Meeting new people, moving away from home, and getting things done at home and school alone are known struggles a college student faces after high school. Indeed, being alone and independent is a double-edged sword that can strengthen or weaken one’s character. Handling finances and supporting oneself without constant help from your parents is another thing.
Nonetheless, many college students still find time and resources for other things like investing. Although getting additional money requires more energy and effort, many young individuals have started to prepare for their future. The financial impact of the pandemic has been an eye-opener for many individuals.
Investing while still in college can help students graduate with spare funds and start retirement plans. Even those with limited cash reserves can build a portfolio as early as today. And it’s an advantage because starting early means learning early and dealing with smaller inevitable losses. While we’re at it, students must know that some investments may need only a small portion of money.
This article will discuss why college is a perfect time to start investing. We will list the basic and popular investments college students can choose from. Also, we will include a step-by-step guide on how to start an investment journey as a college student.
Why College is a Wonderful Time To Invest
College students are often perceived as being broke. Recent data shows that 43.5 million Americans have chosen to get a student loan to cover their essential and non-essential needs. But college can be an excellent time to begin investing.
Investing does not impose an age limit. Even better, it does not set a minimum amount, and you can start for as low as $5. And since building assets will take time, the earlier you start investing, the better.
Investing as a college student will give you real-world money experience to sharpen your skills. This approach will allow you to become an expert once you graduate. Also, losing money will be less risky since the amount invested is much smaller. But most importantly, investing early can help generate higher payouts in the future.
Popular Types of Investments
College students may be overwhelmed with various investment types as they enter the financial market. We will narrow it down to five investment types to simplify our discussion.
Mutual funds
Mutual funds are investment vehicles that pool assets from shareholders. These are invested in assets, such as bonds, REITs, stocks, and money market instruments. Investment advisors or mutual fund managers allocate mutual funds to different assets to generate income or capital gains.
The portfolio is structured to match the fund’s objectives disclosed in its prospectus. This is divided into several categories, showing the kind of securities it invests in, the level of risk investors are willing to take, investment objectives, and returns.
For example, a risk-averse fund may invest primarily or fully in low-risk assets like bonds or bond funds. The opposite is true for risk-loving investors, opting for equities like stock funds and index funds.
Investment managers may split the fund between bonds and stocks into whatever ratio matches investor preferences. Some go to 80-20, 70-30, and vice versa. Others prefer balanced fund splits like the 60-40, 40-60, and 50-50. As such, the purpose of a mutual fund is to balance risks and rewards. Of course, you can divide these into multiple asset types, including REITs and money market instruments.
An advantage of mutual funds is the accessibility to professionally managed funds. They can track the fund’s performance, usually in the total market capitalization. Given this, shareholders’ gain and loss participation are proportionate to the amount they invest in the fund.
For instance, investors derive returns typically every quarter, half-year, or yearly. These may earn dividends on stocks and interest on bonds and come in the form of distribution to investors. Investors may receive distribution checks or reinvest their earnings to get additional shares.
There are other mechanisms where investors can generate earnings even before dividend distributions. The fund manager may sell a security that has increased its price to derive capital gains and distribute them to investors. Investors may also sell their mutual fund shares once the share price increases.
College students may choose this investment type since someone else will manage it. They can easily enter and leave the market by buying or selling their shares. Also, there is flexibility with their risk appetite. However, these also come with fees and commissions and do not have FDIC coverage.
Bonds
Bonds are loans made by investors to corporate and governmental borrowers. These fixed-income instruments can be considered an I.O.U. (I owe you), a document acknowledging the loan’s existence.
Like a typical I.O.U., the bond document includes the loan and payment details, such as the principal amount, maturity date, and variable or fixed interest payments. Common bond issuers are corporations, municipal governments, states, and the national government. They use these bonds to raise funds for projects and business operations.
Bonds are often considered fixed-income securities or instruments since these are traditionally paid with a fixed interest rate. But today, variable rates are also quite common. This makes bonds earn through interest income or yields. Given its nature, bond prices have a high inverse correlation with interest rates. Hence, bonds are more attractive in a low-interest environment.
Bonds are favored mainly by risk-averse investors due to their nature. Yet, returns are typically lower than equities. Even so, government-backed bonds, such as T-bills or bonds, municipal bonds, and government-sponsored enterprise securities, are quite different from typical bonds. They are more adaptable to inflation and have better hedges against valuation losses during interest rate hikes.
Stocks
Stocks or equities are the largest and most popular on the list due to the market size and coverage. The stock market has been the foundation of investment portfolios for over a century after outperforming most other investments.
Given the huge influence and impact on economies, the stock market must always adhere to government regulations. For example, the Securities and Exchange Commission shields investors from trading companies’ fraudulent activities and unethical practices.
Investing in stocks or equities means a fraction of the issuing company. Stock units are called shares, allowing investors to access the company’s assets and income in proportion to their stock ownership.
These are bought, sold, and traded on different stock exchanges worldwide. Since these are more volatile than other investment types, risks are greater. Yet, returns are much higher. Price changes can be over 10% in a day.
Investors can earn through dividends. Not all stocks pay dividends, but most do, especially those existing for an extended period. But of course, not every dividend stock is worth buying, so you must check the dividend yield by dividing the dividend by the stock price.
You must also check the consistency of dividend payouts and the frequency of increases. To maximize potential dividend income, you may choose the Dividend Champions or stocks increasing dividends for over 25 years. Dividend Contenders or those raising dividends for 10-25 consecutive years, and dividend challengers or those doing the same for at least five years.
But a more traditional way is selling stocks when the selling price exceeds the entry or buying price. That is why you must closely monitor price changes to derive gains.
Some prefer making technical analyses using different techniques. These include the Simple Moving Average (SMA) of the stock price for the past 50 days. Others combine the Average True Range (ATR) with the SMA to get the target price range.
But the most crucial thing is checking the fundamentals of the company. These include the historical and projected performance of the company. Investors may focus on company KPIs, such as sales, EBITDA, net income, receivables, cash, FCF, inventories, and borrowings.
Cash, borrowings, and EBITDA are essential for capital-intensive companies since they compare viability with liquidity. Investors also check external factors affecting the company, such as competitors, industry performance, and macroeconomic indicators. Lastly, investors may employ stock valuation techniques like price multiples and the DCF model to get the target price.
Tip for investors eyeing two or more stocks in the same industry: they can check the historical performance of the stock using stock price alone. The Sharpe Ratio checks the returns and volatility of the stock price. They can fuse it with the Efficient Frontier to get the optimal allocation of the stock price.
Below is an example of the Sharpe Ratio of several S&P 500 insurance stocks. Annual returns are taken by getting the average price change since the Global Financial Crisis. The Risk-Free Rate is equivalent to the 10-year T-bill rate.
Meanwhile, the standard deviation can be computed by getting the square root of variance or the dispersion of price changes in the M.S. Excel. Using the information, the Sharpe Ratio can be taken using (Annual Returns – Risk-Free Rate) / Standard Deviation. The higher the ratio, the better.
Clearly, Arthur J. Gallagher (AJG) is better than Assurant (AIZ) and The Hartford (HIG). It also outperformed the S&P 500 average. It had the highest returns of 13.82% since the GFC. Even better, the standard deviation is also lower than its peers. Hence, it optimized risks and rewards.
REITs
For dividend investors, REITs can be an excellent choice. Despite the volatility in the real estate industry, REITs have shown promise over the years. They have appreciated as property demand remains high. Today, property shortages in the US remain high as demand still exceeds supply despite the price. This is why a real estate bubble burst remains avoidable.
Aside from high dividends and value appreciation, REITs have a low correlation with stock market changes. They have a much lower standard deviation and beta than the S&P 500 average. Hence, price changes have always been relatively stable regardless of macroeconomic changes.
Certificate of Deposits (CD) and High-Yield Bank Accounts
CDs and high-yield bank accounts are optimal choices in a challenging macroeconomic environment. They can generate higher yields with low risk than other bank accounts as interest rates remain elevated.
So, with CDs, investors can leave money in the bank for a specific period without moving it. After the period, the money saved and the interest yielded are returned to the customer.
How College Students May Start
Now that you’re familiar with primary investment types, it’s time to help you prepare for your investment journey. As college students, it’s understandable that you have limited resources. Hence, you may follow these steps to make a sound investment decision.
Identify the amount of money to invest
Preparing a budget as early as now is a great way to kick off your investment journey. Doing so helps you determine how much money you make before and after taxes and track your expenses. That way, you can determine how much money remains after covering your necessities.
From there, you can estimate how much money to save, invest, and spend. Be careful not to confuse savings with investment because they are different.
You can do the 80-20 or the 70-20-10 rule wherein 70% of your after-tax money goes to personal living expenses. The remaining 20% and 10% go to your savings and fun bucket.
After setting your 20% aside, you must figure out how much will go to personal savings, emergency savings, and investments. For instance, if you are making $10,000 monthly, $2,000 remains at your discretion.
You can divide it by three into $670 each or $1,000, $500, and $500 for bank savings, emergency funds, and investment, respectively. That way, you are targeting three things simultaneously— building finances, creating financial fences, and generating passive income.
Choose your preferred investment type
We have already discussed several investment types in the previous section. As an investment newbie, you can start concentrating on them to avoid overspending and over-diversification.
Examining your risk appetite is the best way to determine your investment option. How much risk are you willing to take? How much money can you forgo? If you want the safest choice, a certificate of deposit can be your best option. Yet, yields are lower than the other investment types.
Bonds can be a more viable choice if you want to have more yields while remaining conservative. They have higher earnings, albeit higher risks. But stocks are the go-to option if you are a risk-taker and wish to experience actual trading and learn more from it.
Again, you can mix and match your investments. If you have $1,000 and your risk-aversion is low, you can allot 80% for stocks and 20% for bonds or CDs. Of course, you don’t have to stress yourself out. You are still planning and making your investment blueprint.
Look for low-cost but reliable trading platforms and brokers
Trading platforms and brokers have varying requirements, from documents to the minimum amount required to start investing. The good thing is that you have plenty of options to choose from. And as the digital revolution peaks, trading apps have become more accessible and user-friendly.
Some trading platforms allow traders to trade in different investment types simultaneously. Others have an option to determine risk tolerance and offer suggestions for diversification.
However, you must be cautious to avoid fraudulent activities. To that end, you must research before listing your trading platforms. If you’re too busy to find time to trade on your own, you can start with mutual funds. But again, you must do some research and find low-cost but reliable brokers.
Begin by investing a little every month
After determining your preferred investment type and trading platform, you can start by investing a little every month. Doing this will allow you to test the waters and decide whether your chosen app and investment work for you or whether you should transfer to another one. Remember you are new to the platform with limited resources, so losing money can be risky.
You can set $20 aside and observe the money in action in the financial market. Some brokers in the stock market are now allowing investors to buy fractions of a share. Start as early as now, regardless of macroeconomic conditions. That way, you may be motivated to observe the market, conduct more research, and make more precise analyses. Who knows, you’ll be an expert and make millions out of it in the long run.
And once you get a better grip on it, you can start diversifying your portfolio. You can invest in different stocks or across various investment types. You can even invest in index funds, especially the S&P 500, since it holds a wide variety of stocks, so it’s highly diversified. Also, the volatility as a whole is more manageable than by specific industries.
Since the GFC, the average annual returns of the S&P 500 stocks have been 7.42%. It shows that the S&P 500 has remained durable regardless of macroeconomic disturbances.
Open an IRA
Opening an individual retirement account (IRA) while still in college may seem too early. Yet, it is an excellent opportunity to start building your finances even if you’re already making money with part-time jobs and investments. Having an IRA helps in deferring taxes on any income or dividends. Also, it allows you to deduct contributions from taxable income.
The earlier you start, the longer you will utilize the power of compounding interest to maximize your account. You may also turn to a Roth IRA. since contributions are made with after-tax dollars. As such, withdrawals during retirement will be tax-free. You can also avoid larger taxes when your income increases. Lastly, the amount you put is more likely to compound tax-free in this account.
Start Your Investing Journey Early
Investing while still in college can provide a unique opportunity to build wealth and gain financial freedom earlier. By exploring various investment options and opening an IRA, you can create a solid foundation for your future.
Starting early and staying consistent will allow you to succeed in your investment journey. Thus, it’s essential to understand the risks and rewards of each investment type to find the optimal choice.
Featured Image Credit: Keira Burton; Pexels
