In This Chapter

If terms such as bull market, the Dow Jones Industrial Average, tax-deferred savings, mutual funds, and blue chip stock are enough to make you run screaming into your room, just chill for a minute. The stock market is hot, and people of all ages are learning that investing in it can be really fascinating, as well as being the best way to really grow your money. Of course, this doesn’t mean you should get online and invest that $100 Aunt Suzy gave you for Christmas. Investing does involve some risks, so you have to know what you’re doing before you jump in.

This chapter introduces you to the stock market and other investment vehicles. Mutual funds, money markets, certificates of deposit (CDs), and individual retirement accounts are sound investments for those just starting out. I’ll also give you places to go for more information about investing. There’s a lot to know, and plenty of places to look if you’re interested in learning.

If you still think of investing money as an adults-only activity, you couldn’t be more wrong. Teens and 20-somethings are jumping into the stock market in record numbers, sometimes showing up the old-timers with their earnings. More and more of you also are using investment vehicles such as CDs and money market accounts.

Young people are far more savvy about money and money-related issues than they used to be, and the Internet has made investing a lot easier. You can research, buy, and track stock online without having to pay the fees of a full-service broker. You can obtain information and buy mutual funds, get the latest rates on certificates of deposit, and explore many other investment-related areas.

There are plenty of opportunities for investors, both young and not-so-young, but not everyone is ready to start investing in the stock market or buying CDs or mutual funds. Read on to get an idea of whether you should jump in.

Financial experts have varying opinions regarding all kinds of money-related topics. However, one thing that nearly everyone agrees on is that the best time to start investing money is when you’re young. The more time your money has to grow, the better off you are. It’s a simple concept. It’s way better to start earning on your money when you’re 18 or 20 than it is to wait until you’re 35 or 40.

Check out the Motley Fool Web site, located at www.fool.com, for some examples of how starting to save early pays off big time.

The best time to start investing is as early as possible. That doesn’t mean that you should jump online or rush out to a brokerage firm to start buying stock. First, you’ve got to know what you’re doing. When you’re just starting out in investing, it’s a really good idea to find somebody to help you. This could be a broker, who is a person trained to buy and sell investments; or an adult you know who has knowledge of the stock market or other investment vehicles.

Another idea might be to join an investment club, which is a group of people who pool their money to buy stocks or other investments. Belonging to an investment club is a great learning experience, because each member is required to research companies and learn about buying and selling stock.

Investment clubs have been around for a long time, but they’re more popular today than ever before. Most clubs don’t require huge contributions, and members like them because they learn a lot about the stock market and investing.

It doesn’t make any sense to take steps toward investing, though, if you don’t have any money or if you owe money. Understand that you don’t need a lot of money to begin investing; but obviously, you do need some.

If you owe money on a credit card, don’t even think about investing. The best investment you can make is to pay off that high-interest money eater. It makes no sense to invest money to earn 12 or 13 percent when the interest rate on your credit card debt is 18 or 20 percent. However, if you’re debt free and have some money saved up, you might seriously want to think about investing.

To most people, thoughts of investing money conjure up images of the stock market; and for those who take the time to learn about stocks and understand the risks involved with buying them, the stock market might be a good place to invest. However, there are different kinds of investments from the stock market, some of which might make more sense for a beginning investor.

Even the savings account that you might already have is a type of investment, although at 2 or 3 percent interest, it is not a very good one. Some better investments for people just testing out the financial waters are mutual funds, money market funds, and certificates of deposit. If you happen to have a job with a company that offers a 401(k) plan (an employer-sponsored retirement plan to which you contribute a portion of your income to grow, tax-deferred, until you retire), make sure you take advantage of it.

Employers who offer 401(k) plans often match employees’ contributions, which is like getting free money. If Tom has $50 taken out of his paycheck every two weeks and put into his 401(k) savings, and his employer matches his contribution, lucky Tom is doubling his investment.

Money contributed to a 401(k) plan goes into investment options that the employee chooses. Companies often will have financial advisors available to advise employees about the best choices for their investments. Let’s take a closer look at some of these investment options.

You learned a little about money market accounts and certificates of deposit in Chapter 9, “Making Your Money Work for You” so you should recall that a money market account is really a kind of savings account that generally pays a little higher interest than a regular account.

There’s another type of money market called a money market fund (MMF). This is a specialized mutual fund (an investment in which a professional portfolio manager places the money of many investors in stocks, bonds, and other holdings) that pays you interest on your investment. It’s different from a money market account in several ways.

Money market funds are held within mutual fund companies and are not insured, unlike money market accounts, which are insured by FDIC. That of course makes MMFs riskier than money market accounts; but as you might have guessed, the earning potential is greater in a fund than in an account. And even though MMFs are not insured, most mutual fund companies try to keep them safe enough so that the risk you take is very small. They are considered to be safe short-term investments, and some offer tax advantages.

Certificates of deposit (CDs) are accounts in which you deposit money for a specified amount of time—usually between three months and several years. You usually earn more interest on your money in a CD than you would in a savings or money market account, but you have to let the money sit for the required time or suffer a penalty. A minimum amount of money also is required to open a CD. Some kinds of CDs require $1,000 or more to get started, but others require $500 or even less.

Most CDs pay fixed interest rates, meaning you’ll know up front how much interest your money will earn, and the rate won’t change during the time your money is invested. Some CDs do offer variable rates, meaning that the interest rates can fluctuate during the time your money is invested.

If you’re interested in opening a CD, be sure to shop around—you don’t have to open it where you have a savings or checking account.

Mutual funds are the most popular form of investment for individuals; there are several reasons for this. The biggest reason probably is that you don’t need much money to get into a mutual fund. Some will let you in for as little as $50. This makes them very appealing, especially to younger investors.

Mutual funds pool the money of many investors to buy stocks, bonds, and other investments. Professional portfolio managers (also called fund managers) and researchers decide what to buy. When you invest money in a mutual fund, you’re really investing in whatever the portfolio manager decides to buy. You might own stocks or bonds in companies that you’ve never even heard of.

Think of a mutual fund as a big pie. When you hand over some of your money to buy into a mutual fund, you get back a slice of pie. If the value of the mutual fund increases, the pie—and your slice of it—gets bigger. If the value decreases, the pie—and your slice—gets smaller.

The diversity of mutual funds is appealing to many people. Diversity in this sense means that the money you invest is spread around over a wide range of stocks and bonds. This makes it very unlikely that the fund will ever lose its entire value. One aspect of the fund might decrease in value; another increases. Mutual funds carry almost no risk of going bankrupt.

The following list contains some facts about different types of mutual funds.

If you’re looking to start investing some money, mutual funds might be a good option. However, as with any investment, make sure you understand what you’re doing and the risks involved before jumping in.

Anyone who makes any money by working can contribute up to $2,000 per year in an individual retirement account (IRA). Money you put into an IRA is tax-deferred and probably tax-deductible. That means you don’t have to pay any taxes on it until you take it out of the fund when you retire, and you get to deduct the amount you contribute from your taxable income.

If you earn money and don’t report it, you’re out of luck as far as an IRA goes. You can’t contribute to an IRA if you earn—but don’t pay—taxes. Sorry about that. So, even if you earn $3,000 a year from your lawn care/snow removal business, you can’t get into an IRA if you don’t report the income. You could, however, be risking trouble if the Internal Revenue Service ever comes knocking at your door.

The idea behind IRAs is that you’ll invest your money and leave it in the fund to earn interest until you retire. You can get your money before retirement if you need it, but you’ll pay a pretty hefty penalty.

A variation of the basic IRA is the Roth IRA. Basically, a Roth IRA is different from a regular one in the way that your contributions are taxed. When you contribute to a regular IRA, your money isn’t taxed until you take it out of the fund. With a Roth IRA, your money is taxed before you contribute to the fund. So what’s the advantage, you ask? Your money accumulates in the fund (including the interest) tax free. If you leave your money in a Roth IRA for at least five years, you can get it, and the interest you’ve earned, without paying any more taxes on it.

There’s also an IRA called an educational IRA, which is set up especially to fund education expenses. And there’s an SEP-IRA, which is a retirement plan for people who are self-employed.

It probably seems to you that you’re too young to start thinking about saving for retirement. After all, you want to save for a car, and college, and the post-prom trip to the beach, and all those other things. But, retirement? Just remember that the best time to start saving and investing for anything is when you’re young, with lot of time to let your money grow.

Now that you have a basic understanding of some other investment options, let’s take a look at stock and the stock market. What is the stock market, exactly, and how does it work? How do investors make—or lose—money in the stock market?

The stock market is a generic term that we use to describe the organized arena in which securities are traded. Securities are simply investments—either stocks or bonds. The three biggest stock exchanges in the United States are as follows:

You’ll often hear on the radio or TV, or hear people say that the stock market is up, or the market is down. The overall performance of the stock market is measured in many ways. One measure—the one you can hear each day—is the Dow Jones Industrial Average (DJIA).

The DJIA is a group of 30 stocks with a daily average. It goes up or down, depending on the average price of those 30 stocks. If the average value of those stocks has increased, we say the DJIA has gone up. If the value of the stocks decrease, we say the DJIA is down. There are other measures of the stock market as well, but the DJIA is most commonly used.

When you trade in the stock market, what you’re doing is buying and selling securities. Let’s have a look at how stocks and bonds are different, and how investors (hopefully) make money from them.

Stock is something you buy and own. You buy stock because you hope it will increase in value, and you’ll be able to sell it and make a profit. When you buy stock in a company, you’re really buying a little piece of that company. A company sells those little pieces of itself to raise money. Stock is sold in units called shares and, when you buy some, you become a shareholder in the company.

The ideal is to be able to buy stock when it’s cheap, hold onto it until it increases in value, and then sell it. As you can imagine, that scenario doesn’t always play out. The value of stock can fall, meaning that the shareholder has lost money.

There are a lot of different kinds of stock, some of which carry a lot more risk than others. Some of these stocks and their definitions are listed in the glossary at the back of this book.

Bonds are another type of investment. With bonds, you don’t own—you loan. When you buy a bond, you’re lending your money to an organization such as the U.S. government or a corporation. The organization uses your money, and in exchange agrees to pay you interest on your money, and to return it to you after an agreed-upon period of time.

Just as there are different kinds of stock, there are different kinds of bonds; and as with stock, some involve more risk than others. You read about some of the different types of bonds in Chapter 9.

No investment, whether it’s stock, bonds, real estate, or whatever, is without some risk. It’s possible that you’ll buy stock or bonds, just before the entire market undergoes a drastic downturn. It’s possible that you’ll buy land, only to have the entire area be devalued because it’s discovered to be polluted.

The key to making any investment is to research carefully and fully understand what you’re doing. Starting to invest your money at an early age is really great, and if you do it properly, you’ll be really glad that you did when you get older. If you invest your money in junk, however, you’ll have wasted a lot of time and money; but at least you’ll have time to get back on track.

The Least You Need to Know