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By Rob CurranMallika MitraCheryl Winokur Munk and Ian Salisbury
February 22, 2021
Illustration of a group of people of holding calculator, coins, pencil, and money bill.
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You don’t have to be a Wall Street pro to know markets are hot right now.

The Dow just raced past 30,000 and hasn’t looked back, Bitcoin is blowing up and money “experts” on FinTok are giving questionable tips to millions of viewers. Forget short sellers — share prices are now at the mercy of Reddit trolls and whatever Elon Musk wakes up and decides to tweet. Oh, and have you heard about GameStop?

If investing once seemed stuffy and exclusive, pandemic-induced boredom — not to mention the arrival of stimulus checks — has suddenly turned it into America’s favorite pastime. And thanks to new players like robo-advisors and the trading app Robinhood, the barriers to entry have never been lower.

But if you’re a younger investor trying out the stock market for the first time, there’s actually a lot you need to learn. That’s especially true now, because when the market is up — and making money seems fun and easy — is also when it’s easiest to make mistakes. After all, the object is to buy low and sell high, not the reverse.

Want to make sure you’re doing it right? Here are nine key questions we think new investors need to ask themselves right now:

1. Should you own mutual funds or ETFs?

While some people like to own individual stocks, most small investors — and even plenty of sophisticated institutions like universities and pension systems — find it convenient to pool their money into investment funds that can own hundreds or thousands of stocks and bonds at once.

Mutual funds, the basic building blocks for most individual investors especially in retirement plans, have been around for decades. But recently their close cousins exchange-traded funds have been gaining fans, especially among financial advisors, and now seem set to overtake traditional mutual funds in terms of total dollars invested, according to Morningstar.

That doesn’t mean ETFs are right for everyone — a lot depends on how hands-on an investor you want to be. “Like any investment type, it’s important to know what you own,” says Jason Blackwell, chief investment strategist of The Colony Group, a wealth advisory and business management firm.

Of course, both ETFs and mutual funds have a lot in common: Both can hold stocks, bonds or even other assets like gold. Both charge annual investment fees, but have plenty of low-cost options available. And both come in active and passive, index-tracking, versions (although ETFs have traditionally focused just on tracking indexes.)

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The key difference is that ETFs must be bought and sold like stocks through a brokerage account, such as Schwab, Fidelity or Robinhood. That means you can trade ETFs throughout the day at prices that fluctuate with the market, flexibility that a lot of professional investors love. Mutual funds, by contrast, can be bought either through a brokerage account or directly from fund companies. But you can only buy or sell once a day, and you always get the price at 4 p.m., the time the market closes.

Also, with ETFs, the minimum investment is generally one share (though in some cases fractional shares are available), whereas many mutual funds have investment minimums that are based on a flat dollar amount. ETFs also tend to be more tax-efficient than mutual funds, which may be important for some investors.

The upshot is that most investors starting out today choose ETFs. And if you sign on with a financial advisor or one of the new robo-advisors (more on that below), chances are that is where they will put your money. But 401(k) plans continue to favor traditional mutual funds, which make bookkeeping easier.

Whatever you choose, be prepared to stick with it. Switching from an existing mutual fund to an ETF (or vice versa) typically means cashing out your position, a move that could prompt a capital gains tax bill — an annoyance that’s likely far bigger than any benefit you stand to gain from owning a different type of fund.

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2. Expense ratios: Are you paying too much...or too little?

Generally, mutual funds and ETF investors should aim to keep their costs as low as possible, since every dollar in fees lowers your investment returns. But many investors wonder what’s reasonable? The good news is funds' annual fees — known as their “expense ratios” — are easy to find and compare.

U.S. stock mutual funds' expense ratios average 0.52%, and bond mutual funds a slightly lower 0.48%, according to the latest available figures from the Investment Company Institute. That means stock fund investors paid average annual fees of $52 for every $10,000 invested in 2019.

Another way to look at it: If the average stock fund returned 10% before fees, it’s return after fees — the actual return for investors — was 9.48%. No wonder so many investors have come to favor low-cost, benchmark-tracking index funds in recent years. The average stock index fund had an expense ratio of just 0.07% in 2019, according to the ICI, compared to 0.74% for stock funds that aimed to actively pick stocks, meaning they are less than one-tenth the price.

The Financial Industry Regulatory Authority’s Fund Analyzer is a handy way to find information on over 18,000 mutual funds, exchange-traded funds, and exchange-traded notes. You can search by fund name, family, ticker or keywords and estimate the value of your funds and how your investment is affected by fees and expenses. You can also look up applicable fees and available discounts for funds.

Just another word of caution about using fees as your only reference point. With so many investors seeking low-cost funds, some firms have launched index-tracking products that charge no fees at all (in other words, with a zero expense ratio.)

Of course, there always costs associated with running a fund or ETF, even if you don’t see those costs directly. If you’re thinking of buying a zero-expense ratio index fund, it’s worth checking its long-term performance against another fund that tracks the same index. If the higher-cost fund comes closer to matching that actual returns of the index, it may still be a better bet, regardless of the extra costs.

3. ESGs: Is there room for politics in your portfolio?

Investing with your values seems to be all the rage. With issues like climate change, gender diversity in the workplace and gun control top of mind, investment dollars flowing into sustainable U.S. mutual funds and ETFs hit a record $51 billion in 2020, according to Morningstar. That’s more than double the $21 billion they collected in 2019.

If you want to put your money where your mouth is, ESG investing is a technique to consider — but make sure you don’t expect more than the strategy can actually provide. While corporations may tout that they meet sustainable and socially conscious goals, how those goals are actually measured can be varied and unclear. Plus, companies may only report what makes them look good — or even report inaccuracies — and the data often isn’t audited by a third party, says Tensie Whelan, professor and director of the New York University Stern Center for Sustainable Business.

There’s also the challenge that while a lot of ESG funds have seen great returns recently, many of them have big bets on technology companies like Tesla (and being too heavily invested in that sector comes with risks of its own).

With those caveats in mind, If you do want to dip your toes into ESG investing, there are tools to help you do so. With Morningstar’s ESG screener you can search for mutual funds that say in their prospectus — a disclosure document with details about the offering — that they integrate ESG analysis or avoid stocks of companies that make fossil fuels or guns, for example. Sustainable ETFs from iShares were popular last year, with four of them receiving more than $1 billion flows, including iShares ESG Aware MSCI USA ETF and iShares Global Clean Energy ETF. The Brown Advisory Sustainable Growth fund and Vanguard ESG U.S. Stock ETF were also among the top funds.

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4. Do you have enough international stocks?

After a decade in which U.S. stocks have outperformed, it may be time for investors to look abroad. China’s economic growth has outpaced the U.S.’s for decades. It even managed to grow its economy last year, by about 2.3%, when the U.S. economy shrunk 2.3%. Yet the SSE Composite Index, a benchmark for the Chinese mainland stock market, is still down more than 25% from its 2015 peak, while U.S. stocks have roughly doubled in that time.

The upshot is that stocks in China, and many other nations look a lot cheaper than U.S. counterparts. Overall, foreign stocks trade at prices of about 16 times their annual profits, compared to nearly 22 times for U.S. stocks.

Index firm MSCI’s All Country World Index — a benchmark designed to treat dozens of global stock markets around the world as one — has a roughly 50-50 balance of U.S. and international stocks. That reflects the fact that the total market value of all U.S. stocks is about half the total market value of all stocks around the globe. Based on gross-domestic product, the balance would be even more tilted toward international holdings, according to money manager BlackRock.

By contrast most popular retirement-investment vehicles, target-date funds, have significantly less exposure to international markets, likely because of both U.S investors' comfort levels and their portfolio managers’ expertise. Fidelity Freedom, one of the largest fund families, maintains a roughly 60-40 split between U.S. and international stocks within its stock portfolio.

What’s more, focusing too much on U.S. stocks might mean missing out on some important growth areas: Globalization in its current form has led to industrial specialization, meaning that it would be difficult to get exposure to vast fields like semiconductor fabrication, concentrated in Taiwan and elsewhere in Asia, by investing in only American companies.

“International investing offers opportunity up and down the value chain across industries that can be overlooked in U.S.-centric portfolios,” said researchers at BlackRock in a report last year.

5. Are you ready for a stock-market bubble?

It’s not just stock prices that have been rising recently. It’s also investors’ spirits. When Bank of America polled fund managers in February, it found global growth expectations were at an all-time high, even surpassing levels during the 2000 dot-com bubble. Meanwhile thousands of individual investors have rushed to start trading stocks, congregating in forums like Reddit’s WallStreetBets — and perhaps recalling the famous Wall Street maxim that when shoe shine boys and cab drivers start trading stock tips, you know the market has entered a speculative frenzy.

None of this means stocks won’t continue rising in the short term. The bubble could inflate further, but, strategists warn, it will eventually pop.

One thing’s for certain: the stock market moves faster than ever. Think back to the March 2020 selloff. It struck like lightning – the Standard & Poor’s 500 lost 30% of its value in 22 trading days, the fastest ever crash, according to analysts at Bank of America. It would be followed by the fastest ever recovery.

So you have to ask yourself: Are you ready to be struck by that lightning a second time?

The age-old method of cushioning blows from selloffs is to shift some of your portfolio into bonds. Take some time while the market is still up to look at how different mixes of stocks and bonds have performed historically. According to this table published by Vanguard, the worst-case scenario for an all-stock portfolio was 1931, a calendar year when stocks lost 43% of their value. A portfolio split evenly between stocks and bonds lost only 23% that year. Of course, in the very long run stocks do outperform. Going back to the 1920s, the've returned 10.2% a year on average vs. 8.6% for a mix that's half stocks and half bonds.

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6. Should you hire a robo-advisor?

Robo-advisors can be a good place to receive low-cost investment help with low or no account minimums. This can be a viable option, particularly for investors starting out who don’t have complicated investment needs. That’s because these investors can get help for a price that’s far below what a financial advisor would generally charge.

Sometimes financial advisors will even recommend robos as a possible option to investors who aren’t currently a fit for their practice. “We discuss whether that service fits their needs, goals, and price-point,” says Stacy J. Miller, a certified financial planning and partner at Bright Investments.

In addition to banking services like checking accounts, robo-advisors typically recommend a portfolio of stock and bond exchange-traded funds, based on factors like your age, tolerance for market risk and savings goals, such as saving for retirement or a down payment on a house. The annual management fee for a robo typically ranges between 0.25% and 0.5%. This is separate from other potential charges, including fund fees and trading fees.

There are dozens of popular robo options today, so there are plenty of offerings to compare: For instance, Wealthfront — one of the first robo advisors and one with low minimums — pitches itself as a one-stop shop for fully automating a person’s finances, offering high-interest checking accounts, investing help, and free automated financial planning all in one place. You can get started with $1 for cash and $500 for investment accounts. For its investment accounts, Wealthfront charges an annual advisory fee of 0.25%.

Betterment, another early entrant to the market, offers a bit of both — automation and the human touch. For a similar 0.25% annual fee, you get automatic features like portfolio rebalancing, dividend reinvestment, and auto-adjust, which allows your mix of stocks and bonds to be automatically adjusted over time — and you don’t have to keep a minimum balance. But if you want a higher-touch option and maintain a minimum balance of $100,000, you can also get unlimited access to certified financial planners, for a slightly higher 0.4% annual fee.

Another option for a hybrid platform offering automation and financial advisor access is Vanguard Personal Advisor Services. This platform is meant for investors with a minimum of $50,000 of investable cash or securities in their portfolios. The advisory fee starts at 0.3% of assets and decreases for investors with higher balances.

7. Are you making the most of your 401(k)?

Retirement can seem really far off — and for many of us, it is. But that doesn’t mean you can ignore saving for it, and taking advantage of a 401(k) is a good way to start. A 401(k) is an employer-sponsored plan that you contribute to directly from your paycheck. Employers will often match your contribution up to a certain amount.

Many 401(k) plans are invested in target-date funds, which are mutual funds pegged to your target retirement year. The fund’s manager automatically adjusts the mix of stocks and bonds to become more conservative as you approach retirement.

So how much should you actually be contributing to your 401(k)? At the very least, as much as your employer will match, says Andrew Laino, a financial planner at Prudential Financial based in Jacksonville, Fla. If your employer tacks on 3% for every 3% you contribute, that’s essentially free money. Who wouldn’t want that? But in 2019, only two-thirds of retirement plan participants received the full employer-matching contribution, according to Vanguard’s How America Saves 2020 report.

The amount you contribute above your company match depends on your projected retirement expenses where else you’ll get income — like Social Security or a pension — and how much you can currently afford to tuck away in the 401(k), Laino says. Experts tend to recommend putting 10% to 15% of your income towards your 401(k), if possible. If you can’t get there all at once, consider increasing your contribution by one percentage point every time you get a raise. Many brokerages, like Vanguard, have calculators you can use to determine how much makes sense for you to save for retirement.

If you withdraw money from your traditional 401(k) before age 59½, you’ll face a 10% withdrawal penalty and income taxes (with certain exceptions). If having all your retirement savings locked up worries you, consider contributing some to a Roth IRA, which allows you to withdraw money you contributed without penalty any time since you’ve already paid taxes on it. By contrast, when you withdraw money from a traditional 401(k) or IRA, you’ll owe income tax on the amount withdrawn.

8. Do you want to take a flier?

Let’s face it, seeing Bitcoin or stocks like GameStop rocket into the stratosphere is exciting. Who doesn’t like to ponder the idea of instant riches?

There’s no harm in taking a big swing, as long as you are not using money that’s a significant part of your long-term financial plan and are prepared for the possibility that you’ll lose it all.

Rich Steinberg, chief market strategist at The Colony Group, recommends young investors put the first $20,000 of their savings in steady index-tracking investments. Only once they've established that relatively safe nest egg should they dabble in what he calls "casino mentality" investments. Even then, young investors should only put 5% to 10% of their next batch of savings into that basket. And they should not experiment with derivatives or borrowed money, which make it possible to lose more than your original investment, he says. "There should be no leverage used at all, no margin used at all, no options used at all.”

If you are determined to join the speculation, the trick is to catch something while it’s still getting hot, before the news coverage becomes saturated.

Cryptocurrencies have had an incredible run but some, including the largest, Bitcoin, have paused for a breather recently. In 2018, Yale economist Aleh Tsyvinski and his junior colleague Yukun Liu conducted a study of cryptocurrencies to try to asses how big a share of investors' portfolios these could ideally become. The economists concluded that anywhere between 1% to 6%, based whether an investor thought the cryptocurrency's recent rate of gains could be maintained, would be appropriate.

Special-purpose acquisition companies are another popular new investment, but extensive reading of S-1 documents is required to figure out who is behind these "blank-check companies" and what kind of ventures they decide to invest in.

Electric vehicles are likely to remain in vogue for some time, given the Biden administration’s planned shift from carbon fuels. But it’s hard to imagine Tesla’s stock has much gas left in the proverbial tank. Analysts at brokerage Morgan Stanley recently recommended looking at smaller companies, such as battery-technology firm Quantumscape and putative Tesla rival Fisker.

9. Are your taxes in order?

It’s been a great time for stock market investors, with the S&P 500 returning a remarkable 132% over the past five years. Just remember: When you go to sell and collect your winnings, Uncle Sam is going to demand his share.

For short-term traders — those who hold stocks (or for that matter bonds or bitcoins) — for less than one year, investment gains are taxed just like income.

Long-term investors, defined as those who own their assets for more than a year, typically benefit from lower rates. For most middle-class and even wealthy filers (singles earning $40,401 to $445,850; couples earning $80,801 to $501,600), the rate on long-term capital gains is 15%.

There are a number of details investors need to keep in mind. Many states tax capital gains too — typically at the same rates they tax income, without giving long-term investors a special break. In addition to capital gains, single filers earning more than $200,000 ($250,000 for couples) may also have to pay an additional 3.8% Net Investment Income Tax on both long- and short-term capital gains.

And, if you sell stocks during the year, don’t wait until April 15 to pay up. If you earn a paycheck, your employer deducts your estimated taxes from every paycheck. That doesn’t happen with your investment gains. The IRS considers taxes due each calendar-year quarter. If you wait until tax season, you may owe penalties.

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