When investing in my 20s, I had no idea what I was doing. For one thing, investing wasn’t discussed in college classrooms and most of what I learned from older generations boiled down to contributing to my 401(k).
I didn’t take an interest in personal finance until after college. As I stumbled through confusing investment strategies in my young adult life, I made a few costly mistakes. For example – I didn’t invest in stocks when I should have.
Sure, Millennials understand the importance of investing, but there seem to be too many options and a lack of investment knowledge to make the right choice. I liken my early investment choices to that of Goldilocks and the three bears.
Here’s how I tried to make my investment bed three different ways until I found a strategy that works.
I contributed 2% to my first 401(k) plan
I really needed a beginner’s guide to saving for retirement when I landed my first full-time job after college. Clueless, I stared at the retirement plan, unsure of what to contribute. My co-worker who was six years my senior asked me what she should contribute.
I found this odd because I didn’t have a clue either. We both shrugged our shoulders and decided 2% was a good place to start. Except it wasn’t a good place to start at all. The company had a 401(k) matching program in which they would match up to 5% of your 401(k) contributions.
Had I decided to max out my 401(k) plan from the beginning, I could have a bigger nest egg now. If I increased my contributions by an extra 3%, I could have had 10% going towards retirement. Lesson learned: Contribute to your 401(k) up to the employer match.
I opened an annuity at 23 years old
What was I thinking here? An annuity is a financial product that offers a guaranteed income stream during retirement. Annuities are primarily used by retirees, and I was attracted to the idea that I’d have guaranteed income. The stock market just seemed too unpredictable and confusing. The annuity seemed safe.
However, an annuity at 23 years old is too conservative. Interest rates on annuities are comparable to what you can earn with a Certificate of Deposit (CD). In fact, fixed annuity interest rates currently hover around 3%, which isn’t that much better than inflation.
With most of my working years ahead of me, I lost out on investing more aggressively in the stock market. Plus, I paid taxes to withdraw the money from the annuity once I figured out that my money would do better in a more aggressive investment.
I invested with an expensive mutual fund advisor
Once I realized annuities weren’t the right fit, I did a 180 with my finances and decided to seek out a mutual fund advisor. I was so excited to start investing money, that I didn’t take the time to understand the associated fees for a financial advisor.
First, the mutual fund company I signed up with had an upfront 5.75% fee. That means the amount of money that I used to open the account was now worth 5.75% less. The fee went directly to the advisor. I thought, “That’s fair, so long as the advisor makes me money.”
We moved forward by selecting various mutual funds the company had to offer. Each fund that I selected had more than a 1% annual management fee. I had to pay an admission fee for the mutual fund ride.
The hypothetical expense summary
When I invested with the mutual fund company, I had $10,000. Each quarter, the company would send me a statement of how my investment was performing. Plus, they showed me how my investment could perform overtime with the hypothetical expense summary.
This is a snapshot of what the company sent me and how much I would have paid in expenses over time.
Without investing a penny more, I could end up with $13,771.67 before expenses. Once the 1.26% annual expense fee is applied, I’m left with $13,606.41. That doesn’t seem so bad in one year. But over the course of 10 years, I would have paid more than $2,000 in fees. That’s money I never get back. Yikes.
Then I found index funds
When I moved from Kansas to California, I was in between jobs and had some time on my hands. It didn’t sit well with me that I had to pay so much in fees to invest my money. I hit the bookshelves and picked up Ramit Sethi’s book, “I Will Teach You To Be Rich.”
He mentioned index funds being a great low-cost option to invest in the stock market. My curiosity piqued, I looked up index funds and landed upon John Bogle and Vanguard. I picked up Bogle’s book, “The Little Book of Common Sense Investing,” and decided this was the place for my money.
An index fund is a type of mutual fund that tracks the performance of a given index. The S&P 500 is an index. The Dow Jones Industrial Average is an index. John Bogle puts it this way: “Classic index funds […] represent the entire stock market basket, not just a few scattered eggs.”
Index funds are extremely low cost
The great part about index funds is that they are low cost. Vanguard index funds offer no-load mutual funds. That means there are no sales fees upfront when you buy funds and there are no sales fees when you sell funds.
Vanguard index funds also have an extremely low expense ratio compared to other investment companies. According to the Vanguard website, the average Vanguard expense ratio is 0.10%, while the industry average is 0.57%.
You can buy all the stocks, not just one
Index funds also allow you to buy stock in every company listed in a particular index, which allows you to diversify your investment with one fund. For example, the Vanguard Total Stock Market Index Fund (VSTAX) is made up of 3,551 individual U.S. stocks.
Instead of cherry-picking stocks, you can have them all with one fund. Plus, the expense ratio is just 0.04% and has more than a 10% annual return over the past 10 years.
In fact, the hypothetical scenario that Vanguard supplied showed that a $10,000 investment in 2010 could grow to $26,301.34! That’s way better than what the mutual fund company predicted.
The three major mistakes I made with my investments cost me money and time. If you are unsure of how to invest, I suggest doing at least the following:
Look up your expense ratio. Do a quick health check on your investments by looking up your expense ratios for each fund you invest in. If it’s more than 1%, you might be paying too much.
Do you pay sales fees? Sales fees can be disguised in various terms, such as load, front-end load, or back-end load. Find out what they are and if you are receiving any benefit by paying these fees.
Understand your investments. You could be investing too conservatively or too aggressively, depending on your goals. Find out the annual returns of your investments, and how that number changes over time.
Educate yourself. Further your investment education by reading books, blogs (like this one!), and seeking advice on all aspects of investing. Then you can make an educated decision with your investment strategy.