Investing Made Simple: More Options for Small Investors

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Dr. Maggie Baker's story is a cautionary tale of risk and investing.

Back in the mid-1990s, as she was hitting middle age, Baker decided to take a more active role in managing her and her husband's investment portfolio. As she tells it, she replaced her long-time, stodgy broker with a younger, more dynamic one who advocated for the booming tech sector. By the end of the millennium, through the new broker's guidance and her own research, she had invested her portfolio 85% in the tech sector. Their money had doubled. And then the bubble popped.

"From January 2000 on, I just watched the market go down and I was so paralyzed," Baker recalls. "I thought I had been doing the right thing, but I had not paid attention to the money."

Today, Baker and her husband have recouped their losses by taking a more conservative approach to investing. She is part of a local investing club and keeps their money as diversified as possible with big index funds. Their slow recovery has not only been financial, but also emotional, and the experience prompted Baker, a psychologist, to research the irrational decisions she had made as an investor. Out of that effort came her book, Crazy About Money.

"People avoid feeling the pain of loss so much that they will hold on too long to the fantasy that it will come back," she says. "They don't have to write it off because it is still unreal."

Baker's story underscores a paradox of investing: Economics is a rational discipline, and investing tools are designed with that premise in mind, but human beings -- each with unique their own set of knowledge, experience, and emotions -- often behave irrationally, especially when it comes to money and investing. Behavioral economics, which studies how psychology and economics dovetail, has revealed many clues as to why we behave the way we do around money, and the marketplace is responding with new tools and products designed to counter our irrational behavior.

A Simpler Way to Invest

Betterment.com offers one of those new products. CEO Jon Stein started the company in 2008 while he was at Columbia Business School, and has already racked up kudos from the personal finance world: Among other honors and awards, it was named "New York's Best Startup 2010" by TechCrunch.

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The website offers a "set it and forget it" tool for personal investors. When depositing money, users make only two choices along a sliding scale: asset allocation (what percentage of bonds vs. stocks do you want?) and a time horizon (how long are you planning to invest?). Investors can also opt to add more money monthly with an automatic deposit option.

Stein's goal is to make investing as simple as possible by removing the maze of choices that he says plague too many products. By boiling it down to two questions -- rather than letting clients slice and dice sectors and funds -- he says he keeps the performance of his clients' portfolios performs is competitive with the market.

"Simple makes it smarter," he says. "People get very distracted by all the options that don't really matter."

That simplicity and savings-account like accessibility appealed to Brian Lonergran, a writer and researcher for a luxury travel company. Last summer, Brian, 34, and his fiance decided to invest $500, and contribute a little each month to the account, as a way of saving money for their 2012 wedding and a down payment for a home in several more years. "I was interested in the notion of a hybrid savings account," he says.

Betterment hopes to attract more small and mid-level investors like Lonergran who have specific investing goals and want to take a hands-off approach. Since launching last year, the company has seen its client base grow to more than 3,000 people and $10 million in investments. With its online-only presence, minimal fees (the only fee is between 0.3 to 0.9% of a user's yearly balance), and efficient design, the site is appealing for first-time investors who may want to start small and get a feeling for what it's like to be in the market.

Average customer returns over the past year have been about 20% with an average allocation of 77%, and this closely reflects the growth in the market, says Stein. In his pitch for the company, he cites research showing that index management rather than active management is more successful over time. For young investors who may feel that $500 today is worth more than $500 invested, the numbers show a different story: A 25-year-old investing $500 per year until retirement at age 68 would earn $142,375 at a constant return rate of 7%.

'Cash Pays You Nothing'

For investors who want more personal attention, brick-and-mortar brokerages still offer what online resources cannot: a live, human conversation. "The person who is most fearful about investing is really who should be in front of someone," says Charles Schwab financial adviser Colleen O'Brien. "It's all about principal protection, and people who have a longer time in the market can take more risk. But you have to take a little risk. Cash pays you nothing."

Whichever way feels more comfortable -- using an online investing tool or a broker -- certain guiding principles remain for sound investing: Have an investing plan, do it early and don't play around with it too much.
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