In my last article Why You Should Start Investing Today we broke down the importance of starting to invest sooner rather than later.
Now we’ll get into the fun part: how you can actually start investing. We’ll focus on making long term investments, like retirement, and I’ll break down three options with some practical tips so you can get started quickly.
Option 1: Retirement Plans
Retirement plans are often the easiest places to start investing. Through your employer or through an investment account you set up yourself, your money is spread out over a diverse set of investments. A major benefit of retirement plans is that most of these plans allow your money to grow tax-deferred, which means you don’t pay taxes on it until you take distributions from the account.
If you have a company sponsored retirement plan, like a 401(k), it should be your first place to invest. Many companies offer sponsored plans with low fees and they will automatically take the money out of your paycheck—so you don’t miss the extra cash at all! In addition, some companies will match your contribution into your retirement account, so if you’re not taking advantage of that, you’re basically missing out on free money. If you do leave your company you are able to take the money with you by rolling it over to another retirement account.
If you’re self employed or don’t work for a company that offers a retirement plan, you can still take advantage of setting aside money in a tax-deferred retirement account with an IRA (individual retirement account). When you open an IRA, you’ll be given a list of investments the financial institution recommends, as well as the past performance of each investment (how much each investment has earned or lost over a 1, 5 and 10 year period). You can review the investments offered with your IRA and decide exactly where you’d like to put your money. Most financial institutions have online tools or advisors you can speak with to help you determine what type of IRA is right for you and which investments are best for you to choose.
Common types of IRAs include:
- Traditional IRA: This IRA is funded with pre-tax money, meaning you won’t pay taxes on that money now but you will pay taxes on your withdrawals in retirement. You can invest a maximum of $5,500 per year into a traditional IRA.
- Roth IRA: You fund the Roth IRA with money you’ve already paid taxes on, so when you take withdrawals in retirement you won’t have to pay any additional taxes. You can invest a maximum of $5,500 per year into a Roth IRA.
- SEP IRA: This is a traditional IRA for anyone who is self-employed. The major feature of the SEP IRA is that you are able to contribute up to $53,000 per year.
- Rollover IRA: This is a type of traditional IRA. If you leave a job where you had a traditional 401(k), you are able to take the money with you by rolling it directly to a Rollover IRA. When you open a Rollover IRA account, be sure to get specific instructions for how to do the rollover correctly so you don’t inadvertently get charged any early withdrawal penalties.
IRA accounts are offered through most major financial institutions like Vanguard, Capital One 360, and Charles Schwab, as well as through newer digital investment advisors like Betterment and Wealthfront. You’ll find details on what type of plan you qualify for and the fees they charge on their sites.
Choosing a traditional retirement plan like a 401(k) or an IRA has many benefits, but there is one major point of caution: If you need to withdraw money before retirement you may be hit with large penalties.
Pros: tax deferred growth; no minimum investment
Cons: limits on how much you can contribute annually;to avoid penalties, money must stay invested until you reach retirement age
Option 2: Index Fund or Actively Managed Mutual Fund
If you have taken advantage of tax beneficial retirement plan investments from Option 1 and you are looking for other simple ways to invest, a fund might be your next best option. Unlike retirement plans, there are no maximum limits as to how much you are able to invest. But while there are no maximum investment limits, you also don’t have any of the tax advantages you had with a 401k or IRA.
Funds, like an index or an actively managed mutual fund, allows you to diversify. Instead of researching and investing in individual stocks or bonds, you can invest in a fund and your money will be spread out over many different investments. For example, instead of buying stock in one company like Apple, you could invest in part of a fund that owns stock in a variety of different technology companies, including Apple. That way, you haven’t put all of your eggs in one basket. There are many different fund investments you can make: you can focus on investing in a fund made up of specific type of stocks, bonds, or other investments like real estate.
Index funds and actively managed mutual funds are similar, but there is one important difference to note: An actively managed mutual fund has a fund manager that is making trades and monitoring the performance of the fund. This oversight can lead to larger management fees, which can take away from your earnings. Index funds are not actively managed so the fee you pay is generally smaller.
Similar to an IRA, you can find both index fund and mutual fund options through most major brokerages (Vanguard, Capital One 360, Charles Schwab, etc). They’ll have information on the different funds they offer, the past performance of each fund (how much money it has earned or lost over a period of time), and the fee associated with the fund. They will also have information about the minimum initial investment you can make into the fund (which usually starts around $2,000).
Pros: easy diversification (as opposed to choosing individual stocks) and you can cash out your investment before retirement without any penalties
Cons: fees and the initial investment can be high
Option 3: Digital Investment Advisor (or “robo-advisor”)
The newer option on the investment scene (a robo-advisor) uses algorithms to invest money, rather than human advisors. When you open an account with a robo-advisor, you answer questions about your risk tolerance and your goals and they suggest a diversified investment portfolio. They’ll select a variety of different funds, so you get more diversification than if you were to just choose one or two funds yourself. Once you set up your account, the algorithm will automatically adjust and balance your account so you don’t have to do much (if any) work.
Robo-advisors still charge a fee to manage your account and, though the fee can vary between different providers, it is generally much cheaper than fees from other investment options. There are also some robo-advisors that do not have a minimum initial investment amount so you can potentially get started with less than is required than some of the other index and managed mutual funds.
Pros: a cheaper alternative for hands-off done for you investing; low to no minimum initial investment
Cons: less personal control and you generally can’t edit their fund selection
- Review initial investment minimums, management fees, and performance history with the type of investment you’d like to start with (either with a retirement account in option 1, fund investments from a traditional provider in option 2, or a robo-advisor in option 3).
- Open an investment account with a financial institution and transfer money for your initial investment.
- Set up an automatic monthly transfer from your checking or savings account to make sure you are contributing to your investment account regularly. Be sure that your automatic transfer will trigger an automatic purchase into the fund or investment of your choice so your money isn’t just sitting in cash.
Remember, there are risks associated with investing, including losing your principle investment, so you want to make sure you have a well-funded emergency account and you feel comfortable with the investment option you choose. Most financial institutions have advisors you can call and speak to for any questions or clarification.
Bottom line: Take a little time to find the best option for your situation and get started investing today!