My employer sucks, I don't have a match. Should I still invest in my 401k?
Maybe. Tax advantaged space like the 401k is very valuable for its tax free growth benefits. The current yearly contribution limit on the 401k is $18,000 a year. That's $18,000 you can invest tax free, and grow tax free. However, there's more to the story...
It's time to cover some long term investment vehicles. As this is a basic guide, I will focus on two major types of investments: bonds and stocks. Bonds are basically securities that are used by various entities, government and private company alike, that allow them to borrow money, from you the investor, in exchange for paying it back at a certain percentage. We don't need more detail than that for the purposes of this guide, but essentially, they are a mostly safe investment option, with decent long-term returns, but not nearly as good as stocks. Stocks are basically tiny fragments of a business you can buy. Stocks can grow and shrink in value, depending on market valuation and trading, as well as produce dividends. Technically speaking, bonds can also grow and shrink in value, on top of the interest, this is the NAV price, but you don't need to worry about that just yet.
A long term portfolio, at the highest level, is a combination of bonds and stocks. You will hear, and probably have heard, this being called an asset allocation. It is the ratio of fixed-income, safer securities, i.e. bonds, to riskier but higher expected reward securities, i.e. stocks. This ratio is one of the most important decisions to make in an investment strategy, as it, at its core, defines your risk/reward profile. Risk and reward are not only important to achieve your goals with the minimum amount of risk, but also to allow you to sleep at night. If you are the type of person that will panic during a sharp stock market decline, you need to be less risky, i.e. more bonds. If you are a person nearing financial independence, my preferred term, instead of retirement, you want more bonds. If you are a person who needs high enough returns to generate a large portfolio in the future, i.e. someone younger and/or someone with a longer investment horizon, you need more stocks.
The question is, how much is right? There are many formulas out there, and you will have to figure out your individual situation, but as a general rule of thumb created by Jack Bogle, the founder of Vanguard, it's as follows:
Your age in bonds.
This means if you are age 35, you would have 35% of your portfolio in bonds. If you are 70, 70%, etc. Some use more risky formulas, such as age - 10. Some go for a fixed bond percentage up to a certain age, say 20% until age 40, 30% until 50, etc.
In general, you never want less than 10% in bonds. Now you might ask, if you're really young, or have nerves of steel, why not go 100% stocks? The reason is re-balancing.
Re-balancing is selling an over-performing asset to buy the other asset(s). For example, suppose you have a 50/50 allocation and stocks have a great run. Your allocation becomes 60% stock and 40% bond due to all the growth in stocks. You would sell some stocks and buy some bonds to make your allocation 50/50 again. In effect, this is buying low (the bonds) and selling high (the stocks) - ideally what you want. Similarly, if it is 2008 and stocks burn like jet fuel, you would sell some bonds and buy some stocks.
Long-term, re-balancing can produce higher returns and/or less volatility combined with nearly same returns, and all with less risk. Now we're talking...
If you were alive, you surely heard of all the horror stories during the financial crash in 2008/2009. People lost their retirements overnight. This is a prime example of failure to understand risk and asset allocation, as well as paper losses vs. realized losses. More on the latter part later.
If you had an allocation to bonds during that time, and every investor should, it was mostly stocks that dropped like a rock. If you re-balanced during this time, the money you re-balanced into stocks would have returned about 170% from the bottom of the market. Yup, one of the worst crashes in history could have more than doubled some of your investments. Furthermore, if you were a person who was retired or nearing retirement, you would have had assets that did not drop, or did not drop much. And, you would have a lot more money in short-term reserves, since you need the money short-term. A stock market crash ruining your retirement is usually a failure of planning.
Going back to the paper vs realized losses part, if you own stocks and they drop 50%, you did not lose any money. What? That's right, you lost nothing. Why? Because you still own the same number of shares, that are simply worth less than before. So, the only way to *really* lose that money, is to sell those shares. You only really lose or gain money if you sell the shares, remember that during the darkest times. Many people forget this fact, and sell when things hit the fan, and buy when things look rosy. This is the worst thing you can do. This is simply buying high, and selling low, i.e. losing money.
Warren Buffet, the most successful investor ever, says:
"Be greedy when others are fearful, and be fearful when others are greedy".
This means buy when there's blood on the streets (2009), and sell when things are fantastic (2000). The question now is, buy and sell what?
You can certainly buy individual bonds, and individual stocks. However, doing so exposes you to a very high level of risk. For example, suppose you buy a bunch of stock of company X. Suppose company X goes bankrupt. ...So do you. Suppose company X becomes ultra successful and returns 100%+ year for years. ...You make a boatload. Do you know what company X will do? I don't. Neither do most professionals. I don't like risk, and neither should you, so I want safer options.
This is where mutual funds come in. Simply put, mutual funds are bundles of particular types of investments, that a financial manager and his team invests for a fee. There are bond funds, stock funds, real estate funds, government bond funds, you name it, it's there. There are funds investing in tiny companies, and huge companies, US companies, and international companies, oil companies, healthcare companies, Treasury Inflation Protected Securities, intermediate term bonds, junk corporate bonds, Real Estate Investment Trusts, gold, socially responsible companies... You get the point.