Advice on investing for the recent college grad


If you have just graduated from a college or university and have joined the labor force -- or are about to do so -- you may already feel that you've had all the advice you can digest.

But there's probably one kind of advice that you have not yet received and that you could find useful, if not as uplifting as your commencement speech. It's how to build your capital gradually, systematically.

We're in a recession and you may be having trouble landing the job you really prefer.

But you're lucky in a way that your commencement speaker probably didn't mention: You have a long investment horizon -- much longer than those of your parents and other older people.

In other words, you have more time to endure stock market risk. Therefore, you can better afford to seek the high returns that stocks, on the average, offer over the years. You also have more time to enjoy the benefits of compounding investment income.

Your parents had these opportunities when they were your age but may not have taken advantage of them. Investing for growth wasn't as popular or as easy then as it is now.

You, however, have conveniently available a variety of investment choices. You also have inducements to investing in the form of income tax reduction or deferral and even, if you're with an enlightened company, employer matching of your dollars.

You can invest in one of at least three ways:

* A regular, taxable account in which you invest what you can afford after paying income taxes and living expenses.

* An individual retirement account (IRA) to which you annually contribute a sum. That sum may or may not be deductible from your taxable income, depending on your retirement plan participation and income level. But in any case your dollars will grow, tax-deferred, until you retire.

* A 401(k) plan, usually offered by an employer after one year, in which you have part of your salary invested for you.

That reduces your taxable compensation, and your money also grows tax-deferred. Some employers match employee contributions dollar for dollar; others, 50 cents for each of your dollars. (If you're still comparing prospective employers, ask whether they have such plans and what they provide.)

No matter which course you take, you may be able to pick a superior equity mutual fund to help you achieve your investment goal. Funds are, of course, available to you when investing on your own in a taxable account or IRA. Nowadays, an increasing number of employers are offering them as 401(k) options, too.

A good equity fund offers you a sensible way to invest in the stock market. It provides the diversification that prudent investment warrants, the portfolio management for which you probably won't have time, and the means for you to put very small amounts of money to work.

Although you are aware that stocks earn a higher return over time than other financial assets, you may wonder whether a stock fund would be too risky for you.

This would be true if you could not plan to keep your money invested very long. But if you can take advantage of your long investment horizon, a good stock fund is a reasonable choice.

Using 1926-1990 data based on the Standard & Poor's 500 Stock Price Index -- a proxy for the U.S. stock market as a whole -- the table illustrates how the risk of loss drops with time.

Clearly, there has been the risk of significant losses in any single year or even five-year periods. But the poorest performance for the index in the worst 20-year stretch during this period was a positive annual return of 3.1 percent. Some funds manage to beat the index each year, but most usually lag behind it.

Over the last 15 years -- crash and all -- the index has averaged an annual rate of 13.9 percent. While a bit higher than the long-run average of 12 percent, this figure was exceeded by a number of funds, led by Fidelity Magellan's 26.8 percent, according to Lipper Analytical Services.

What could a fund investment achieve for you?

If you could invest as little as $50 a month for 35 years -- or a total of $21,000 -- at only 10 percent in a tax-advantaged account, you would have $189,832 in 35 years.

If you were to wait 10 years before starting to invest and then put in $50 a month to earn 10 percent for the following 25 years, you would have invested $6,000 less but would wind up with only $66,342.

You may wish to perform different calculations by varying the assumptions. If you're limited to a fund in a taxable account, the numbers will be more difficult to forecast because you can't predict tax rates. (When choosing a fund, look for a well-managed growth fund that pays minimum dividends and capital gains distributions.)

Even though thoughts of retirement or of other uses for a big lump sum (such as a business of your own) are bound to be far away when you're just starting to work, the rewards of starting early to invest become obvious -- maybe even convincing -- when you try out different scenarios on your calculator.

Market returns

This chart shows the best, average and poorest performance of the Standard & Poor's 500 Stock Price Index over different periods of time. The chart includes index performance from 1926 to 1990.

1 year ... 5 years ... 10 years ... 20 years

Best ... 53.9% ... 23.9% ... 20.1% ... 16.9%

Worst ... -43.3 ... -12.5 ... -0.9 ... 3.1

Average ... 12.0 ... 9.9 ... 10.2 ... 10.3

Source: The Vanguard Group

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