Making new friends, leaving home to live alone, and handling tasks independently both at home and school are challenges faced by university students after high school graduation. Indeed, solitude and independence can be a double-edged sword, potentially strengthening or weakening one’s character. Dealing with financial issues and being self-reliant without continuous parental support is another matter altogether.
Nevertheless, many university students manage to find time and resources for other things, such as investing, even though gaining extra money requires more effort and dedication. Many young people have already started preparing for their futures.
Investing during university can help students have emergency funds upon graduation and start retirement planning. Even individuals with limited cash reserves can begin building an investment portfolio today. This is advantageous because starting early means early learning and facing smaller inevitable losses. During this process, students must be aware that some investments may only require a small portion of their funds.
This article will discuss why university is the perfect time to start investing. We will outline the basic and popular investment options that students can choose from. Additionally, we will include a step-by-step guide on how university students can embark on their investment journey.
University students are often considered penniless. The latest data shows that 43.5 million Americans opt for loans to meet their basic and non-essential needs. However, university can be an excellent starting point for investing.
Investing has no age restrictions. Better yet, it doesn’t have a minimum amount either; you can start with as little as $5. Since accumulating assets takes time, the earlier you start investing, the better.
Engaging in investment as a university student will provide you with real-world money experience to hone your skills. This method will make you an expert after graduation. Furthermore, the risk of loss is also lower as the amount invested is much smaller. Most importantly, early investment helps secure higher returns in the future.
When university students enter the financial market, they may feel overwhelmed by various types of investments. To simplify the discussion, we’ll narrow it down to five investment types.
Mutual funds pool assets from shareholders to invest in various assets such as bonds, Real Estate Investment Trusts (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 structure of investment portfolios aligns with the fund’s objectives disclosed in the prospectus. It is segmented into several categories, showing the types of securities it invests in, the level of risk investors are willing to take, the investment goals, and returns.
For example, a fund inclined towards risk aversion may primarily or entirely invest in low-risk assets like bonds or bond funds. Conversely, risk-loving investors may opt for equity funds and index funds among stock investments.
Portfolio managers may allocate funds between bonds and stocks in any proportion based on investor preferences. Some may adopt an 80-20, 70-30 approach, and vice versa. Others prefer balanced fund splits such as 60-40, 40-60, or 50-50. Therefore, the goal of mutual funds is to balance risk and return. Of course, you can divide them into various asset classes including REITs and money market instruments.
One advantage of mutual funds is the access to professionally managed funds. They can track the fund’s performance, usually total market value. Consequently, shareholders’ gains and losses reflect their proportionate investment in the fund.
For instance, investors typically receive returns quarterly, semi-annually, or annually. These may constitute stock dividends and bond interests distributed to investors in the form of allocations. Investors can receive dividend checks or reinvest them to acquire additional shares.
Before stock dividend distribution, there are other mechanisms to make profits available to investors. Fund managers may sell a security that has appreciated to generate capital gains and distribute them to investors. Investors can also sell shares in the mutual fund when the share price rises.
College students may opt for this investment route because someone else manages it. They can enter and exit the market easily by buying and selling shares. Additionally, they can adjust their risk preferences flexibly. However, these come with fees and commissions, with no Federal Deposit Insurance Corporation (FDIC) protection.
Bonds are loans provided by investors to companies and government borrowers. These fixed-income instruments are akin to a promissory note (I.O.U.), serving as documentation of the loan’s existence.
Similar to regular loans, bond documents contain details of the loan and payments such as principal amount, maturity date, and fixed or floating interest payments. Common bond issuers include corporations, municipal governments, state governments, and national governments. They issue these bonds to raise funds for projects and business operations.
Bonds are typically deemed fixed-income securities or instruments as they usually pay a fixed rate of interest. However, floating rates are common nowadays as well. This allows bonds to earn income through interest or returns. Due to their nature, bond prices are highly inversely correlated with interest rates. Therefore, in a low-rate environment, bonds become more attractive.
Primarily favored by risk-averse investors due to their nature, bonds generally offer lower returns than stocks. Nonetheless, government-backed bonds like treasuries or bonds, municipal bonds, and government-sponsored enterprise securities differ significantly from regular bonds. They are more inflation-adjusted and provide better hedging against valuation losses during rate hikes.
Stocks, or equities, are the most popular due to their market size and coverage. The stock market has been the foundation of portfolios for over a century, outperforming most other investments.
Considering its significant impact on the economy, the stock market must adhere to government regulations at all times. For example, the Securities and Exchange Commission in the US protects investors from fraudulent and unethical practices by brokerage firms.
Investing in stocks means owning a portion of the issuing company’s equity. Units of stocks are called shares, allowing investors to receive a portion of the company’s assets and income proportionate to their ownership.
These stocks are bought and traded on various stock exchanges worldwide. They are more volatile than other investment types, thus carrying greater risks. However, they offer higher returns. Prices can fluctuate over 10% in a given day.
Investors can profit through dividends from stocks. Not all stocks pay dividends, but most do, especially well-established companies. However, not every dividend-paying stock is worthy of purchase, hence the need to check the dividend yield by dividing the dividend by the stock price.
Consistency and frequency of dividend payments must also be scrutinized. To maximize potential dividend income, one can opt for “Dividend Champions” (stocks with consecutive dividend increases for over 25 years), “Dividend Contenders” (stocks with consecutive dividend increases for 10-25 years), and “Dividend Challengers” (stocks with consecutive dividend increases for at least 5 years).
A more traditional approach is selling stocks when the selling price exceeds the buying price. This is why monitoring price changes closely is crucial to yield profits.
Some prefer using different technical analysis tools. This includes the Simple Moving Average (SMA) of the past 50 days’ stock price. Others combine the Average True Range (ATR) with SMA to derive target price ranges.
But the most crucial step is examining the company’s fundamentals, including historical and anticipated performance. Investors might focus on Key Performance Indicators (KPIs) of the company like revenue, Earnings Before Interest, Taxes, Depreciation, and Amortization (EBITDA), net income, accounts receivables, cash, Free Cash Flow (FCF), inventory, and debt.
For capital-intensive companies, aspects like cash, debt, and EBITDA are crucial as they compare feasibility with liquidity. Investors also examine external factors affecting the company, such as competitors, industry performance, and macroeconomic indicators. Finally, investors might employ stock valuation methods like Price-to-Earnings ratios and Discounted Cash Flow (DCF) models to derive target prices.
For investors focusing on two or more stocks within the same industry, utilizing price alone to check historical performance is a tip. The Sharpe ratio assesses the return and volatility of stock prices. Combined with the efficient frontier, one can achieve the optimal configuration of stock prices.
Here are examples of Sharpe ratios for S&P 500 insurance stocks. The annual return rate denotes the average price change since the global financial crisis. The risk-free rate is equivalent to the 10-year Treasury bond rate.
Simultaneously, standard deviation can be derived from the square root of variance or calculated in Excel from price change dispersion. Leveraging this information, the Sharpe ratio can be computed by dividing the (annual return rate – risk-free rate) by standard deviation. The higher the ratio, the better.
Evidently, Arthur J. Gallagher (AJG) outperforms Assurant (AIZ) and The Hartford (HIG). It also surpasses the average S&P 500 level. Since the global financial crisis, it has the highest return rate at 13.82%. Better yet, its standard deviation is lower than its peers. Thus, it optimizes risk and return.
For dividend investors, Real Estate Investment Trusts (REITs) are an excellent choice. Despite volatility in the real estate industry, REITs have shown positive prospects over the years. With demand for real estate remaining high, they have appreciated. Today, the US still faces a severe shortage of real estate, with demand surpassing supply despite high prices, preventing a real estate bubble burst.
Apart from high dividends and value appreciation, REITs exhibit lower correlation with stock market fluctuations. Their standard deviation and beta coefficients are far below the S&P 500 average level. Hence, their price movements remain relatively stable regardless of macroeconomic changes.
In the challenging macroeconomic environment, Certificates of Deposit (CDs) and high-yield bank accounts are optimal choices. With interest rates still high, they generate higher returns with low risk compared to other bank accounts.
Hence, through CDs, investors can lock funds in a bank for a specified period without access. Upon maturity, the deposited funds and interest are returned to customers.
Now that you’re familiar with the main investment types, it’s time to prepare for your investment journey. As a university student, understanding your limited resources is crucial. Therefore, you can follow the steps below to make wise investment decisions.
Establishing a budget early is an excellent way to kickstart your investment journey. This helps you determine pre-tax and after-tax income and track expenses. This way, you can ascertain how much money you have left after meeting essential expenses.
From there, you can estimate the amounts to save, invest, and spend. Be careful not to confuse saving with investing as they are different facets.
You can adopt the 80-20 or 70-20-10 rule, with 70% of after-tax income allocated to personal lifestyle expenses. The remaining 20% and 10% are dedicated to savings and entertainment, respectively.
After setting aside the 20%, you must decide how much goes into personal savings, emergency funds, and investments. For example, if you earn $10,000 per month, you have $2,000 for discretionary use.
You can split it into thirds, with each at $670, or allocate $1,000, $500, and $500 separately for bank savings, emergency funds, and investments. This way, you target all three objectives—building financial strength, creating financial buffers, and generating passive income.
We have already discussed various investment types in the previous section. As a novice investor, you can focus on them first to avoid overspending and over-diversifying investments.
Checking your risk appetite is the best way to determine investment options. How much risk are you willing to take on? How much are you willing to lose? If you want to opt for the safest option, CDs might be the best choice. However, their returns are lower than other investment types.
If you want higher returns while keeping it conservative, bonds might be the more viable choice. They offer higher income, albeit with greater risk. But if you are risk-tolerant and want to experience actual trading and learn, then stocks are the go-to option.
Again, you can mix and match your investments. If you have $1,000 and have low risk aversion, you can allocate 80% to stocks and 20% to bonds or CDs. Of course, you don’t have to be too stringent. You’re still planning and drafting an investment blueprint.
Trading platforms and brokers have varying requirements, from documentation to the minimum amount needed to start investing. The good news is you have plenty of options. Moreover, with the peak of the digital revolution, trading apps have become more user-friendly.
Some trading platforms allow traders to trade various types of investments simultaneously. Others offer risk tolerance tests and provide diversified investment recommendations.
However, you must be cautious to avoid fraudulent activities. For this reason, you must research before listing trading platforms. If you’re too busy to trade on your own, you can start with mutual funds. Nonetheless, you still need to do some research to find a low-cost and reliable broker.
Once you determine your preferred investment type and trading platform, you can start with small monthly investments. Doing so allows you to test the waters, assess whether the selected app and investments suit you, or if you should pivot to another platform. Keep in mind, you’re a novice with limited resources, so there might be a risk of losses.
You can set aside $20 and observe its performance in the financial market. Nowadays, some stock market brokers allow investors to buy fractional shares of stocks. Regardless of the macroeconomic condition, start now. This way, you might be motivated to observe the market, conduct more research, and make more accurate analyses. Who knows, you might become an expert in the long run and earn millions.
Once you gain more experience, you can diversify your investment portfolio. You can invest in different stocks or various investment types. You can even invest in index funds, especially the S&P 500 as it covers various stocks, thus offering high diversification. Moreover, its overall volatility is easier to manage than specific industries.
Since the global financial crisis, the average annual return rate for S&P 500 stocks has been 7.42%. This indicates that regardless of macroeconomic turbulence, the S&P 500 consistently stays resilient.
Opening a personal retirement account (IRA) during university may seem premature. However, even if you’ve earned money through part-time jobs and investments, it’s still a great opportunity to establish financial stability. Having an IRA helps defer any tax payments on income or dividends. Additionally, it allows you to deduct payments from taxable income.
Starting early allows you to leverage the power of compounding for a longer duration, maximizing your account balance. You can also opt for a Roth IRA, as contributions are made with after-tax funds. This way, withdrawals from the account at retirement are tax-free. Additionally, you can avoid paying higher taxes as your income increases. Finally, the amount you deposit is more likely to earn tax-free compounding within this account.
Investing during university provides a unique opportunity to accumulate wealth and achieve financial freedom earlier. By exploring various investment options and opening an IRA, you can lay a solid foundation for the future.
Starting early and staying consistent will lead to success on your investment journey. Therefore, understanding the risks and returns of each investment type to find the best fit is crucial.