Dear SmallIvy,
My daughter – she is 18 has received about $2500 for graduation money. What is the best way to invest it? She is all set for college – have 529 and she works part-time making $7 an hour. Takes home depending on hours she is given $50 to $200 per week. Appreciate any thoughts. Thanks!
Thanks, Reina
Dear Reina,
It’s great that your daughter has such a great gift to help her start her adult life. It is also great that she’s thinking about investing it so that it will last rather than spending it on frivolous things. Here are some suggestions of things that she could do with the money:
1. Use it as the start of an emergency fund. An emergency fund is 9,000-$15,000 that you keep around to pay for things like emergency car repairs and unexpected medical bills. It is money that keeps you from pulling out the credit card and going into debt at 18% interest whenever life throws you a curve. It is also money that you can use if you lose your job while looking for another one. It should be replenished as fast as possible when you need to dip into it – before you go on vacations or even go out to eat – because it really needs to be there when you need it.
With $2500, she could buy shares of an ETF such as the SPDRs (S&P500 fund, pronounced “spiders”) or the DIAs (Dow Jones Industrial average tracking fund, pronounced “Diamonds”). To buy the ETF you would need to go through a broker. With $500 more to add to the $2500, she could buy index mutual funds such as an S&P500 fund through Vanguard or another fund company. During college the value of her ETF or fund could go up of down depending on what the market and the economy does – four to five years is a short amount of time for investing in stocks – but by investing in mutual funds she has a chance of growing the value to $4000-$6000 in 5-10 years. She could then sell the fund around the time she starts work and put the cash in a bank account as a starter emergency fund, add to it over time from her salary, and then have a fully funded emergency fund that would give her a good measure of financial security within a year or so. If the fund doesn’t do well and perhaps sinks in value (worst cases scenario would be that it was worth maybe $1000 after five years, which would only happen if we had a very serious economic decline like the Great Depression; this is very unlikely statistically) she would just hold onto the funds and build up an emergency fund from her salary. When the fund recovered enough after a few years, she could then sell and top off her emergency fund.
2. Invest it in a mutual fund or ETF as a starter portfolio. In this case she would invest in an ETF or a mutual fund as before but just plan to leave it invested for a long period of time. With a mutual fund, when she started working she could then add to the position with regular contributions from her paycheck, for example, adding $300 per month. With an ETF it would not be cost effective to invest $300 at a time. Instead, she could just save up each month in a savings account until she had enough to buy a second ETF or more shares of the same ETF. She would do this each time she had enough money saved up to make the brokerage fees she’d pay when she bought the ETF a reasonable percentage of the amount she was investing.
3. Use the money to start an IRA. Since she is working, she could invest as much of the $2500 in an IRA as she earns in wages during the year. If she puts the money in an IRA and then invests it in a mutual fund or ETF in the IRA, she would go a long way towards funding her retirement before she even goes to college. If she could earn 10% annualized between the age of 18 and 70, which is very possible invested in stocks, she would have $355,107 when she retired at 70 years old just from that first investment. If she could work a few summer jobs in college while staying at home during the summer to avoid rent and food costs, she could invest a few thousand more in an IRA and easily be set to be a millionaire before she retires.
4. Invest in a business. Many people who buy individual stocks try to beat the markets by trading, where they buy a stock, hold if for a few months, then sell for a small profit. This is a losers game and I would not recommend it. Instead, one option is to buy an individual stock with the money but do so as if she were buying a stake in a business as a venture investor. She would want to find a company that has a great product, a stellar management team, and plenty of room to grow and expand over the next ten to twenty years. She would then buy in with the idea of holding through think and thin, giving time for the company to grow and reach its potential. There is certainly a risk of losing the money by doing this (maybe one in 100 stock picks will go belly-up entirely, while maybe half will just sit there for years and not grow), but $2500 is a small amount of money compared to her future earnings and it could grow into enough money to make a good down payment on a house in ten years or so if she picks the right stock.
As with investing in mutual funds, she could also set aside some money from her salary when she starts working and buy shares in other companies with good long-term prospects each time she has $1,500-$3,000 saved. She should start to put some money in mutual funds as well as her portfolio grows to protect the wealth she gains. By doing so she would build up a portfolio and eventually reach financial independence.
Regards,
SmallIvy
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Disclaimer: This blog is not meant to give financial planning advice, it gives information on a specific investment strategy and picking stocks. It is not a solicitation to buy or sell stocks or any security. Financial planning advice should be sought from a certified financial planner, which the author is not. All investments involve risk and the reader as urged to consider risks carefully and seek the advice of experts if needed before investing.
