January 24, 2018

How to Start Investing

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Thinking about investing? Learn how to make your money grow. This beginner's guide offers 7 smart steps to start investing.

1. Start Saving

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To get started investing, first you need to get into the habit of saving. Make sure you're spending less money than you make. Then start "paying yourself first" by auto-depositing your savings into an online savings account. That way, you don't see the extra money in your checking account, so you're less likely to spend it.

One great place to put your savings is in an online savings account. These can offer higher rates than traditional bank accounts. Check out the best online savings accounts for some options. You might also want to put your money into a CD account.

Feel like you're only able to save small amounts at a time? That's ok. Everyone starts somewhere. Two strategies you can adopt are:

  • Establish an emergency fund, which can be held in your online savings account or CD account.

    Emergency funds cover, well, emergencies and allow you to quickly withdraw cash for unexpected expenses. Financial advisors tend to recommend having 6-12 months of living expenses, but first, start with $500. This means you won't have to sell any of your possessions or investments when an unexpected expense comes up.

  • Set up an auto-savings tool like Acorns. Acorns takes your spare change and automatically invests it in a portfolio. If you make a purchase of $4.69 at 7-Eleven, Acorns rounds your purchase up to $5 and puts the extra 31 cents into a low-cost portfolio. You'll hardly notice the difference, and it's a great way to establish an account.

2. Start or Improve Your 401(k)

Does your employer offer a 401(k) plan as a benefit? If so, do they "match" any of your investments? You might be able to find this on the company's internal website, or just ask Human Resources about it.

If your employer does offer a 401(k) with a match, you should take advantage by "maximizing your match". Here's how it works:

  • You contribute a certain percentage of every paycheck to your employer's 401(k) plan; and
  • Your employer "matches" some portion of every $1 you contribute to your 401(k).
  • This means you're contributing your own $$ to your future, and your employer is giving you extra free money too.

Typical match rates are around 3-6% of employee paychecks. This is like getting a 3-6% raise.

Your priority should be to maximize this match. For example, say your employer will match 50 cents of every dollar you contribute, up to 12% of your paycheck. This means the maximum they'll contribute is 6%. BUT you have to actually contribute the full 12% to "maximize your match." If you only contribute 5% of your paycheck, you'll only get 2.5% from your employer. Don't short-change yourself like that.

Keep in mind that there are maximums to how much you can contribute to a 401(k) plan each year (the IRS limits how much you can contribute annually). As of 2018, you can contribute up to $18,500 per year (in addition to anything your employer contributes). For people over age 50, you can add an extra $6,000 per year to that limit.

Every employer is different, and not all of them offer 401(k) plans. This is why you should make friends with your HR/Benefits department, because they can help you take advantage of your benefits. Most 401(k) plans offer free retirement advice to employees, so you should use it if you can.

If you don't work for a company that offers a 401(k) plan, don't fret. Read about other types of retirement accounts here.

3. Consider Hiring a Robo-Advisor

One great service for both beginners and experienced investors is robo-advisement. A robo-advisor (such as Betterment) is a computer algorithm that selects and manages your investments for you. When you set up an account, they'll ask you a few basic questions about your level of comfort with risk. Then they do the investing for you. Robo-advisors pick your initial investments and manage your portfolio as a whole, too.

This is a super-easy way to get started investing, since you can make your money work for you before you've had time to learn about investments.

4. Avoid High Fees

One of the biggest mistakes an investor can make is to overpay for fees. Yes, financial services cost money, but they can really eat into your returns. Index funds, or baskets of investments that simply track an index, are a great way to keep your expenses low. This is because you don't need to pay a portfolio manager to pick investments.

Let's take an example:

  • Assume Emily invests $10,000 in a low-cost index fund. She searches for the cheapest one, as measured by the expense ratio. This is the percentage of your assets that mutual funds and ETFs charge you each year. Emily's fund tracks an index, so it doesn't cost her as much. Her fund's expense ratio is only 0.10%, or one-tenth of one percent.

  • Bill invests $10,000 in an actively-managed fund that invests in the same types of investments as Emily's index fund. But he thinks his portfolio manager can outperform the market by picking the right investments, better than what Emily's index fund does automatically. He is willing to pay 1% of his own assets every year for this service.

After 10 years, who comes out ahead? Well, history shows that about 75% of the time, Emily does. Why? Because even if both funds made the same returns, Emily's fund charged her 1/10th the amount in fees as Bill's fund did. Emily pocketed an extra 0.9% per year. Over 10 years, that amounts to an extra $1,733, or over 17% of the amount they both invested.

See how powerful it can be to keep your fees low? Even renowned investor Warren Buffett cares about the topic. He made a famous bet that over the course of 10 years, a simple, cheap index fund would outperform a group of the most prestigious hedge funds. He didn't just win, his simple index fund crushed the hedge funds. A big reason is because hedge funds are so expensive relative to simple, cheap mutual funds.

The moral of this story? Pay attention to expense ratios, which all funds are required to show.

5. Open a Low-Minimum Brokerage Account

It's a myth that you need lots of money to open an account. It's also a myth that you have to know everything about the stock market in order to get started investing.

Lots of low-cost, low-minimum brokerage accounts exist these days, some of which offer robo-advisement too. We've reviewed several in depth below, and all of them have low or even $0 minimums to open accounts:

  • Ally Invest: No account minimum
  • TD Ameritrade: No account minimum; over 4,000 no-transaction-fee mutual funds
  • ETRADE: $500 account minimum; over 2,000 no-transaction-fee mutual funds

6. Allocate Your Investments

Asset allocation is a way to diversify your investments so that you're not too "exposed" to any one risk. For example, someone who invested everything in the U.S. stock market in 2008 probably did very poorly.

Asset allocation also helps you over time as your needs change. When you are very young, you have a lot of time to recover from any market downturns, like what occurred in 2008. But as you approach retirement, you'll start to need your investments, and you won't be have as much time to make up for it. Asset allocation helps you allocate risk over time.

This can be a very complex topic, so we recommend that beginners use robo-advisors to help them get started.

7. Maintain Your Portfolio

The last step is an easy one: Just set a calendar reminder to review your portfolio every 6 months. That's it.

Seriously though, lots of people get very upset when they see their portfolio value change every day. So don't watch it that much. It's that simple. Unless you want to become an investment professional, you shouldn't try to chase returns. (And Step 4 illustrates that even hedge fund managers don't always know what they're doing any better than indexes.)

When your 6-month calendar reminder goes off, log into your account(s) and call the 1-800 numbers for advice. Or, just do it yourself by learning more about investing here.

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Bottom Line

If you followed the 7 simple steps in this guide, you probably invested only a total of 1-2 hours of your time for major returns in your future.

There's a lot more you can learn, but you're done with the very hardest part: Getting started.

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Before You Invest

  1. Make a Budget
    You might be tired of hearing it, but it's true: You need a budget. This is because even if you have a lump sum to invest right now, your focus should be on investing now and regularly in the future. And how can you invest regularly if you don't know how much your regular expenses are?

    There are lots of budgeting tools to help you, so it doesn't have to be hard. The best place to start is by reviewing the last 3-6 months of your spending habits by downloading your credit card and checking account activity. You can do this on each of your bank websites, or you can sign up for an online tool like Mint.com and they can do it for you.

    Use your previous spending activity to build your budget. Categorize your purchases and determine the monthly average amount you spend on each category (for example, utilities or restaurants).

    That's it. Now you have a monthly budget. It might not be the ideal monthly budget, though, which is why you should...

  2. Trim the Fat (off your budget)
    In the process of making your budget, you probably noticed some areas to improve. That's great. Pat yourself on the back for noticing where you can trim the fat. And then do it. Set goals for how you'll reduce your spending, and remind yourself why you're doing this. You're investing because it'll help you retire earlier or save for your children's education or something else important to you, right? It can be hard to visualize those goals because they seem so far in the future, so I'll give an example here:

    Say you notice that you spend $500/month going out to eat with your spouse or friends, and you'd like to reduce that amount to $300/month. That's a savings of $200/month, and it still leaves you with the ability to regularly enjoy going out to dinner.

    If you invest that $200/month in a low-cost index fund tracking the stock market*, you can expect it to be worth $34,768 in just ten years.

    *Assuming a long-term rate of return of 8%.

    Doesn't that example make you want to trim the fat off your budget? See 10 Smart Ways to Save $1,000 a Month for more ideas.

Disclaimer: Opinions expressed here are those of the author's alone. Please support CreditDonkey on our mission to help you make savvy financial decisions. Our free online service is made possible through financial relationships with some of the products and services mentioned on this site. We may receive compensation if you shop through links in our content.

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