How to Start Investing From Scratch – Part 2

How to start investing from scratch

Photo courtesy of thenext28days

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:

  1. If you have a 401(k) with a match, start there
  2. Learn a little about investing (with some suggested resources)
  3. 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:

  1. Are the investments options in any way able to mimic your desired investment plan?
  2. What are the costs associated with each of those options?
  3. 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:

  1. Get used to making regular contributions. Setting up monthly automatic transactions from your checking account is a good way to make this happen.
  2. 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:

  1. What type of account to open
  2. What company to open that account with
  3. 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:

  1. 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.
  2. 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.
  3. 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.

Good luck!

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41 Comments... Read them below or add one of your own
  • Laurie @thefrugalfarmer November 11, 2013

    More great info here, Matt. We are strongly considering Vanguard for our investment account. Seems like they’ve got a great track record.

  • DC @ Young Adult Money November 11, 2013

    Great post, as usual, Matt. Opening an IRA is definitely the next step for me, as I’m contributing the full amount needed to meet my employer match for my 401k. I haven’t really looked into IRAs but have it on my goals list for 2014.

    • Matt @ momanddadmoney November 11, 2013

      Sounds good! Are you not happy with the investment options within your 401k? They often aren’t great, so I can definitely understand wanting to go with an IRA as opposed to just contributing more to the 401k.

  • Kali @ Common Sense Millennial November 11, 2013

    Yet another great, informative post! I love how straightforward your “how tos” are; it makes it extremely easy for anyone starting from square 1 to learn this really vital information.

  • John S @ Frugal Rules November 11, 2013

    “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.” I could not agree more Matt! Far too many stress over what type of IRA or other account they should start with and the key is to just start. You’re likely not talking about a ton of cash in the beginning, so just start. I say find something that is as low cost and as easy for you as possible and get started. If you follow this, generally speaking, you’ll be much better off than by vexing over what kind of account to start with. Thanks for the shout out as well, much appreciated!

    • Matt @ momanddadmoney November 11, 2013

      It’s so true. By simply starting you’ll be so much further along and you can figure out the details along the way. The longer you wait the less effective each contribution will be.

  • Holly Johnson November 11, 2013

    Greg has an old IRA from his first job and we really need to roll it over somewhere else. That is definitely on my list of things to do!
    Other than that, I agree about opening retirement accounts at Vanguard. Almost all of our stuff is in Target Date Funds.

    • Matt @ momanddadmoney November 11, 2013

      My wife had a pension with her old company. The rollover paperwork was incredibly simple but it took FOREVER to actually complete. I guess rolling funds out of their account wasn’t at the top of her old employer’s to-do list. Then again her old employer was the state, so maybe that explains some of it.

  • Andrew November 11, 2013

    Great advice. Keep contributing and stay the course. I think that’s one of the main philosophy of the bogleheads and I think it is one of the most important. I’m also a big fan of Vanguard and their low cost funds. The majority of my 457 and IRA are in Vanguard funds.

    • Matt @ momanddadmoney November 11, 2013

      I think you’re spot on that that’s probably the most important advice of all. There’s tremendous power in doing the same thing over and over again (assuming that thing is beneficial). It might be boring, but it’s incredibly effective.

  • Stefanie @ brokeandbeau November 11, 2013

    I only get 401k contributions when I book work through the actor’s union and seeing how work is unpredictable, I can’t let my retirement contributions be unpredictable. So I invest in a Vanguard ROTH. Love it.

    • Matt @ momanddadmoney November 11, 2013

      That definitely makes it tough to use a 401k. Sounds like you found a nice solution. I started with a Roth IRA as well. Very easy to set up.

  • MyMoneyDesign November 11, 2013

    A 401k is a great way to get the investment habit going. Just invest the money and forget that you even have it. You’ll be surprised at the mountain of cash that builds after years of living without it in your paycheck.

    For Vanguard I usually like to tell people to go with one of their balanced funds. STAR fund has always been a favorite and really, really cheap ($1K to start). Wellington is another that I like, but I believe the minimum was $10K.

    • Matt @ momanddadmoney November 11, 2013

      “You’ll be surprised at the mountain of cash that builds after years of living without it in your paycheck.” So true. Just like I said to Andrew, there really is a magic in the power of regular contributions.

      The STAR fund is fine. It’s a little more expensive and in my opinion a little more difficult to understand than the target date funds, simply because it’s composed of so many other funds. But both that and Wellington are fine options. It looks like the Wellington minimum is $3,000. I’d still prefer the lifestrategy funds there as well, but again it’s more a matter of personal preference. Wellington is an actively managed fund.

  • Grayson @ Debt Roundup November 11, 2013

    Awesome post Matt. I think Vanguard is a great place to start. If people don’t have enough money to open the account, then I would tell them to try Betterment and then switch. I know plenty of people that have done that and were happy.

    • Matt @ momanddadmoney November 11, 2013

      The problem I have with the “start somewhere else, move the money later” approach is that most people will never move the money. They’ll just stay wherever they started. Betterment seems like a fine option, but I personally like Vanguard better and would rather wait until I had the $1,000 to invest there.

      • Grayson @ Debt Roundup November 11, 2013

        I can say the same thing about “just save up in order to open an account”. Can’t we agree that getting them to just start investing with a little amount is better than waiting for them to save up? Just as most people won’t move over the account when they reach the threshold, most people won’t save up the necessary funds in order to start investing with Vanguard.

        • Matt @ momanddadmoney November 11, 2013

          It’s a fair point. And yes, I 100% agree that starting to invest is by far the most important step. Our little debate here is a minutia that is largely unimportant.

  • Shannon Ryan November 11, 2013

    Great post, Matt. So many people do get stuck on wanting everything to be “perfect”. They get so caught up in finding the perfect investment that they never invest because they can’t find the perfect investment. I think because their is this belief that investing must be complex that people overcomplicate things. The reality is it can be straightforward and simple.

    • Matt @ momanddadmoney November 11, 2013

      Very true. And the other reality is that there is no “perfect”. There are simply many “good enough” strategies and the trick is finding one you believe in and can stick with.

  • Brian @ Luke1428 November 11, 2013

    Absolutely agree Matt that habits are key. We’ve held accounts at Vanguard for years and just set them up on automation. Money from our paychecks goes directly to our retirement accounts and is invested per our desired allocation. Great write up!

  • E.M. November 11, 2013

    Thanks for these posts, Matt. I have been too caught up in wondering if I should go with a traditional or Roth IRA, that I have held off on opening one. I really need to just do it. I definitely plan on using Vanguard as I’ve heard such great things about them.

    • Matt @ momanddadmoney November 12, 2013

      I can definitely understand the feeling of not knowing how to decide. I’ve been there with plenty of decisions myself. The reality is that when you’re young there are a lot of unknown variables that make it almost impossible to know for sure which one is better. Best to just pick one and move on. You can always make adjustments later.

  • Kim@Eyesonthedollar November 11, 2013

    Great advice. Jim’s 401k used to match, but they stopped and the fees are too high, so we don’t put money in there and use Vanguard IRA’s instead. Since I am the boss, my work plan is also with Vanguard. They are my favorite also, and I have no complaints after 13 years of using them. Target retirement funds are great if you don’t know much about investing and really give you no excuses about getting started.

  • Jacob @ iHeartBudgets November 12, 2013

    Spot on (as usual), and great call on building good habits from the beginning. I moved my Roth IRA from Edward Jones to Vanguard and am saving a butt-load in fees! I started with a target date fund to match my plan and tolerances, and will venture out from there.

    • Matt @ momanddadmoney November 12, 2013

      Did Edward Jones make it hard for you to leave? I’ve heard some horror stories about trying to get out of places like that.

      • Jacob @ iHeartBudgets November 12, 2013

        Wasn’t hard, Vanguard took care of the details. They called once, I didn’t answer.

        The killer was the almost $200 in account cancellation and yearly fees they tacked on. Sort of letting the door hit me on the way out, as it were. Ridiculous. Don’t worry, I’ll write about the process at some point. 🙂

        • Matt @ momanddadmoney November 12, 2013

          I’d like to see that article. Glad to hear it was easy though. The fees are painful but well worth it to get out.

  • Simon | Modest Money November 12, 2013

    Excellent how to Matt. I’d only emphasize consistency…once you set things up, the rest is just contributing regularly and upping your contributions if your financial situation is favourable.
    Vanguard – I second that recommendation 🙂

  • AvgJoeMoney November 12, 2013

    Nice piece. Personally, I’ve never liked all of my eggs with a single company, regardless of their track record. In the late 1990s Fidelity was the hot pick that everyone was writing about. In the early 2000s as the markets changed, headlines all read “Is Fidelity Dead?” I never want to get into a spot where I have to move all of my funds.

    • Matt @ momanddadmoney November 12, 2013

      I can understand that if you’re talking about a taxable account, since you may not be able to simply move into the same funds with a different broker. But even then there are many cases where you could do a trustee-to-trustee transfer and face minimal tax liability, if any.

      With retirement accounts I’m not sure what the concern would be. Beyond a concern that the company would go bankrupt, transferring to another institution is pretty easy and totally tax-free. I moved my IRA from Fidelity to Vanguard a few years ago and it was a very simple process. Certainly not something I would be trying to hard to avoid.

  • Done by Forty November 12, 2013

    That quote at the beginning, from Zig Zigler, covers a lot of issues in personal finance…but especially investing. So does “Pick Vanguard” or “Avoid Fees”. I love that, in this particular field, keeping it simple just also happens to point you to the right strategy, too, in most cases.

    I’m passing this along to my buddy and really do think these two posts of your are going to help a lot of people. Cheers.

    • Matt @ momanddadmoney November 12, 2013

      That quote is really applicable to pretty much everything in life. We only give ourselves a chance to be great if we get started.

  • Charles@Gettingarichlife November 13, 2013

    I invest with Vanguard but also use Fidelity. With their new Ishares ETFs their fund fees are much lower than Vanguard funds. If you use Fidelity the trades are free. I recommend it for people who don’t have thousands to invest.

    • Matt @ momanddadmoney November 13, 2013

      Fidelity is a good company with some good products, but it’s not true that they’re cheaper. If you want to use ETFs it would actually appear that the pricing is prety much the same. Vanguard was slightly cheaper for Total US, they were the same for Total International, and Fidelity was slightly cheaper for Total US Bond. So there may be instances where Fidelity is slightly cheaper, but the blanker statement of “their fund fees are much lower” does not hold.

      Furthermore, if you use Vanguard their trades are also free. Also the free ishares trades only apply for people who have invested at least $2,500. You can get into Vanguard for $1,000.

      I have nothing against Fidelity and in fact think they’re a good company. I use them for some of my banking needs, though not my investing. I just want to keep the information accurate.

I’d love to hear from you, please leave a comment