Attention New Investors: Invest That Cash
Jun 12th 2012 11:45AM
Updated Jun 12th 2012 1:20PM
You win the lottery; your great-uncle bequeathed you his fortune made during Prohibition; or, more likely, you worked slavishly while saving pennies to amass a pile of cash. No matter the way in which the cash appeared in your account, inflation is slowly eating away at its value unless you do something about it.
For example, if you have $1,000,000 in cash sitting in your account, even at today's inflation rate of 2.3%, it will lose 20% of its purchasing power over 10 years, and after 30 years, it will only be able to buy half as much as it can today. And with today's low interest rates, it's unlikely the cash sitting in your bank is earning very much. To beat inflation, invest that cash.
How should you invest it? Here are plans for two different hypothetical investors: one for an investor not interested in researching and following companies, and one for an investor who finds such research fascinating.
For the investor with other passions
Researching stocks isn't for everyone. If you have absolutely no interest in learning about how a specific company operates, who leads it, and envisioning the potential future of the company, then picking single stocks isn't for you. And that's OK.
If you fit this description, you can use a portfolio of low-cost funds that track major indexes. Make sure to rebalance it every so often, and it is likely that you will outperform a majority of actively managed mutual funds. How is that possible? Well, about 84% of those mutual funds underperformed their benchmark indexes last year.
Many such example portfolios with specific fund selections are available through the Motley Fool's Rule Your Retirement community. Here's a general example of such a portfolio that's aimed at those who are getting closer to retirement:
Source: Rule Your Retirement.
While this takes away the anxiety from investing in specific companies, you might still worry about investing at a market top. To solve this, take smaller chunks of your cash and invest them over a longer time period (called dollar-cost averaging).
For the investor with passion
On the other hand, if you love learning about how a company operates, who runs the show, and fantasizing about a company's future, don't be afraid to select companies that you think will outperform the market. Read The Motley Fool's "13 Steps to Investing Foolishly," which will give you the basic knowledge required to make your first investments, such as:
- Spread out your risk. Just as the portfolio above is spread across different geographies, sizes, and types, a portfolio made up of single companies should be spread across a wide range of classifications. This ensures that if one stock goes to zero, your entire portfolio isn't worthless.
- Look for sustainable competitive advantages. Companies that have no competitive edge, or moat, won't survive long. Look for companies that benefit from their large scale, intellectual property, or regulation to ensure that a competitor won't appear and steal future profits -- and shareholder returns.
- Invest for the long-term. Constant buying and selling not only requires a lot of time and effort, but it also increases transactions costs, fees, and potentially taxes. If you buy and hold, you can avoid paying too much to invest and realize greater returns.
If you're looking for specific ideas, Fool colleague John Grgurich writes a great series on stocks for beginners, with recent articles on McDonald's (NYS: MCD) , MasterCard (NYS: MA) , and Whole Foods Market (NAS: WFM) . John likes McDonald's gross margin of about 40% compared to its industry's 30%, and its profit margin of 20% compared to its industry's 10%. MasterCard sports a healthy pile of $5 billion in cash and zero debt, with a large moat of being an established credit card processor. Whole Foods' brand helps it earn one of the best profit margins in the supermarket sector of 3.5%, and the company is riding the trend of more health-conscious consumers.
Keep fighting inflation
While you should set aside enough cash for emergencies or upcoming purchases, the rest of your cash should be working its hardest to earn you more money and fight inflation. Investing in funds that track indexes is an easy way to earn the market's return. Investing in individual stocks takes more effort, but as The Motley Fool's record shows, can earn you substantially more than the market.
To find out more stocks to invest in, read our free report on "3 Stocks That Will Help You Retire Rich."
At the time this
article was published Fool contributor Dan Newman holds no position in any of the above companies. Follow him @TMFHelloNewman.
The Motley Fool owns shares of Whole Foods and Mastercard. Motley Fool newsletter services have recommended buying shares of Whole Foods and McDonald's. The Motley Fool has a disclosure policy. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. Try any of our Foolish newsletter services free for 30 days.
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