TL;DR
- A college students first instinct may be to place all earned money toward a savings account, but this will do little for accumulating wealth down the line (and paying off that student debt).
- A brokerage account allows you to buy and sell various investments such as ETFs, mutual funds, and stock.
- There are many different brokerage accounts to choose from, but often online brokerage accounts have low or no trading fees when compared to traditional managed brokerage accounts.
- ETFs and mutual funds are considered lower risk because they consist of various investments and therefore dont rely on a single companys performance for success.
- Compounding is powerful and can lead to a natural accumulation of wealth over a long period.
College is a great time to start investing
Being a college student is often synonymous with being broke. Most college students work part-time and are faced with accumulated student debt after graduation. So why is college a great time to start investing? There are a couple of reasons. While a college students first instinct may be to place all earned money toward a savings account, this will do little for accumulating wealth down the line (and paying off that student debt). Investing a portion of earnings is essential to growing money over time. Investing early in life may allow you to reach certain financial goals sooner; whether that may be retiring early or paying off student loans.
The stock market
Before you start investing, it is important to understand some fundamental information about the stock market. As the name implies, the stock market is where stocks are traded. Investors use various financial instruments and techniques to profit off of the stock market and these investing activities are usually facilitated by a stock brokerage. Often, people will refer to different market indices such as the S&P 500, Dow Jones Industrial Average (DJIA), and Nasdaq Composite. A market index simply shows the performance of a subset of the stock market. For example, the S&P 500 shows the performance of the top 500 companies in the U.S. while DJIA shows the performance of only 30 influential companies in the U.S. Some investors will refer to the market as being either bull or bear. A bull market is a market that is doing well and growing, while a bear market is a market that is struggling and decreasing in value. The stock market can be intimidating and the terminology can be confusing, but the best way to learn is to start investing.
Brokerage accounts
To start investing, you will need to set up a brokerage account. A brokerage account is an investment account that allows you to buy and sell investments such as ETFs, mutual funds, stocks, and bonds. An investor is expected to deposit money into a brokerage account and use available funds to invest in various securities such as stocks, bonds, and mutual funds. There are two common types of account providers: online and managed. An online brokerage account allows an investor to manage her investments through a website or app. A managed brokerage account provides an investor with a human or robot investment manager who advises what securities are best for her portfolio. While a managed account is ideal for someone who wants to take a more hands-off approach to investing, there are often trading fees associated with the catered service. An online brokerage account with low or no fees may make sense for the college student trying to save money wherever possible.
How to start investing as a college student
As mentioned, brokerage accounts can be used to buy various investments such as stocks, mutual funds, and ETFs. But how do these securities differ from one another and where should a new investor start?
A stock is simply a slice of ownership of a company. On the other hand, a mutual fund is a group of stocks, bonds, and other investments that are managed by financial professionals. Therefore, a mutual fund provides investors with the opportunity to invest in many different companies with a single purchase. An ETF or exchange-traded fund is very similar to a mutual fund in that it is a collection of securities. Unlike mutual funds, ETFs can be bought and sold like company stock.
Since ETFs and mutual funds consist of a collection of various investments, they tend to be less risky because success isnt reliant on one company doing well. Therefore, investing in ETFs and mutual funds rather than individual stocks may make sense for early investors given the inherent diversification they provide. College students have limited funds to invest and may be less willing to bet their small earnings on one companys potential success.
Growing your wealth
As mentioned, investing is essential to growing wealth over time, but you may be wondering why that is the case and how that growth occurs. Accumulated growth over time is due to a concept called compounding. Here is an example that demonstrates the power of compounding.
For this example, lets consider what would happen if a college student invested $1,000 in an ETF that had an average annual return of 8% at the beginning of her first year at college. For reference, the average annual return of the S&P 500 since its inception is about 10%.
- Year 1: $1,000 X 1.08 = $1,080
- Year 2: $1,080 X 1.08 = $1,166
- Year 3: $1,166 X 1.08 = $1,259
- Year 4: $1,259 X 1.08 = $1,360
As you can see, investing $1,000 at the beginning of your first year of college can result in a 36% gain or a $360 gain by the end of college. If the investor decides to keep her $1,000 in the stock market for another 5 years and it continues to experience an annualized return of 8% she will double her original investment.
As you can see, time is your friend in the world of investing. The earlier you start your investing journey, the sooner you may be able to reach some financial goals that once seemed lofty.
Bottom line
Investing may not be top of mind for the average college student, but it should be. Investing early, even with a small amount, can lead to large returns down the line. And those large returns can be used to pay off student debt. Investing can be daunting, but there are certain techniques to minimize risk and cut investing costs as a new investor. Low fee brokerage accounts and low-risk investments may be a good choice for the young college student looking to set off on their investment journey.