I'm in my 20s. How do I start investing?

By Walter Updegrave, senior editor

(Money Magazine) -- I'm in my late 20s and would like to invest some money in the market. I've never done it before, though. Where would be a good place to start? -- Clint S., Traverse City, Mich.

There are two ways to interpret the phrase "a good place to start." One is the way most people would probably expect -- i.e., which investments should you start putting your money into? The other is less obvious.


That phrase can also be thought of as how to start out with the correct attitude or philosophy or, at the risk of sounding like I'm going all metaphysical on you, approaching investing with the right weltanschauung, or world view.

I'm more than happy to tell you what I think someone like you who's ready to put money in the market should be investing in. But before I do, I first want to address this second interpretation.

Fact is, there's no way any individual can possibly evaluate all the investment choices available at a given time. There are just too many.

That's why I think that developing a set of principles you can use as a guide or filtering system is even more important than getting specific investment picks from me or anyone else.

To lay out a few key principles, I'm going to invoke some insights from a man who is arguably the world's most famous and -- with an annualized return more than twice that of the Standard & Poor's 500 index since 1965 -- most successful investor.

I'm talking, of course, about Warren Buffett. Each year on his company's web site, Berkshirehathaway.com, Buffett posts a letter to his shareholders.

Along with tidbits of folksy wisdom, these missives contain a wealth of astute observations about the economy, the markets and investor behavior that make them great reads for anyone who wants to be serious about investing.

In this year's letter, for example, Buffett cautions investors from getting spooked by uncertainty and pessimism. He notes that throughout his lifetime "politicians and pundits have constantly moaned about terrifying problems facing America."

But he goes on to say that prophets of doom have always focused too much on uncertainty and too little on the ability of the American system to unleash human potential, which is hardly exhausted.

"Money will always flow toward opportunity," he writes, "and there is an abundance of that in America ... America's best days lie ahead."

To me, the theme here is that you shouldn't get too swept up in the prevailing mood. When things are going well, investors tend to err on the side of irrational exuberance and take too much risk.

After the markets have slumped, people become fearful and get too conservative. A better approach is to maintain a sense of equanimity and, especially when you're young and will be investing for many years, tune out the short-term noise (whether euphoria or gloom) and focus instead on the long-term.

Another lesson I take from this year's letter is that to be a successful investor you don't have to follow the latest craze.

These days, everyone's gaga about social media, so much so that people are dying for ways to get into companies like Facebook and Twitter even though they're not publicly traded.

I suppose there's a case for investing in the most hyped areas, but there are dangers too. It's extremely difficult to know early on which sectors or companies are really poised for breakout gains.

And if you get in after investors have decided which firms or industries are the anointed ones, you may end up buying at bloated prices that limit gain potential.

Buffett, by contrast, is less interested in what investments are popular than in which ones have the most value. The investment move he singles out as his best of last year is none other than his acquisition of Burlington Northern Santa Fe.

That's right, a railroad. But as he points out, railroads have significant cost and environmental advantages over their main competition, trucks. Which is why he thinks the industry that was at the cutting edge of technology in the 19th century will remain a major player in the transportation sector of the 21st century.

At the end of the day, the companies that generate the best returns aren't necessarily the ones that create the most buzz, but those that can consistently generate profits and that sell for a reasonable price.

The final lesson I draw from Buffett's letter this year is the importance of holding the line on investing fees and expenses. Granted, he doesn't address costs in a way that's directly applicable to individual investors.

Rather, he writes about the "owner orientation" he strives to instill at Berkshire Hathaway -- avoiding inefficient bureaucracies, holding down operating costs and emphasizing that managers should treat the shareholders' money as if it were their own.

But the basic idea is that being a good investor involves being a good steward of the money you're investing. And for individual investors that means, among other things, keeping an eye on costs.

The less trading you do, the fewer transactions you make and the less you shell out in management fees and other expenses, the higher the returns you're likely to earn, and the more your money is likely to grow.

So, how do you translate these themes or lessons into specific investments?

Well, if you're willing to devote the time and do the research to find investments that are attractively priced relative to their earning power or the underlying value of their assets, then you can put together your own portfolio of investments.

Problem is, that approach requires not only time and effort, but considerable skill (which also takes time and effort to develop). I don't think that's a realistic way to go for most people to go, and certainly not someone just getting started.

So I think the best place for you to start is with broad-based index funds or ETFs like those available on our MONEY 70 list of recommended funds.

By putting your money into a total stock market index fund or ETF, for example, you get the entire U.S. stock market. Which means you get shares of lots of companies that are all the rage (although only those that are publicly traded). You also get shares of companies that are unpopular and may be undervalued.

In short, you're getting a bit of everything. Big stocks and small, growth shares and value. Every sector of the economy and every industry. The whole enchilada in one fund.

And you're getting this incredibly diversified portfolio of stocks at a very low cost, an annual management fee as small as 0.07% a year, or $7 per $10,000 invested.

That's less than a tenth of what you would pay for the average stock mutual fund. (For more on the advantages of indexing, check out this interview I did recently with another investing icon, Vanguard founder Jack Bogle.)

Finally, if you invest in such a fund on a regular basis -- ideally, each month by arranging to have money automatically transferred from your checking account to the fund -- then you'll be following that "equanimity" principle I talked about earlier rather than falling into the trap of being too aggressive when the market is hot and too cautious after it's flamed out.

Remember, though, this is just a start. Another key principle I didn't get into here is asset allocation, which means creating a portfolio with different types of stocks, bonds and, possibly, other assets.

So after seeing what Mr. Buffett and Mr. Bogle have to say, you may want to head over to our MONEY 101 lesson on Asset Allocation, and think about how to get started on that too. To top of page

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