investments, which causes us to hold back from investing for just a little longer.

Chances are, someone you care about lost money investing. They took a chance, and lost everything.

The problem is you don’t hear the full story of how they lost their money. In my experience, most people lost money because they didn’t understand investing, and didn’t perform their due diligence. They didn’t have realistic expectations, and took aggressive, sometimes stupid investment positions.

“Are you sure you want to invest? My cousin lost everything in the stock market.”

My friend told me a story about how his cousin lost tens of thousands of dollars in the stock market. I’ve heard stories before about friends of friends losing money, but this story really bothered me for some reason. Maybe it was because he told it to me when I first started investing.

I was a little disturbed, but I decided to dig deeper and asked more questions – questions that focused on what his cousin invested in. I knew the stock market was risky, but it seemed crazy for someone to lose everything.

I found out that his cousin lost everything in early 2000 when the dot-com bubble burst. The guy had all of his money invested in two tech companies that were going to “take off” according to his financial advisor.

You will find these people everywhere

Many people lost money during the dot-com burst because they were greedy. They wanted to get rich quick off of their stocks. Everyone was in a competition to see who could achieve the highest returns. They took on risky positions, investing in only a few companies that were expected to rocket upwards.

Then they lost everything – to no surprise of actual investing experts. When this happened, friends and family heard all about it. They heard of the losses. Many of us were young when we heard these stories. This led us to believe investing is risky. However…

Perceived risk in the market is overstated

The fact is, smart people benefit off the stock market. They don’t take excessive, risky positions, because they know the stock market is a tool to help them grow their money.

There is risk associated with investing. This can’t be denied. There is a chance that your money will lose value in the short-term.

However, many people lose money because they don’t have a sound investment strategy. They take on excessive risk, instead of taking on a smart, long-term investment strategy that will allow them to grow their money.

It can be scary putting your money on the line. You don’t want to lose your hard earned cash in the market; this is understandable.

Most young adults don’t feel comfortable investing in stocks. But this fear must be overcome, and it is my hope that this book will help you get over these fears.

You will never grow a money tree if you never invest your money. You won’t get rich by stashing money under your mattress. As a matter of fact, this makes your money even less valuable over time as you will soon find out.

A smart investment plan substantially lowers your risk

There are no guarantees when you invest; it’s not like a bank where your money is FDIC insured up to $250,000. There is risk involved. Risk that has been blown out of proportion, and that has held many of us millennials back from investing.

Don’t let this fear of risk hold you back. This book will teach you how to invest smart with a long-term approach so that you lower your risk while growing your money tree.

While the perception of risk holds some people back, others haven’t invested because…

Money Tree Tip #2: Society doesn’t nurture investing.

In society today we are lured in by the lust of instant gratification.

Not only that, but society is chalked full of propaganda and subliminal messages encouraging us to buy now.

TV shows glamorize and decorate the people who spend exorbitant amounts of money. Keeping up With the Kardashians, Real Housewives, all of the shows on E! Network promote this glamorous and expensive lifestyle.

These shows encourage you to spend money on a bunch of stuff so you can live what appears to be a rich life. Although viewership is on the decline, almost 2 million people still watched Keeping up With the Kardashians in June 2014. Millions of people watch this show and imagine what it’s like to live like that. They attempt to imitate what they see on TV.

Imitating these celebrities has one big problem. On TV you see these people living a glamorous lifestyle, but you don’t see what they did to get there. You don’t hear the story of how they made their fortune and what they had to do to acquire it.

You are witnessing the result of years of hard work by those celebs or their parents or spouses who built up their wealth. This result allows celebs to live a life of luxury. But they didn’t start out living luxuriously. They had to scratch and claw their way to build their fortune.

People don’t see this part though. Instead, they watch this result, and strive to live the luxurious life as well, without the hard work.

Television shows aren’t the only culprit

Advertisements bombard us all the time. Every 10 minutes, ads pop up on the TV telling us to buy something that we can’t live without. Facebook and Twitter display advertisements in our news feed constantly; even worse, these ads are catered to our specific shopping patterns, making the impulse to buy even more tempting.

We are encouraged to spend our money. We aren’t encouraged to save money. Saving isn’t sexy. Investing is not sexy. Thus, the habit of saving is never established.

Check out my newest…mutual fund?

Have you ever seen someone brag about the mutual fund they invested in? Probably not. If you did, then you would probably just laugh at them.

You can’t show off your newest mutual fund to your neighbors. You can’t park it in your driveway as a sign of your wealth. But you can do that with a BMW, and this is the route most people take.

Instead of accumulating true wealth, these people accumulate things that are signals of wealth. These things represent the image of wealth and give others the impressions that they are rich. The reality is, these things are merely just illusions of wealth.

Going broke for an illusion

In a desert you see the illusion of water. As you inch closer, you realize there was never any water to begin with. The illusion tricked you into believing there was something there when there wasn’t. This is true with wealth as well.

You will witness people putting on the illusion of wealth in the form of nice cars, big homes, expensive boats, and so forth. It isn’t until you inch closer you realize that all of these are just illusions. While these people own a bunch of expensive, nice things, they have nothing put away.

In many cases, the nice things they own are backed by expensive mortgages, leases, or loans. Instead of having a positive financial position, they are in a negative financial position, all for the illusion of wealth.

You must fight the noise around you. Avoid the gravitation pull of spending. Spending is a habit that pulls you down further and further. Before you know it, you will routinely spend your entire paycheck, and never put anything away. You will end up borrowing money in order to buy a bunch of crap because that’s what society is telling you to do.

Push back. Start saving and start investing. You won’t see many of your friends and family encouraging you to save or invest. It’s not something that is appealing or fun to do. However, when you do start saving and investing, you are growing your money tree – the only tree that will give you the freedom to do what you want, when you want.

Do you have money stashed away but haven’t gotten around to investing? Read on, because the next tip will tell you how your habit of saving is not enough, and how you could be losing money as a result.

Money Tree Tip #3: If you’re not investing, you’re losing money.

Every month that goes by and you’re not investing, you are losing money. Not just a small amount of money either – huge chunks of money that compound over time.

Example

Assume you have $10,000 in cash sitting in a bank account accumulating virtually zero interest. You decide to sit on that money for the next five years.

In those five years, that $10,000 will only be worth today’s equivalent of $8,810. You lose almost $1,200 by doing nothing with your money. How could this happen? What is taking away about 2.5 percent of your money every year?

One word: INFLATION

Inflation occurs when the general price level of goods and services increases over time. As a result, the same amount of money buys less goods and services as time passes. This is known as a reduction in the purchasing power per unit of money.

When your money sits in a bank account it loses value. Over the past ten years, the average inflation rate is around 2.5 percent a year. Over a longer period of time (over 100 years) the average rate of inflation is 3 percent per year.

To further illustrate this example, let’s look at a real life example. Suppose you had $10,000 in 1995 that you stashed under your mattress. Due to inflation, that $10,000 is only worth $6,454 today. In 20 years, you lost almost 35 percent of your money’s value without doing anything at all!

If you have extra cash that you don’t need immediate access to, you need to invest it!

Your money grows weaker over time

Imagine your money as a muscle. If you don’t work it out consistently, it will shrink. Doing nothing puts your money in reverse and causes its value to shrink over time.

Just like your muscle dystrophies over time when you don’t use it, your money “dystrophies” as well. It becomes weaker with each passing year, and becomes worth less as time passes, until eventually it becomes worthless.

Money Tree Tip #4: Investing is simple but not easy.

Investing is as simple or complicated as you choose to make it. Most people make it hard, but it doesn’t have to be.

One reason people complicate investing is because they believe they will achieve higher returns by putting in more work. It’s only natural to feel this way – that’s how our brains are wired.

More work does not equal more money

With a traditional job the more you work, the more you get in return; unfortunately (or fortunately, depending on how you look at it) investing doesn’t work like this. Putting in more hours, doesn’t mean you will achieve higher returns.

Most individuals fail to beat the market. It’s difficult to predict how the markets will perform. When you make investing hard, you have a tendency to mess around with your portfolio.

You don’t want to tinker

David Swensen, Chief Investment Officer at Yale University, and manager of their investment and endowment fund totaling $23.9 million, says investors tend to tinker too much with their portfolio. “When investors tinker, they tend to buy things after they’ve gone up and sell things after they’ve gone down, which is a terrible way to manage a portfolio.”

Don’t make investing a difficult venture. Instead, I want you to make it as simple as possible. Investing can be as simple as opening a brokerage account, investing in one fund, setting up automatic deposits, and sitting back and watching your money tree grow.

Once you understand a few basic concepts, you’ll wonder why you didn’t start sooner.

Being simple is not the same as being easy

Warren Buffet recognizes that “Investment is simple, but not easy.” As you will learn in this book it is easy to get started. The hardest part of investing is staying the course and withstanding the fluctuations in the market.

Your emotions can get the best of you. You will second guess yourself. You will see news about the market dropping and be tempted to pull out.

You will consider pulling out and selling all of your investments. You must realize one thing: the absolute worst time to sell investments is when they bottom out.

Shopping for stocks

Investing is similar to shopping. Imagine you are shopping for chicken breast and it’s 50 percent off. Naturally you stock up on chicken.

The stock market is very similar. When stocks go down significantly, that means they are selling at a bargain. You have an opportunity to buy great stocks at bottom of the barrel prices.

For example, if you invested in an index fund like the S&P 500 after the market bottomed out in 2009, you would have bought shares at a steal. You would have enjoyed a return on investment of almost 170 percent in the past five years!

However, if you sold your shares at rock bottom prices, you ended up getting screwed over and lost out on a ton of money. Not only did you sell your stocks for a loss at a low price, but you missed out on the huge upswing that followed.

No matter how simple you make it, watching your investments drop in value and resisting the urge to sell is extremely difficult.

You need to be patient. Prepare to weather the storm. Your investments will go up and down over time, this isn’t a bad thing. But this is exactly why investing is not easy.

Money Tree Tip #5: Investing is not just for the rich.

“Investing is for the rich.” This myth holds many back from investing, including myself at one point.

Investing is not reserved for those who have a pile of cash. If you believe it is, you will never get started.

Investing is not just for men in suits working on Wall Street. Investing is for everyone who is interested in growing their money – no matter how big or small – into something substantial over time.

My story

When I was in college, I hesitated to invest because I didn’t think I had enough to get started. I had a little extra money, around $2,000, in a bank account with 0.5 percent of interest a year. I thought $2,000 wasn’t enough. I thought I needed $10,000 or more put away in order to start investing.

The truth is, I didn’t need $10,000 to invest. If I wanted to, I could have invested the $2,000 in the stock market or bonds. Instead I chose to do nothing and I regret doing so.

$2,000 is not a lot of money, but I could have made a few hundred dollars in a few years from safer investments. If I invested in the stock market, I would have made thousands.

But I didn’t get to enjoy this.

I believed investing was for the rich. And I wasn’t rich, so I didn’t deserve to invest. Learn from my mistakes. You do have enough to get started.

They rich don’t invest because they are rich. They are rich because they invest.

You don’t need $50,000 to start investing. You don’t need to be a millionaire. A few hundred dollars is all it takes to get started.

With the help of technology, everyone can invest their money. In the old days, you had to have a broker; they were the only ones with access to research tools needed to make investments.

If you did want to do the work yourself, you had to go to the local library to read financial literature and research various company’s securities.

Nowadays, information about stocks, bonds, and mutual funds is available with the click of a button. Investing is simple. You can start with a few hundred dollars. Being rich is no longer a requirement to invest.

Part II: Planting the Seeds

Money Tree Tip #6: Save 20 percent of your income.

You must develop the habit of saving if you want to grow a money tree. Without a habit of saving you will never have any money to invest.

Develop the habit of saving at least 20 percent of your income.

Where does 20 percent come from?

This number is recommended by most personal finance experts. While 20 percent may seem like a random number, there is actually a valid reason behind it.

Most experts agree that the perfect savings rate is a guess. In an article on Investopedia, Tim Parker explores the perfect savings rate. The article goes into detail about replacement rate, and other factors which I won’t delve into here. According to one source cited in the article,

“…Wade D. Pfau, CFA, professor of retirement income at The American College, found that historical data over nearly the past century indicate that a person would have to save 16.62 percent of salary to retire 30 years after beginning the savings plan with enough money to fund a replacement rate of 50 percent from his or her “accumulated wealth.”

If you are interested in reading more, check out this [_ Investopedia article_].

That study recommends a savings rate of 16.62 percent. I’ve rounded this number up to 20 percent. If you are looking to retire sooner or want to save more for retirement, a 20 percent savings rate is a great place to start.

Saving needs to be a habit

Saving a little here and there is not enough. You will never achieve the results you want if saving is not a habit.

When you do the minimum on your part, you will never save enough, and your investments will not grow. As a result, your money tree will be weak, and never grow big enough to provide for you.

When you develop a habit of saving, you feed your money tree and allow it to grow to its full potential.

Saving 20 percent or more of your income monthly develops a saving routine. The best way to make saving a routine is to…

Money Tree Tip #7: Pay yourself first.

Pay yourself first. This is one of the oldest pieces of personal finance advice. It’s been around since 1926 and was first introduced in the book “The Richest Man in Babylon” written by George Clason.

This piece of information has sustained the test of time for one reason: it works!

Pay yourself before everything else

Pay yourself first – before food, entertainment, gas, and any other bills. When you pay yourself first, you set aside a portion of your income to save each and every pay period.

This tip works because you become the most important bill you pay.

I know what you’re thinking; “How am I supposed to pay myself first? I can’t even pay the bills I have!”

You have a rent or mortgage payment, student loans, credit card bills, electricity, gas, etc. The advice to pay yourself can seem foreign.

Let me ask you something. How often has this happened? Every month you promise to save money. You say you will cut your expenses, then save what’s leftover. But at the end of the month, there’s nothing leftover!

Without the habit of saving, you get used to living paycheck to paycheck. You keep telling yourself, “next month I’ll save some money. I have a lot of bills this month and can’t do it.”

Create the habit of saving

Paying yourself first is the best way to develop a habit of saving. It works because you put yourself first, and make the most important bill you. Not your landlord, not your bill collectors, but you.

Paying yourself first also works because it forces you to cut expenses. Your other bills will come later, and you find ways to cut down on expenses where you can.

Flipping your budget upside down

Paying yourself first flips your budget upside down. Most people’s budget looks like this:

Income – Fixed Expenses – Variable Expenses = Savings

First you subtract out fixed expenses. Fixed expenses are those expenses which remain the same from month to month no matter what.

Examples of fixed expenses are things such as rent or mortgage payments, student loan payments, car payments, internet service, phone service, and so forth. These are called fixed expenses because you know exactly how much these expenses are every month.

Next you subtract out variable expenses. Variable expenses are things like groceries, eating out, gas, clothing, entertainment and so forth. These expenses change from month to month, and can be adjusted and controlled more than fixed expenses.

Finally, we come to savings. Most people have savings at the very end of the equation. This is whatever they have leftover at the end of the month – which is usually nothing.

By paying yourself first, you take the old budget equation and flip it upside down. Instead of leaving saving for the end of your budget, it becomes the first expense that you have in your budget.

New budget formula

Our new budget formula will be as follows:

Income – Savings – Fixed Expenses = Variable Expenses

We’ve flipped the budget by putting savings first.

Saving becomes an automatic expense every month, and now you must adjust your variable expenses to get to the point where you are living comfortably.

I still can’t save 20 percent every month

If I paid myself first, I wouldn’t have any money to pay for my rent?”

What if you can’t save 20 percent every month? I have a trick to help you get into the routine of saving more each and every month.

The 1 percent method

I recommend the 1 percent method to get into the habit of saving.

You start by paying yourself 1 percent of your typical income each pay period. During each subsequent month you work to save another 1 percent of your income. As time goes on, you save more every month.

By increasing this number 1 percent every month, you don’t get shocked by how hard it is to save 20 percent or more of your income. Instead you slowly work your way up to a 20 percent savings rate.

Example of the 1 percent method

Timothy makes $2,000 every month after paying taxes. He commits to the 1 percent rule and saves $20 in his first month. He puts the $20 in a separate savings account which earns more interest.

The reason he uses a separate savings account is two-fold. One, he earns a higher rate of return in a high yield savings account. Two, his money is outside of his regular bank account and is not readily available for him to withdraw.

In month two he commits to saving an extra 1 percent. He is now paying himself 2 percent of his regular salary. He saves $40 and now has a total of $60 put away into his high yield savings account.

By the end of one year saving this way, Timothy will have $1,560 put away. Not too shabby for someone who didn’t have any money to save before.

Using the 1 percent method, you slowly work your way up to saving 20 percent of your income. This method will take time, but it works. You realize that saving doesn’t have to be a difficult task, and slowly work your way up to your goal.

What account do I pay first?

In the example above, I used a high yield savings account as one place you could save.

The number one recommendation would be to contribute to your 401(k) every month, if you aren’t already. You are losing out on free money if you don’t. We’ll go into more detail on 401(k)’s a little later on.

Once you have contributed to your 401(k), I recommend you contribute to a Roth IRA account, which you will also learn about shortly.

[] Action Tip

If you have not developed the habit of saving, use this action tip to get started:

#
p<>{color:#000;}. Pay yourself first starting this month. Save 1 percent of you income at a minimum.

If you can save more than 1 percent, go for it. I recommend 1 percent for most people to get started because it is manageable and easier to stick to.

#
p<>{color:#000;}. Put this savings into a completely separate savings account apart from your regular checking account.

This money needs to be set aside from your checking account so you are not tempted to spend it. Place the money into your retirement accounts first. If you don’t currently have retirement accounts set up, put it in a savings account separate from the bank where you have a checking account.

If you don’t want to open a completely separate savings account, place this money into a savings account at your bank where you have a checking account and do not touch this money.

#
p<>{color:#000;}. Set a reminder for the beginning of next month to transfer 2 percent of your income to your savings or retirement account.

Using reminder alerts on your phone, or a good ole sticky note, leave yourself a reminder to transfer 2 percent of your income to your savings or retirement account next month.

Set up this reminder for the beginning of the month, and make sure you do this before paying any other bills.

#
p<>{color:#000;}. Repeat this process, adding 1 percent for each subsequent month.

Set up reminders for the next 12 months to pay yourself first. Develop the habit of saving by paying yourself at the beginning of each and every month.

Money Tree Tip #8: Make money work for you.

To achieve financial independence, you need to make money work for you. The way you do this is by investing.

Investing is a different way to make money than what we’re used to. We’re accustom to trading our time for money. If you want to make more money at your job, you work more hours. The problem is that you can only work so many hours in a day.

Make more money without working more hours

This is where investing comes in. Investing is different. You don’t trade your time and receive money in return. When you invest your cash, you put your money to work for you.

I want you to imagine something. Imagine your cash is a little employee working for you. It’s the best employee you will ever have. Your cash employee will go to work for you 24 hours a day and never complain.

While you are sleeping, your money will be hard at work, earning you more money. You don’t have to pay your money to work for you. You don’t have to worry about the headache that comes with managing employees. Money goes to work and gets the job done.

Money is the best employee you will ever have

When money works for you, you maximize your earning potential. While you work during the day, your money will also go to work for you and make you even more money.

The best part of it all is you don’t have to do anything! You don’t have to work extra hours. You don’t have to pick up an extra job. Instead your money is working for you. No one else.

Imagine you have $100,000 put away in an investment earning 5 percent a year. Every year your money is working for you to make and extra $5,000 without any effort on your part.

Now imagine you have $500,000, which is possible if you harness the power of saving and compound interest. This $500,000 would net you a cool $25,000 a year, once again, without any effort on your part. That is the power of money going to work for you.

Putting money to work for you lessens your workload. Especially in your later years in life. While you are winding down your work career years before your peers, your money will continue to work hard, so you don’t have to.

Money Tree Tip #9: Compound interest is the eighth wonder of the world.

Compound interest is one of the greatest tools that helps you grow your money tree.

Albert Einstein once said, “Compound interest is the eighth wonder of the world. He who understands it, earns it, he who doesn’t, pays it.”

If you’ve ever had unpaid credit card debt you learn pretty quickly what compound interest is. When you make minimum payments on your debt and it never seems to go away this is compound interest working against you.

Instead of having compound interest work against you, have it work for you. Compounding interest is the number one reason you need to invest your money.

Remember the last Money Tree Tip? The reason your money works for you is because of the compounding effect.

Example

You invest $100 today in something that returns 10 percent year.

In the first year, you have $100 and you earn interest of $10 on that amount. Now you have a total of $110 invested.

In year two you earn 10 percent interest on your $110 invested, so you receive $11 in interest. This is the compounding effect in action. You make $10 off your initial investment, and then another $1 from the interest you earned in the first year.

In year three you have $121 total invested, and earn $12.10 in interest. Each year you continue to earn more and more interest, because your money is compounding on itself.

This is extra money you earn every year without any effort on your part!

This is the power of compounding interest. As your money grows, it grows and earns you more money, and you earn more interest with each passing year.

The branches of your money tree

Another way to think of compound interest is in terms of our money tree. As your tree grows larger, it develops more branches. As your tree branches out, it produces more fruit, so you earn more money from each branch.

This is why compound interest is such a great tool and why the rich become richer. They use compound interest in their favor. The great thing is, you can have compound interest to work for you too!

Money Tree Tip #10: Understand what investing is not.

Too many people have the wrong perception of money. This goes back to our first Money Tree Tip. However, people on both sides have a skewed perception of investing.

On one side, people think investing is about taking a gamble and hoping their money grows substantially by investing in a few companies.

Then you have the other extreme. People think investing is a form of gambling, so they choose not to participate.

Both sides think investing is a gamble. One side thinks they are going to win, the other side avoids it because they don’t want to lose.

Investing is about growing your money slowly

Don’t get into investing for the wrong reason. Your goal should be to focus on growing your money slowly over time through your investments.

This is why I use the analogy of a money tree. It will take time to grow and develop, but when it does it becomes sustainable.

Don’t get into investing because you hope to get rich quick. I’ve seen too many people trying to figure out how they can beat the market. Whether it be on Yahoo Answers or online forums, these people always ask for stock tips and hot stocks that can help them beat the market.

Companies push the idea of getting rich quick

Even websites like the Motley Fool, which I think is a great resource for those looking to do stock research, pushes the idea that you are going to get rich quick thanks to the stock market.

As an email subscriber, I can’t tell you how many times I received emails from them telling me how they discovered a new industry that is set to take off in 2015.

Unfortunately, this website, along with many others, lead people to believe investing is a vehicle that you can use to achieve incredible market returns.

They make it seem like investing is a gamble, and that in order to win this gamble, you must buy their product or service.

Millennials today choose not invest because they don’t want to gamble and lose. They are more risk averse than their parents in part because they have skewed perception about what investing is.

Millennials keep their savings in cash, not stocks and bonds, to avoid gambling

According to BankRate.com, 39 percent of 18-29 year olds choose cash as their preferred way to invest money they don’t plan on touching for 10 years.

Remember the UBS study cited earlier? Well 52 percent of millennials have their savings in cash. Carrying this much cash is detrimental to young adults. Why?

For one, you miss out on the compounding interest effect when you keep your savings in cash and not investments. You sacrifice returns today because you are opting for the safer option of cash.

In addition, as we established earlier, inflation eats into your cash, and its purchasing power diminishes over time.

Finally, when you choose cash as your main savings vehicle, it’s easy to put off investing for years. By waiting one year, you will lose out on tens of thousands of dollars. This means when you are older you will have to save even more money in order to retire comfortably.

What is the goal of investing?

The goal of investing is twofold: to preserve and protect your money against the effects of inflation. And to slowly grow your money over time using the power of compounding interest.

Money Tree Tip #11: Taper expectations.

Suppose you aren’t risk averse when it comes to investing. What if you are on the other side of the coin and are hoping to get rich quick off the market?

This advice is for you: taper your expectations. Know that you won’t get rich off of the market immediately. Investing is a slow growth process.

The goal is to grow a money tree. You’re can’t grow a tree overnight. The same thing goes for your money. It’s not going to sprout up and bear fruits immediately.

It will take years to grow. But once it does, it will provide for you forever, as long as you continue to nurture and maintain it.

You will not get rich quick by investing. If you are planning on getting rich quick, look elsewhere. You won’t strike gold in the stock market. This is gambling, and the house holds the cards.

What you need to know about investing

Stocks are the highest returning asset class. According to stern.nyu.edu, the average return on stocks from the period of 1928 to 2013 is 9.55 percent and over 2004 to 2013 the average return was 7.34 percent. If you want to see more details, check out their website [+ here+].

I personally estimate my return to be around 8 percent a year after inflation. If you don’t maintain this expectation you will get greedy. You will take on too much risk, and can end up losing money.

The stories of your family members or friends who lost money in the market will become a reality for you if you don’t taper your expectations. Be smart. Be reasonable.

Part III: Getting Down to the Roots

Money Tree Tip #12: Save and invest as soon as you can.

This piece of advice is as old as time. I have included it here because it needs to be reiterated to our generation.

Time is on your side when you are young. You have many factors working in your favor that encourage you to start investing today.

One is compound interest.

Remember our example from earlier? Compound interest rewards those who have been invested in the market for a long time.

The sooner you start investing the more compound interest will work in your favor. As your money is invested longer it makes you money. But you need to start today.

Let’s look at another example involving compound interest. This time we’ll look at it from an age perspective.

The effect of waiting on compound interest

Say you put away $50 a month starting at the age of 20. You invest this money in the stock market earning 8 percent per year. You continue to put away a meager $50 per month until you reach the age of 65.

By the time you are 65 years old you will have $263,727.

What if everything stays the same from the example above, except you wait just one year? What will the effect be?

At $50 per month, you will have earned $242,941 by the time you reach 65.

By waiting one year you lose out on $20,786! Every year you fail to save money, you are losing out on thousands of dollars due to the compounding interest effect.

Let’s take this a step further. Suppose all things the same, except you decide to wait until you are 25 years old to invest your money. By the time you are 65 years old you will have $174,550. You lose out on $89,177 by waiting five years to invest! As time goes on, the money you lose out on will only continue to grow.

Even if you manage to invest only $50 a month, or $12.50 a week, the compound effect can be huge. The smallest amounts have a huge impact on the bottom line. This is precisely why Albert Einstein called compound interest the eighth wonder of the world.

You can’t go back in time and start investing, but you can start investing today.

Money Tree Tip #13: Pay into your 401(k) for full employer’s match.

The most important financial advice is the following: pay into your employer’s 401(k) plan and make sure you pay enough to get a full 100 percent match from your employer. If you aren’t doing this, you are losing out on free money.

A survey performed in 2012 by Wells Fargo Retirement found that, of millennials who are not automatically enrolled in their company’s 401(k) plan, only 13.4 percent of them enrolled and participated. Also, of those millennials enrolled in a 401(k), 47.3 percent contribute 3 percent or less of their income.

This low savings rate is concerning. Saving 3 percent or less of their income means almost half of millennials are not benefiting from their employer’s full match. Additionally, millennials aren’t saving enough for their later years in life.

What is a 401(k)?

A 401(k) is a one type of retirement account. 401(k) plans offer certain tax benefits. These benefits allow you to invest your pre-tax income. In other words, you get to invest your money without paying any income taxes today.

With an ordinary brokerage account, you can only invest your income after paying taxes. Then you pay taxes again on those investments if they go up in value.

With a 401(k) you invest pre-tax money and allow compound interest to work on your money. It isn’t until you withdraw your money from your retirement account that you pay taxes.

Another great benefit of a 401(k) plan is that most employers match your contributions one to one up to a certain percentage.

This means for every dollar you put in, your employer will match that contribution up to a certain percent of your salary. It is as if your investment doubles immediately because your employer is matching what you put in. Let’s take a look at an example.

Example

Morgan makes $4,000 per month before paying any taxes. Her employer will match all of her contributions to a 401(k) plan up to 3 percent of her salary.

Morgan can contribute $120 each month, or 3 percent of her monthly salary, and her employer will match those contributions dollar for dollar up to $120. Every month, between Morgan and her employer, Morgan is investing $240 into her retirement account.

If Morgan doesn’t put any money into her retirement, neither will her employer, and she will miss out on the $120 her employer is willing to contribute to this plan.

In other words, Morgan is losing out on free money if she doesn’t invest in her company’s 401(k) plan!

Another Added Benefit: Autoinvesting

Another benefit of a 401(k) plan is that it encourages automatic investments, or autoinvesting as I like to call it. You learn more about this later, but in summary, autoinvesting is just another way that you “pay yourself first,” by putting money into your retirement account every month.

The hardest part about a 401(k) is getting started. In general, most employers automatically enroll you into their 401(k) plan when you are hired. However, if you don’t believe you are enrolled in your company’s 401(k) plan, contact your HR department immediately and get enrolled today.

Action Tip

#
p<>{color:#000;}. Enroll in your company’s 401(k) plan as soon as possible.

Enroll in your company’s 401(k) plan as soon as you can, if you haven’t already done so. If you aren’t sure if you are enrolled or if you need to enroll, contact your HR person or other personnel and see how you can set up your 401(k) plan.

#
p<>{color:#000;}. Determine how much your company will match.

Each company is different and will only match up to a certain percentage of your income. For example, some companies will do a one to one match up to 3 percent of your salary.

Figure out how much your company will match and…

#
p<>{color:#000;}. Set up your account so you contribute enough money for a full match.

Contribute enough money so that you will receive your company’s full match. If you skip this step, you will be missing out on free money from your company.

Don’t miss out on free money from your employer, invest in your 401(k) plan.

Money Tree Tip #14: Open a Roth IRA.

After contributing to your 401(k) plan, I encourage you to open a Roth IRA. A Roth IRA is another retirement account that has significant tax advantages.

This account is not employer sponsored and is something that you will have to open on your own. It is your responsibility to open this account and to make contributions monthly.

Why invest in a Roth IRA?

A Roth IRA is a great investment tool for young adults for a number of reasons. Roth IRAs enjoy tax advantages in a similar yet different manner than a 401(k) plan. With a 401(k) plan you contribute your pre-tax income then you pay taxes on your money when you go to withdraw the money after the age of 59½.

A Roth IRA is essentially the opposite of a 401(k) plan as far as taxes are concerned. With a Roth IRA you pay taxes on your income and then contribute that money to your investment account. You receive the tax benefits on the back end, so when you withdraw the money at 59½, you don’t have to pay any taxes!

Better access to your money with a Roth

Another benefit of a Roth IRA is that you have better access to your money. With a 401(k) you are not allowed to withdraw money from the account unless you reach the age 59½ or in very special circumstances. If you do withdraw money from a 401(k) plan before you reach this age, you will pay taxes on your withdrawals and a 10 percent penalty, which you do not want to pay.

Roth IRAs are not as restrictive as 401(k) plans. You have better access to your money. You are allowed to withdraw on your principal at any point in time. The only time you are penalized is if you withdraw on your earnings before reaching the age of 59½. This is a great deal, especially for young adults with uncertain finances going forward. Let’s look at another example with our friend Morgan.

Example

After contributing to her company’s 401(k) plan and putting enough money away to get her company’s full match, Morgan has extra money that she would like to invest. She read about a Roth IRA and determined that this was the next investment option she should make.

In her first year with her Roth IRA, Morgan contributes a total of $2,000. In that first year, Morgan earned a total of $150 from her investments in this account.

As the end of the year rolls around, Morgan realizes that she is short on money. She doesn’t have anything in her bank account, and needs to withdraw some money from her retirement account to carry her over to her next paycheck.

With a Roth IRA, Morgan can withdraw all of the contributions she made to the account without suffering any penalty. In other words, Morgan can take out up to $2,000 if she needs to cover bills and not suffer any tax penalties.

However, Morgan cannot take out any of her earnings that she received from her investments, which totaled $150 in the current year. If she does take out any of this $150, she must pay taxes and a 10 percent penalty as a result.

Why are you allowed to take out contributions but not earnings?

It’s important to remember that with a Roth you contributed your money after you already paid taxes on it.

The $2,000 Morgan contributed in the example above was contributed after income taxes were taken out. Therefore, this money is not subject to be taxed again.

However, any earnings that you take out before reaching the age of retirement, or 59½, are subject to be taxed because you haven’t paid taxes on this money. Therefore the IRS will tax you and penalize you 10 percent if you take out these earnings before reaching 59½.

There are a few qualified exceptions where the IRS allows you to take your money, both contributions and earnings, without paying any penalty. Keep in mind, you still pay taxes on your earnings, but you are not forced to pay the 10 percent penalty.

These exceptions include making withdrawals to pay for the following events in your life: disability, death, health insurance while unemployed, large medical bills, purchase of your first house, and so forth.

Drawbacks of a Roth IRA

There are a couple of drawbacks with a Roth IRA. For one, there are income limits for those who can contribute. For 2015, the income limit for single taxpayers is between $116,000 and $131,000 and for married taxpayers is between $183,000 and $193,000.

If you are single and make over $131,000, or married and make over $193,000, you can’t directly contribute to a Roth IRA.

Also, you are only allowed to contribute up to $5,500 per year, or $6,500 if you are over 50 in the 2015 year. If you want to contribute more, you must do so elsewhere. I’ll tell you where in the next Money Tip.

Roth IRAs are great tax plans for young adults. The have flexibility and freedom that allow you to access your contributions at any time. And you still receive amazing tax benefits.

[]Action Tip

#
p<>{color:#000;}. Choose a brokerage firm where you want to open a Roth IRA.

You can skip ahead to Money Tip #17 in order to figure out where you want to open your brokerage account. Research brokerage firms and pick one that you think fits your needs best.

#
p<>{color:#000;}. Set up your Roth IRA with the brokerage firm you chose.

#
p<>{color:#000;}. Set up automatic investments on your Roth IRA

Setting up automatic payments to your Roth IRA is important. We’ll dive into automatic payments more in Money Tree Tip #25, but for now set up automatic payments to your Roth IRA, even if it is only $50 per month.

Money Tree Tip #15: Max out your 401(k).

If you max out your Roth IRA, you should go back to your 401(k) and contribute to this plan until you reach the yearly limit. For 2015, this limit is $18,000, and $24,000 if you are over the age of 50.

You should continue to max out your 401(k) in order to take advantage of the tax benefits. Remember, you want to keep as much money in your pocket as possible. Maxing out your 401(k) will you help you accomplish this.

Money Tree Tip #16: Max out other tax-advantaged accounts.

You’ve maxed out both your 401(k) and your Roth IRA, what next? My recommendation would be to open other tax-advantaged accounts.

If you have children or are planning on having children and want to help pay for their education, 529 Savings Plans or Prepaid Tuition Plans are worth considering. These plans are tax-advantaged accounts that allow you to pay for your child’s education.

They work in a similar manner to a Roth IRA, where you contribute your after tax money to a 529 account. When you withdraw the money to pay for qualified educational expenses, you don’t have to pay any taxes.

If you open a college savings account for your child, it is recommended that you do so after maxing out your retirement accounts. This is because you can always borrow money to help pay for school, but you won’t be able to borrow money to help pay for retirement.

If you are interested in opening a college savings account, check out my book, “The College Tuition Riddle: The Definitive Guide to Saving for Your Child’s Education.”

Self-employed with no 401(k)?

What if you are self-employed and want to open a retirement account? You don’t have a 401(k) plan because you work for yourself, and setting up a 401(k) plan for your small business is a burden. What should you do?

One account worth looking into is an SEP IRA account. This is a Simplified Employee Pension Plan and is very similar to a 401(k) plan, except you can put away much more money.

You are able to contribute 20 percent of your self-employed income and can contribute up to $53,000 in 2015. If you are self-employed this is a great option worth researching further.

After you max out your tax-advantaged accounts, now you can open a traditional brokerage account. You don’t get added tax benefits like you do with the accounts above, but you do get to continue to invest, allowing your money tree to grow further.

[] Money Tree Tip #17: Choose a Brokerage Firm.

You contribute to your 401(k) plan enough and receive your company’s full match. Now you want to open a Roth IRA and maybe a regular brokerage account. To open these accounts you are going to have to choose a brokerage firm.

How should you choose a brokerage firm?

First, let’s establish the difference between two types of brokerage firms. The first type of brokerage firm is a full service brokerage, which I do not recommend.

A full service brokerage firm is a broker that provides a variety of services. Full service brokerage firms provide you with research tools, advice, retirement planning assistance, and tax tips, just to name a few.

This brokerage provides great benefits, but at a steep price. Commissions are much higher when you have a full service broker. These high fees eat into your investment earnings which result in less money for you.

For this reason I recommend a discount broker. With a discount broker, you buy and sell stocks at a reduced price. You don’t receive investment advice, but you save thousands of dollars. You control your account and are not influence by some advisor who could make or break your portfolio.

In addition, most discount brokers don’t require a lot of money to get started. In general, it will cost about $1,000 to $3,000 to get started with most discount brokers; some brokers will let you get started with even less.

Choosing your discount broker

There are many discount broker options available to you; my personal favorite is Vanguard, which I recommend for a number of reasons.

Vanguard has lower fees on their funds. This means you get to put more money towards your investments and less money to the people who are managing your investments. As you will soon learn, most money managers fail to beat the market; putting more money into investments will only benefit you.

Additionally, Vanguard is owned by its clients. If you open an account at Vanguard, you are a shareholder in the company. This means Vanguard is accountable to their customers. This enables Vanguard to focus on keeping fees as low as possible.

Having a company that truly cares about the well-being of their customers is amazing, and this is what you get with Vanguard.

If you are looking at any other options, Fidelity is another option to consider.

Fidelity has been named the best online discount broker according to Kiplinger. They have been given this spot thanks to having a good mix of low fees, solid investment options, and research tools. They don’t charge you if you invest in their funds which is a huge benefit. They also have great stock and fund research tools.

Personally, I prefer Vanguard, but take your time to research and see which discount broker best fits your own personal needs, then open an account with them today.

Action Tip

#
p<>{color:#000;}. Research discount brokers.

Research discount brokers using the information provided above and other resources online. Start with Vanguard, Fidelity, Scottrade, and so forth.

#
p<>{color:#000;}. Choose a broker.

Choose a broker based off the one that fits your needs best. Consider the following when choosing a broker:

*
p<>{color:#000;}. Account fees

*
p<>{color:#000;}. Trading fees

*
p<>{color:#000;}. Account minimums

*
p<>{color:#000;}. Investment options

#
p<>{color:#000;}. Open an account with your broker.

Once you have decided on a broker, set up an online account with that broker.

#
p<>{color:#000;}. Set up a Roth IRA account.

Set up your Roth IRA account after you open your brokerage account. Check out the action tips for Roth IRA account found in Money Tree Tip #14.

Part IV: Fertilizing the Soils

Money Tree Tip #18: You don’t have to pick stocks to invest.

In tip #10 above, I told you that investing is not specifically about picking stocks. While this is one way to invest, the common misconception is that this is the only way to invest. You don’t need to learn how to pick stocks. In fact, you’ll learn why most people shouldn’t learn how to pick stocks.

The two types of investors

Known as the “Father of Value Investing,” Benjamin Graham’s investment firm posted annualized returns of around 20 percent from 1936 to 1956. In addition Graham was the mentor of Warrant Buffet, one of the richest men alive today.

In Graham’s popular book on investing, “The Intelligent Investor,” he says that there are two ways to invest.

The first way to invest is known as active investing. Graham refers to this person as the enterprising investor. The enterprising investor is someone who continually researches stocks and bonds. This person enjoys the challenge of playing the game and picking stocks, has extra time to spend managing their portfolio, and is willing to take on the extra risk involved with picking stocks.

The second way to investor is known as passive investing. Graham refers to this person as the defensive investor, and says most people fit under this profile. The defensive investor is a person who doesn’t have time to research stocks, read financial statements, doesn’t care about playing the stock market game, and prefers a simple portfolio. Instead, this person wants to put their investments on autopilot, with limited work on their part.

There is no right or wrong answer

Whether you want to be an enterprising investor or defensive investor is up to you. There is no right or wrong answer here. However, most are better off as a defensive or passive investor because it requires much less effort.

When you are a passive investor, you can “set it and forget it” when it comes to investing.

Do you enjoy reading financial statements and performing financial analyses of companies? Do you like crunching numbers in your free time?

If you are like most people, you probably don’t. Passive investing has a number of advantages. One, it frees up your time to pursue other activities. Instead of researching companies, crunching numbers, and searching for stocks, you can pursue other hobbies that you enjoy.

In addition, passive investing is less demanding on your psyche. While it may test your emotions at times, you won’t be tempted to jump in and out of buying stocks, which can wreak havoc on your portfolio.

Money Tree Tip #19: Use lifecycle funds for simple investing.

Do you want a portfolio that is hands off, easy to manage, and requires little to no effort on your part? This tip is specifically for those who want to put in the least amount of effort possible with their investments.

Call it the 90/10 approach. By following this investment advice, you put in 10 percent of the effort and are receiving 90 percent of the results.

Now that you have opened a 401(k) plan, Roth IRA, and brokerage account, what will you invest in? I recommend that you go with a lifecycle fund to keep things as simple as possible.

A lifecycle fund is a special, balanced mutual fund where your assets change over time. With a lifecycle fund, you have a certain asset allocation, or collection of different asset types such as stocks, bonds, and cash equivalents, which change over time.

When you are young, this portfolio is made up largely of stocks. This is because stocks are riskier, and you can afford to take on more risk. Your money is expected to be invested in these funds for a long period of time, so you can withstand the fluctuations in the market.

As you inch closer to retirement, your investments become more conservative. You don’t want to risk losing a large sum of money before you retire. Lifecycle funds are designed to help you avoid this.

How lifecycle funds manage risk

Let’s take a look at two different lifecycle funds.

First let’s look at the Vanguard Target Retirement 2050 Fund. This fund is designed for those individuals looking to retire sometime between 2048 and 2053. The person who would buy this fund would likely be someone born between 1985 and 1995.

As of November 30, 2014, the Vanguard 2050 Fund has an asset allocation of: 89.61 percent in stocks, 10.30 percent in bonds, and 0.09 percent in short-term reserves.

As you can see, the Vanguard Target Retirement 2050 Fund is very aggressive, with most of its investments in stocks, and a small portion in bonds. Those who invest in this fund should be invested for 35 years. It makes sense to have more invested in stocks right now.

Now let’s take a look at the Vanguard Target Retirement 2020 Fund. This fund is designed for those individuals looking to retire between 2018 and 2022. The person who would buy this fund would likely be born between 1955 and 1965.

As of November 30, 2014, the Vanguard Target Retirement 2020 Fund has an asset allocation of 60.69 percent in stocks, 39.27 percent in bonds, and 0.04 percent in short-term reserves.

As you can see, the Vanguard Target Retirement 2020 Fund is much less aggressive, with almost 30 percent more invested in bonds.

The goal of this fund is to minimize the risk of the portfolio going down substantially, while still allowing room for growth by investing a large portion in stocks.

What is great about these lifecycle funds is that the asset allocation is automatically adjusted for you over time. You don’t have to worry about rebalancing your portfolio and making sure you aren’t exposed to too much risk.

This fund is easy to maintain and is amazing if you want your investments on autopilot. If you want to make retirement saving easy, I highly recommend you go with a Target Retirement Date fund.

Lifecycle funds can be aggressive. They operate under the assumption that you aren’t going to touch your money until you retire. What if you want to take on a more conservative investment approach as opposed to lifecycle funds? Or what if you want to work on balancing your own asset allocation? Read on…

Money Tree Tip #20: Select your own mutual funds to manage your assets more.

Suppose you want a little more control of where your money is invested, what should you do?

If you want a more hands on approach, I recommend you invest in low cost mutual funds and exchange traded funds (ETFs).

There are a few people who would want to pick their asset allocation.

You wouldn’t want to use a Target Retirement Date Fund if you need access to your cash within the next five to ten years. You would instead want to take on more conservative investments. Instead of investing 90 percent of your portfolio in stocks, like the Vanguard Target Retirement 2050 fund, you would want to keep more money in cash and other safe investments like bonds.

With mutual funds, you determine what you want your asset allocation to be. You have control over what industries or what investments you have, and how much money to put into those investments.

Mutual funds explained

A mutual fund is a collection of stocks or bonds or other investments. With these funds, you get diversified investments while buying into one individual fund. Stocks or bonds are pooled together and sold as individual shares to you the shareholder.

Many funds have very specific strategies depending on what you want to accomplish. For example, with stocks you can choose to invest in large cap stocks (the largest companies available), small cap stocks (smaller publicly traded companies), value stocks (stocks that appear to be undervalued), and growth stocks, just to name a few. For bonds you can choose from high yield bond funds, municipal bond funds, and short term bond funds, just to name a few.

Mutual funds, are different from stocks in that they are valued at the very end of the day.

ETFs are similar in nature to mutual funds. With these funds, they are like stocks in that you buy them on the open market. The value of an ETF varies throughout the day, just like stocks.

Finally, with ETFs, each share is priced individually. You can buy or sell as many shares that you can afford. If one ETF is selling at $80, you can buy one share for $80. This differs with mutual funds that have minimum account balances in order to invest in the mutual fund. For most funds this can range anywhere from $1,000 to $3,000 or more depending on the fund.

Choosing a mutual fund or ETF

Whether you choose a mutual fund or ETF is up to you. You will generally find that most mutual funds have similar ETFs. The main reason you would buy into an ETF instead of a mutual fund is because you are not required to have a minimum account value in order to buy it.

Example

Huey is looking to invest his money. He has $500 that he is ready to invest. Huey wants to invest in a Total Stock Market Mutual Fund from Vanguard.

Unfortunately for Huey, the Vanguard Total Stock Market Index Fund Investor Shares (VTSMX) (which is a mutual fund) requires a minimum investment of $3,000.

However, Huey could go out and buy a few shares of Vanguard’s Total Stock Market ETF (VTI), as it is priced around $105 per share, and does not require an investment minimum. These two funds are essentially the same except for this distinct difference.

You will soon learn how to go about managing your investments if you decide to go the mutual fund or ETF route. However we must first cover the golden rule of investing in mutual funds or ETFs which is…

Money Tree Tip #21: Don’t ever buy an actively managed fund.

When buying mutual funds or ETFs, avoid actively managed funds.

What are actively managed funds?

Actively managed funds are funds that are handled by managers and comanagers. These managers research and use forecasts to select stocks. Based off this information, they use their judgment to buy and sell securities.

The problem with actively managed funds is that they fail to beat the market a majority of the time. As a matter of fact, actively managed funds usually underperform when compared to the market.

According to Nerd Wallet, over the past 10 years actively managed funds beat the market only 24 percent of the time; the other 76 percent of the time these funds underperformed when compared to the market.

So called experts cannot predict the market any better than you and me. While these experts have access to more information and more time to pick stocks, at the end of the day they are still guessing.

Just like human behavior, you can’t predict how the market will perform day in and day out. You don’t know what events will take place that will cause a stock to rise or fall rapidly.

Because these events are so unpredictable, even the best experts have a nearly impossible job of selecting the right stocks.

Another issue with actively managed funds is with the word “active.” It’s someone’s job to pick stocks and constantly stay on top of market news. They pick stocks for a living, and make big money to do so.

As a result, these funds have much higher expense ratios when compared to passively managed funds.

Not only do fund managers fail to beat the market 76 percent of the time, but they charge you more money to do so! This extra expense eats into your investment returns, and takes a huge bite out of your investment earnings.

Money Tree Tip #22: Always invest in passive, low cost funds.

You don’t want to invest in actively managed funds; the solution to this problem is to invest in low cost, passive funds.

Investing in passive funds saves you big money over time. Taking the effect of compounding interest into consideration, this could amount to tens of thousands of dollars or more.

To illustrate the difference between an active fund and passive fund, let’s look at an example.

Example

Passive Pete and Active Alex are two friends who started investing today. Both will put away $500 per month and invest that money into a mutual fund. The average annual return (before expenses) that Pete and Alex will receive for the next 25 years is 8 percent per year.

Passive Pete buys a low-cost, passively managed mutual fund which only has an expense ratio of 0.17 percent. Meanwhile, Active Alex invests in an actively managed mutual fund which charges an expense ratio of 1.5 percent.

Pete and Alex invest $500 every single month for the next 25 years. After those 25 years, Pete accumulates a total of $462,583.

Alex only accumulates $374,418.

All things the same, Alex ends up spending an extra $88,165 for her mutual fund!

Active funds rarely beat the market. I suggest you don’t bother with these funds. Your best bet is to go with low-cost passive index funds. In order to find these funds, focus on the expense ratio of the fund. In general, it is best to find a fund that has an expense ratio of around 0.3 percent or less.

Advice from the best

In case you were still skeptical about investing in low-cost funds, I want you to know Warren Buffet is a huge advocate. When asked what he wants to do with his estate when he dies, Buffet replied:

My advice to the trustee couldn’t be more simple: Put 10 percent of the cash in short-term government bonds and 90 percent in a very low-cost S&P 500 index fund. (I suggest Vanguard’s.) I believe the trust’s long-term results from this policy will be superior to those attained by most investors — whether pension funds, institutions or individuals — who employ high-fee managers.

When you buy into actively managed funds, you make the fund managers richer. Unfortunately they rarely return the favor.

Money Tree Tip #23: Know yourself.

Before selecting your funds, you must know yourself and your risk appetite.

How much risk are you willing to take on?

Do you live fast and on the edge? If so you would likely want to take on more aggressive investments.

Do you live slow, simple, and safe? If so you would likely want to take on more conservative investments.

At the end of the day, it comes down to how much risk you are willing to take on. Do you want to deal with the volatility that comes from the market every day to achieve potentially higher returns? Or would you like something that doesn’t return as much but remains more stable?

This determines what your risk tolerance is. Part of you risk tolerance is also determined by the stage of life you are in.

Age isn’t the decisive factor for your investments

Brad and Karen are both 22 years old. Most would think, “They’re young. They can take on more risk.”

If we just assumed they could invest 90 percent of their money in the stock market, this would be terrible advice.

As it turns out, Brad and Karen are married and have twins on the way. In addition, Brad and Karen are both planning on buying a house within the next year to accommodate their growing family.

Brad and Karen will have more expenses when their children come along, and they want to save up some cash to make a down payment on a home. They don’t want to take on substantial risk at the moment. Because they plan on accessing their cash within the next year, they don’t want to risk losing it due to the fluctuations in the stock market.

Instead, they are better off with safer investments, such as cash equivalents and bonds. Once things settle down and they have a firm grasp of their finances, then Brad and Karen can invest heavily in stocks. However, right now their asset allocation should be heavily weighted with cash equivalents and bonds, and maybe a small portion in stocks.

On the other end of the spectrum there is Samantha. She is 40 years old, single and lives in an apartment in the city with no plans of moving. She is an executive at the firm she works for and doesn’t have any plans for children. Samantha differs from Brad and Karen because she won’t need access to her cash immediately.

As a matter of fact, Samantha can take on much more risk and invest more heavily in stocks than Brad and Karen.

While age matters when investing, you must consider other factors in your life as well.

Action Tip

#
p<>{color:#000;}. Consider where you are in life right now.

Do you have plans to buy a house soon? Do you have plans for children? Do you have plans for a wedding? You may need to save up some money in order to pay for these things.

#
p<>{color:#000;}. Consider how long your investing time horizon will be.

Unless you are planning on making a big purchase, or expect your living expenses to go up soon, plan on having a long-term investment approach. When you have a long term approach, you can take on more risk and invest more heavily in stocks.

In the next tip, we dive deeper into why it is important to know yourself when determining your asset allocation.

Money Tree Tip #24: Choose your perfect asset allocation.

Now that you have a better understanding of your risk profile, you want to pick your asset allocation.

Asset allocation is how you spread your money across various investment types. You have your cash invested in different assets, which include stocks, bonds, cash equivalents, etc.

A brief review of investment types

As you know, stocks are shares of a company which you can buy on the open market. This is what is commonly referred to as the market. Stocks are inherently more risky because they fluctuate from day to day, depending on how the market views them as a whole.

While stocks are historically the highest returning asset class over time, they also expose you to much more risk in the short run. Whenever there is bad news in the world or economy, the stock market suffers. Stocks are the riskiest investments and return an average of 8-12 percent a year over a long time horizon.

Bonds are less risky than stocks, but are also subject to the market conditions. Bonds are fixed investments. When a company issues bonds, you buy them at a certain price. The company then promises that they will pay you a fixed monthly amount for those bonds, and you receive your initial investment, or principal at the end of this term.

While bonds are fixed payments, the underlying value of bonds and the risk of default makes them slightly more risky than cash equivalents, but much less risky than the stock market. Bonds return an average of 5-6 percent a year over a long time horizon.

Cash equivalents are those things which pay a small amount of interest over time but are virtually guaranteed. This includes things like certificates of deposit and money market accounts. While you don’t risk losing money over time, these things also don’t give you a very good return. These investments return an average of 2-3 percent a year.

When allocating assets, these are the three assets where you focus your time.

How you allocate your assets depends largely on your personal situation. Age is not always the determining factor in how you should invest, as we learned in Money Tree Tip #23. How you allocate your assets comes down to your own personal preferences.

I want to give a few examples of asset allocations suggestions that can help you get started.

Aggressive

If you are an aggressive investor, you will take on more risk in your portfolio and invest more heavily in stocks. This is good for someone who likes to live a little more on the edge. This is also good if you plan to have your money invested over a long period of time.

An example of an asset allocation, using mutual funds, for the aggressive investor would be as follows:

*
p<>{color:#000;}. Stocks: 90 percent (65 percent Vanguard Total Stock Market Index Fund Investor Shares, 25 percent Vanguard Total International Stock Index Fund Investor Shares)

*
p<>{color:#000;}. Bonds: 10 percent (8 percent Vanguard Total Bond Market II Index Fund Investor Shares, 2 percent Vanguard Total International Bond Index Fund)

*
p<>{color:#000;}. Cash: 5 percent (Money market account and high yield savings accounts)

Moderate

If you have a moderate investing profile, then you will withstand a certain amount of risk, but don’t want to take on excessive risk. This would probably fit most people. You aren’t conservative and scared to invest, but you don’t want to put all of your money in the stock market either. For a profile like this I would suggest:

*
p<>{color:#000;}. Stocks 60 percent (45 percent Vanguard Total Stock Market Index Fund Investor Shares, 15 percent Vanguard Total International Stock Index Fund Investor Shares)

*
p<>{color:#000;}. Bonds 25 percent (18 percent Vanguard Total Bond Market II Index Fund Investor Shares, 7 percent Vanguard Total International Bond Index Fund)

*
p<>{color:#000;}. Cash 15 percent (Money market account and high yield savings accounts)

Conservative

If you have a conservative investing profile, then you don’t want to take on much risk at all. You want your money to grow slowly over time. Either that or you think you might need access to your money in the near future (within the next five years) and you don’t want to take on excessive risk.

If you have this profile, a good allocation to start with would be:

*
p<>{color:#000;}. Stocks 40 percent (30 percent Vanguard Total Stock Market Index Fund Investor Shares, 10 percent Vanguard Total International Stock Index Fund Investor Shares)

*
p<>{color:#000;}. Bonds 30 percent (22 percent Vanguard Total Bond Market II Index Fund Investor Shares, 8 percent Vanguard Total International Bond Index Fund)

*
p<>{color:#000;}. Cash 25 percent (Money market account and high yield savings accounts)

The examples above should provide a good starting point for you if you do not want to go with a lifecycle fund are looking to allocate you assets.

Part V: Growing the Money Tree

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Money Tree Tip #25: Set up automatic investments.

Setting up automatic investments will set you up for success. Automatic investments help you use the “pay yourself first” principal discussed in Money Tree Tip #8.

I recommend autoinvesting by sending money to your retirement accounts every month.

If you have a 401(k) plan then you are probably already autoinvesting. Each month your employer takes a portion of your paycheck and sticks it into the company’s 401(k) plan.

The next tip I would give you is to set up automatic payments on your Roth IRA.

Personally, I have automatic payments made to my Roth IRA so I can reach the yearly contribution limit of $5,500. Vanguard automatically takes $483.33 from my bank account every month and sends it to my Roth IRA account.

Autoinvesting to fit you

Pick an amount that you are able to save every month. This could be $20 or $100 per month. Whatever the amount, you want to get into the habit of saving every month.

Autoinvesting is a great tool I recommend to everyone. It’s great because you don’t have to think about transferring your money every month. You don’t think about whether you can afford to pay your retirement. Instead money is automatically transferred from your bank account to your retirement account. You adjust your spending to what you have left over from your paycheck.

Best part is, by the end of the year you can look at your retirement accounts and see how much they have grown.

In addition, autoinvesting forces you to commit for the long haul. Because you invest each and every month, you spread your investments out over time.

This is known as dollar-cost averaging. This means you buy you investments when the market is high and when the market is low, thus spreading out your risk over a longer time horizon. When the stock market is low, you buy stocks at bargain prices and when the stock market rises, you enjoy seeing your investment account grow. It’s a win-win situation for you!

Action Tip

#
p<>{color:#000;}. Go to your broker’s website and set up automatic payments on your account.

If you followed the tips from the Roth IRA section, you should have already done this.

#
p<>{color:#000;}. Determine how much money you want to deposit each and every month.

In Money Tree Tip #6 you learned that you should put away 20 percent of your income or more. If this is not manageable, use the 1 percent method to set up your first automatic payment as outlined here.

#
p<>{color:#000;}. Set up a recurring payment for this amount every month.

#
p<>{color:#000;}. Watch your money tree grow.

It is easy to save your money when you don’t have to think about it. Now you can sit back and watch your retirement accounts grow with minimal effort on your part.

Money Tree Tip #26: Ignore the noise.

It’s easy to get caught up in the hype around the stock market. Daily news stories have you believe the market is going to crash one day and then explode upwards the next. Learn how to ignore this noise.

When you commit to investing, this is the first skill you must develop. Understand that short term price changes are meaningless. Don’t let daily fluctuations affect your long-term investment strategy.

Speed hurts your investment strategy

We live in an instant society. We get news in seconds through Facebook, Twitter, and other social media. We also have access to a constant stream of stock market news.

Having news at the tip of your fingers is scary, especially as an investor. The smallest stories about the stock market can cause your investments to drop dramatically, even though the underlying value of your investments hasn’t changed. Doesn’t this seem silly?

Applying stock market behavior to other situations

Imagine you can see the value of your house every single day, like the stock market. Each day your house’s price fluctuates due to the smallest events.

One day you experience a leak in your roof. It’s a small, insignificant leak that can be easily patched up. However, as a result of this leak, you see your house’s value plummet 10 percent in a matter of minutes.

You watch the daily house market news, and they are talking about your house!

“I’m not sure they will be able to recover from this. This leak is serious and it could be a sign of more underlying problems in that house. This could be bad news, and a sign of worse things to come,” says the crazy screaming guy on TV.

Doesn’t this sound a little outrageous? Would you sell your house because of a minor leak in the roof?

Of course not!

While this sounds funny when thinking about your house, this is exactly how the market reacts to stocks. Pundits and experts need something to talk about, and fear sells. So they talk about stock news like it’s the end of the world.

This irrational behavior towards the stock market is based off fear. Fear of losing money and fear of never getting it back. Many people react to the stock market this way. They see fluctuations and see their stocks lose value, and then they sell off their investments.

Tune out the noise of experts

Tune out family members who have hot stock tips.

Understand that there will be stories about the market and that your investments will fluctuate. Most importantly…

Money Tree Tip #27: Prepare for the long haul.

Becoming rich is in your control. Tune out the noise around you and prepare for the long haul. Follow these two rules and you will succeed.

Investing is not something you do for a few months at a time. When you make any investment, have an ownership mentality.

You own your investments and in turn, you own various companies in the market. Don’t look at your investments as numbers on a computer screen. Those numbers represent something. Be proud and take ownership of what you have. Don’t jump ship when something bad happens.

Let’s go back to our example with the house.

You experience a leak in your roof and your house’s value drops 10 percent. You saw your house on TV and the experts said this is a sign of more problems in your house. They want to scare you into selling. What will you do?

You’ll ignore the noise and continue to maintain a long term approach to owning your home. You don’t bounce from house to house, moving into a new house hoping it goes up in value. This would be crazy.

When you buy a house, you have plans to live in it for 10 or 20 years or even longer. You are prepared for the long haul. While the leak is a minor inconvenience, it is not worth selling your house over.

Holding period of over 20 years = guaranteed positive returns?

Consider what you think the value of your investments will be in 20 years. Would the news of today affect you 20 years from now?

In a study performed by Oppenheimer, they found that since 1950, stocks have not suffered an annualized loss in any 20-year holding period ever. They measured returns in rolling monthly periods and did not find a single 20 year period where the stock market lost money.

Keep in mind, from 1950 to 2014 we experienced many market fluctuations that looked devastating at the time. This includes the recession in the mid 70’s and the OPEC oil embargo. It includes the 1987 stock market crash known as black Monday. It includes the dot-com boom and subsequent burst in the early 2000s and also the great recession in 2009.

Have a long-term mindset when you invest in the stock market.

Stocks will go up and down, this is inevitable, but in the long-run, since 1950 the stock market always goes up. Adopt a long-term mentality and prepare yourself for the fluctuations that will come; you’ll be glad you did.

Part VI: Closing

Overview

You are well on your way to growing your own money tree if you follow the advice laid out in this book.

The most important thing you can do for yourself is start today. Every day you that passes by without you investing is another day you are losing out on money.

Don’t rob your future self of a comfortable life and retirement. By not starting today, that is exactly what will happen.

Imagine you have a time machine, and you decide to travel to the future to visit yourself. You want to see how you progressed in your life. While you are there, would you reach into your future self’s wallet and steal a few hundred dollars?

Of course not! But that is essentially what you are doing when you put off investing. You are stealing money from your future self.

Growing your money tree won’t be easy. It will take time. It will test your patience. You will want to give up. It will make you wonder if this is all worth it.

I have news for you…it’s completely worth it! Do you have any grandparents or other older friends who always say “Geez, I wish I would have started saving sooner.”

This is the point in your life where you decide if you want be like those grandparents or the grandparents who were glad they got started at a young age. What side to you want to be on?

We have now come to the close of “Grow Your Own Money Tree.”

My advice to you at this point is to go back through all of the relevant tips, and follow those action tips that apply to you. If there is anything that you have not done yet, do it now.

Better yet, over the next 7 days, I challenge you to go through everything in this book and put those tips into action.

Well, what are you waiting for?!


Grow Your Own Money Tree: 27 Investment Tips for Young Adults to Help You Grow Y

  • ISBN: 9781310910661
  • Author: C.J. Carlsen
  • Published: 2016-04-23 00:35:26
  • Words: 15385
Grow Your Own Money Tree: 27 Investment Tips for Young Adults to Help You Grow Y Grow Your Own Money Tree: 27 Investment Tips for Young Adults to Help You Grow Y