Allocating enough money to support a Friday night bar bill at Coupe de Ville's may be easy enough. But imagine a time, distant as it may seem, when other expenses will become a reality. A home. A car. A family. Without adequate planning, these responsibilities simply impede other obligations. By investing early, the future will be far more manageable.
Saving just a few dollars to invest now can garner huge rewards in the future. Although University students stereotypically are strapped for cash, investing early maximizes profits in the long run.
Based on the miracle of compounding interest, money can grow at an exponential rate when earning interest on itself. For example, by investing $1 today at 10 percent, that compounds to $1.10 next year. To put it in perspective, if that earned interest reinvests itself, that $1 today will amount to $117.39 in 50 years. No wonder Ben Franklin called compounding interest the "eighth wonder of the world."
Unfortunately, the typical University student does not have a surplus of cash lying around to put away.
"When you're in college, it's difficult to invest anything," Commerce Prof. Patrick Dennis said. "I barely had enough to buy beer and pizza."
But even though it may seem costly to invest now, the losses incurred by not investing until 10 years down the road - in terms of lost compounded interest - never can be regained.
To get a better picture of how important time really is, consider this: If a 20-year-old puts $1,000 into a mutual fund that returns on average 12 percent a year, by the time he turns 50, that money will have grown to $35,949. But if he waits until the age of 30 to begin, the return will amount to $10,892. A decade can make quite a difference.
"If you have a good income from a job, treat an investment like a bill you have," Dennis said. "Pay that first, just like you would pay your power, your phone or your rent. That'll help invoke discipline."
First things first
Before one can begin to invest, however, all credit card debt must be paid off and an emergency-fund cash cushion must be established, Dennis said.
Paying interest on credit card bills becomes wasted money that could be used elsewhere.
"If you have a card that charges you 15 percent interest, paying that back guarantees a 15 percent risk-free investment return, which is better than anything you can get in the stock market," Dennis said.
After eliminating credit card debt, a future investor should build a cash cushion equal to about three months worth of living expenses.
This emergency fund allows people to dip into their savings rather than into whatever market assets they may have during unexpected emergencies.
Ideally, the cash cushion should be stored in a money market account, available at any bank. A money market account offers a slightly higher interest rate than savings accounts but with more withdrawal restrictions, such as limiting the size and denomination of checks.
With credit card debt slashed and an established emergency fund, an investor can start building a portfolio of financial assets.
Mutual funds: the rookie investor's best friend
First-time investors should opt for a mutual fund in which investors pool their money in one large, centralized fund encompassing a vast number of stocks.
Index stocks generally offer the best bets for a beginning investor looking for diversification.
"Speculation in one stock is risky," Commerce Prof. Karin Bonding said. "If that one stock drops down, you're left with nothing."
Diversification, buying several types of assets across various industries, smoothes the overall returns and reduces the impact of any one investment in the general portfolio.
"Diversification acts as a stabilizer," Bonding said. "It doesn't guarantee that your fund can't go down, but it ensures you can't lose everything."
Index funds include the Dow Jones Industrial Average, which tracks 30 large companies, such as AT&T, Disney and General Electric, which are traded on the New York Stock Exchange.
Other indexes include the Russell 2000, which follows the 2,000 smallest publicly traded companies, and the Standard and Poor's 500 (more commonly referred to as S & P 500), which watches the 500 largest companies in America. The Russell 3000 is the most highly diversified index, measuring the performance of the 3,000 largest U.S. companies, representing about 98 percent of the shares traded on American exchanges.
Index funds help add to the overall capital gains of investing. Because an investor's account is passively managed, a fund manager will not deduct a load or commission associated with buying or selling stock, thus garnering higher returns.
However, one also should be aware of the fund's expense ratio, the cost of operating the fund itself. The expense ratio is deducted from the fund's overall performance, eroding the investor's monetary gain. Ideally, an investor should go with a fund with less than a 1 percent expense ratio. All fees can be found in the fund's prospectus or fact sheet, often available online.
When shopping for a mutual fund, Dennis advises against purchasing funds solely on the basis of how they did last year, as that is not the best indicator of how the fund will continue to grow in the future.
"Look for one with good performance over the last 5 to 10 years," he said.
Top sites for researching mutual funds include www.morningstar.com and www.lipperweb.com, which provide mutual fund data to news organizations and institutions worldwide.
Funds with no commissions include Vanguard and Teachers Insurance and Annuity Association College Retirement Equities Fund.
TIAA-CREF may be the best bet for student investors as they can start with $50 and have monthly automatic deposits from their main checking account transferred to build the $1,500 minimum principle.
Investors can increase their capital flow dramatically into the fund by systematically depositing a set amount of money either monthly or annually, thus increasing their portion of the overall fund's shares.
Like any investment, mutual funds are meant for the long haul, to fulfill future financial goals. However, funds are easy to buy and sell, so their owners can exit the market painlessly in case of emergency.
"When you get into individual stocks, there's a higher tendency to buy and sell, but people tend not to do that with mutual funds because they're already highly diversified within a portfolio, especially with an index," Bonding said.
But whatever the goal is, consumers must educate themselves about the world of financial assets and its terminology.
Bonding said education particularly is crucial for women.
"It's so important for women to be educated that way," she said. Women "tend to be better investors because they are more patient and they tend to be more careful with their money."
So while money may be tight for the majority of University students who do not have the extra cash to invest, economists agree that because of missed opportunity costs, sooner is always better than later.
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