Learning goal: In this section I want you to get an idea of what type investments you should put your money in and why.

Introduction

So we’ve gone over the most common buckets to put money into, it’s now time to figure out what to actually invest in. You know where to put your money but not what to put it in. I’ll be going over stocks and index funds. If you are just starting out investing, your portfolio should consist mostly of these two.

Stocks

When you buy a stock, you are buying a fractional share of a corporation. What this really means is that you’re giving your money to a company so that they can spend it and they’re compensating you by offering you a little bit of the company (that little bit of the company is called a share).

But what are you going to do with a little bit of a company? Not much. You don’t buy shares to actually own part of the company, you buy shares in order to own the shares themselves.

There are two ways you can make money from owning shares.

The first way is by receiving dividends from the stock. For some stocks, every fiscal quarter the company will take some of its profits and will give share-owners some money based on how many shares they own. The amount of money you receive is based on the company but typically it’s a tiny percentage of the stock price. You can choose to reinvest the dividend back into the stock or cash them out and put it in your savings account.

The second way is by selling shares. Over time, the price of an individual share will fluctuate. If you sell for a higher price than you bought the share for originally, you make money!

Buying shares in one specific company is risky. If the company tanks, you lose all of your money. There’s no guarantee that a specific company will perform well so if you put all of your eggs in one basket you could make a lot of money, or you could lose it all. Picking the companies that are going to perform really well may be a skill that professional traders have, but I sure don’t and I don’t advise you to pick and choose specific stocks when choosing what to invest your money in.

Mutual Funds

A mutual fund is a fund that you put your money into (along with a ton of other people) and then a professional trader manages the pool of money. The professional will pick and choose tons of different stocks with the goal of outperforming the market.

The huge benefit this has over choosing individual stocks is that they are more diverse. This means that if one company goes bust, there may be some small loss for the fund overall but it doesn’t make as much of an impact. Since most mutual funds are managed either algorithmically or by a person, they can rearrange their holdings as the market changes.

The disadvantage is that typically mutual funds have high transaction rates. This means that every time you want to put money into a mutual fund or sell your share of the mutual fund, you will incur a fee. Typically this fee is a percentage of what you’re selling. Since our investment timeline is in the decades, this means we are probably going to be making a lot of money, which turns into a lot of fees paid when you sell your shares.

Index Funds

While mutual funds try to beat the market performance, index funds try to match the market performance, specifically they try to match specific indexes. An index is an indication of how a set of companies in the market are performing. One of the biggest benefits to index funds is that their expense ratios are super low so you get to keep more of the money.

There is a lot more to be said about what index to choose, how a fund attempts to match a given index, and a ton more technical detail, but that’s outside the scope of this post.

You want your money to be in the most diverse investment possible. You want it to be relatively stable, and you want to invest in something that goes up over time. For most people, I recommend investing in Total Stock Market Index Funds. This means you are investing in every single company on the stock market. As such, if one company goes bust, you barely feel a dent. But if the market goes up over time you make money. A good second option is to invest in the S&P 500 index. This index tracks 500 large companies.

When you invest in total stock market index funds, you are betting on the market as a whole, not a specific company. I don’t see the US economy completely collapsing anytime soon (and if it does we have bigger issues to worry about), so I feel that index funds are the best bet.

For Vanguard: VTSAX For Fidelity: FSKAX

Conclusion

Invest in index funds.