By Alex Schneider, Summer 2011 LifeSmarts and Public Policy Intern
Stocks have been taking dives for months now – not exactly great news for any investor. But for students with little to no exposure to the market, a dip like this can lead to some pretty big investing mistakes. Before you buy or sell, here are some tips to keep in mind.
In general, students need cash. For many students who take out loans for college and pay their own bills while taking in less than $10,000 a year from part-time jobs, investing is not practical.
Students who meet such criteria should consider alternatives that can help them make some money. Examples include money market accounts, which offer modest interest rates in this economy but still allow access to cash on demand. But beware – some accounts have high minimum balances, so search for a bank that has reasonable requirements.
Even those students who are making very little should avoid living paycheck to paycheck and should try their best to put 10 percent or more of income into savings for a ‘rainy day,’ whether into a money market or savings account. Ideally, students on limited budgets should set a goal of saving enough so that if they are caught in a financial bind, they have enough money to live three months without an income. Impulsive buyers should especially try to keep cash in a money market rather than checking account, because accessing the money requires advance planning and because transfers between accounts have limits that can help students budget their money.
Money in stocks is not cash
Some students may consider putting their money into the stock market, driven by promises of high returns on investment. But as we’ve seen these past few weeks, all investing – no matter how safe the stock or asset – is subject to economic cycles. Students should not expect to put money into stocks during a recession and then get that money back with high returns within three years.
Three types of student investors
Based on classifications in “Dollars & Sense for College Students” by Ellen Braitman, I have put together three categories of student investors:
Type I: Those who will need their money in ‘a year or so’. These investors may consider short-term bond funds and money market funds, available from your favorite brokerage house (my favorite is Scottrade because they do not have hidden fees.) If you fall into this category, do not even think of putting money into stocks, and keep at least 50 percent of your money in cash, such as bank money market accounts. While the stock market might grow, it might not, and chances aren’t bad that the day you need the money, gridlock in Washington might lead to a downgrade of the U.S. credit rating. By the way, don’t sell your stock on a day like that.
Type II: Those who will need money at the end of three years. These investors may consider short-term or intermediate-term bond funds. In a recession, the best bet is to be on the safe side and keep a sizable cushion of cash in case of any financial trouble – equal to all liabilities that could arise over a three-month period. For many students, building up savings like this is difficult: for such students, putting money into stocks has the potential to be a disastrous decision.
Type III: Those who do not need money for more than three years, and frankly, won’t even need the money in five years. These students might have high paying jobs or have secured jobs for after school or they received scholarships and will not have college loans. These investors are looking for long-term rewards and will have a steady source of income to rely on in the meantime. They will keep a good amount of their net worth as cash and can afford to lose what they put into stocks. Only these investors should put money into the stock market, with the first $5,000-$10,000 into a mutual fund or index fund and then experiment with individual stocks.
Avoid at all costs
Never be in a position where you need to sell a stock in order to pay day-to-day expenses, regardless of whether stock prices are rising or, as was the case this week, falling.