Welcome to Part 2 of my mini-series on how to start investing when you have little money or understanding of investing. I would suggest checking out Part 1 if you haven’t already, but here’s a quick summary of what we covered:
- If you have a 401(k) with a match, start there
- Learn a little about investing (with some suggested resources)
- Make a simple investment plan
Today I want to get into the next steps, beyond taking advantage of a 401(k) match. I want to re-emphasize the point I made in Part 1 that this is the advice I would give to myself if I were just starting out. Each person’s situation and preferences are different, so please make sure to adapt this to your own circumstances.
Re-visit your 401(k)
With your investment plan in hand (created in Part 1), you should have a basic idea of the types of investments you want to choose. If you have a 401(k) or other similar type of retirement plan with your employer, this is the first place to look, primarily because it’s the easiest.
You’ll want to evaluate your 401(k) plan for a few different variables:
- Are the investments options in any way able to mimic your desired investment plan?
- What are the costs associated with each of those options?
- Are there any other costs involved with the plan?
High costs can be a killer to your investment returns, which is why you want to be very aware of what you would be paying. If the costs are high, you may want to look elsewhere once you’ve taken full advantage of any company match.
If the costs are reasonable, and if there are investment options that align with your plan, then the 401(k) is going to be your easiest option. You can choose to have your contributions taken directly out of your paycheck so you never even have to see or deal with the money. You can also start with very small contributions amounts, so you don’t have to worry about account minimums (like we’ll talk about below). If this is the route you’re going, your HR department can help you fill out the necessary forms.
If you have any questions about your 401(k) at any point, your HR department should be able to provide you with the proper information. If you have specific questions about which funds you should choose, email me or check out something like the Bogleheads Forum.
Start the investment habit
If you don’t have a 401(k), or if the investment options aren’t incredibly desirable or don’t meet your investment plan, you’re going to want to look elsewhere. When you do that, the immediate problem you could run into are account minimums. Most mutual funds have a minimum dollar amount that you have to invest, anywhere from $1,000 to $3,000 or even higher. They do this because it’s too costly for them to manage very small accounts, but it makes it harder for someone starting without a lot of money.
No worries. Remember that your early investment returns a largely unimportant, so the most important thing is to simply get started with the investment habit. If you don’t have enough money to meet the minimum account balances, just start putting aside regular contributions into a good old fashioned savings account. Don’t worry about the interest rate, as this is simply a temporary measure and the amount of interest you earn will be trivial. Your dual goals here are to:
- Get used to making regular contributions. Setting up monthly automatic transactions from your checking account is a good way to make this happen.
- Build up enough money in this account to be able to meet the investment account minimums.
It’s much more important to build up strong long-term habits than to immediately get into the “right” investments. Don’t stress out about the fact that you might be missing out on returns while you’re doing this. Over the long-term those returns will be insignificant, but the investment habit will stick with you through thick and thin.
Open an IRA
Once you’ve got enough money to open an account, it’s time to make a few choices. The three big choices you have to make are:
- What type of account to open
- What company to open that account with
- The specific investment choices to make
What type of account to open
If you’re investing outside of your 401(k), your basic options are to invest in a regular taxable account or in an IRA. An IRA will be advantageous if you’re investing for retirement, as there are tax breaks involved. But you might want to consider a taxable account if you think you’ll want the money before retirement.
Personally, I would start with an IRA just because of the tax breaks. Now even here you have a choice between a Traditional or a Roth IRA. There are many reasons why you might want to choose one over the other, but that’s the subject or another post (or potentially several). If I was just starting out, I would worry much more about simply getting started than about choosing the right type of IRA. My default choice unless you are paying very little in taxes right now would probably be a Traditional IRA, but it’s impossible for me to say which one would truly be “best” for your specific situation.
The overall message here: Don’t stress this decision. Open an IRA of whatever kind and move on. You can always do something different in the future, so this is not worth getting stuck on.
What company to open an account with
There are tons of different companies you can choose to invest your money with. I won’t get into all of them here, but the one I would tell myself to choose (and the one I use exclusively today) is Vanguard.
First off, I want to be clear that I make no money off my mention of Vanguard. I simply think it’s a great company that serves its investors incredibly well. I could again devote an entire post to why I like them so much, but here are a few key reasons:
- They basically invented index funds and continue to be the best at managing them. Given that the research shows index fund investing to be better than just about everything out there, I want to go with the people I think are the best at doing it.
- They are investor-focused. Since their founding, Vanguard has made it it’s mission to provide high-quality investment options to people of all levels of wealth. Their policies continue to reflect this mission.
- They are dedicated to keeping costs low. In addition to providing top-quality index funds, Vanguard has always been committed to keeping the cost of their investment options low. Given that costs are one of the most influential factors in investment returns, this long-term dedication is important to me.
There are plenty of other companies that will say they do these things (aside from the invention part), but I like Vanguard because they’ve had this mindset from the beginning. I trust that it’s part of the company’s foundation and will stay part of that foundation for the long-term.
The specific investment choices to make
Once you’ve opened your account, it’s time to start making your investment choices. This is when you’ll again want to look back at the simple investment plan you made in Part 1 of this series.
The easiest way to do this, and the way I actually did it myself when I was just starting out, is to find a single fund that mimics as closely as possible the investments you want to make. Many companies have what are called Target Retirement Funds that are really a collection of multiple funds within one and can probably closely mimic your desired investment plan.
Vanguard’s Target Retirement Funds each have a $1,000 minimum, so it doesn’t take a ton of money to get started. If it were me, I would look through them and pick the one that best matched the asset allocation I had chosen in Part 1, rather than picking the one that matched up with my desired retirement date.
A similar option at Vanguard would be to pick one of their LifeStrategy funds. These are very similar in terms of how they operate, but they have slight different investment mixes and they also have a $3,000 minimum.
Again, other companies will have similar options, so if you’re not comfortable with any of these you should shop around to find something you like better. This is simply how I would start.
One last note. This is not something I would spend too much time worrying about as you start out, but it’s worth keeping in mind as you move forward. You want to treat all of your investment money as one big pot, so anything you’ve invested in your 401(k), or anywhere else for that matter, should be considered along with the decisions you’re making here. This approach will keep your overall asset allocation where you want it to be.
Keep contributing. Stay the course.
If you’ve made it this far, congrats! You now have a basic investment plan you can follow and you’ve done the hard work of putting it into action.
The main work ahead of you is to simply keep feeding the machine with regular contributions and to trust your plan and stay the course even when things get rocky. The best thing you can do is to set your contributions to happen automatically, with the only changes being to increase your contributions as you can. One of the most powerful investment tools you have at your disposal is consistency. Simply staying steady with your contributions and sticking to your plan will give you a really good chance at long-term investment success.
Above all, remember not to stress too much about getting everything right the first time. Investing is a learning process and you’ll have plenty of time to tweak your plan as you gain comfort and knowledge. For now, the most important thing is to form the investment habit and start along the path.