How to Start Investing From Scratch – Part 1

Photo courtesy of thenext28days

A couple of weeks ago I wrote about the importance of starting to invest now, even if you don’t know what you’re doing. The main message of that article was how unimportant your returns are during those first few years of investing, so even if you do poorly you’ll be at an advantage simply from having started. In other words, don’t be afraid to dive into investing, no matter how unsure you feel about it.

In response to that post, my friend Alexa (who runs a great blog over at Single Moms Income) asked for some advice on how to get started. Specifically she said:

I think you should do a post about the best place to start investing for beginners and where you can open up investment accounts with a small initial deposit. I would be very interested to read your suggestions.

Ask and you shall receive Alexa! What follows is the advice I would give myself if I were starting from scratch, with little money or understanding of investing. This will be a two-part series, so make sure to check back next week for the rest of the story. (Click here for Part 2)

Quick note: For more in-depth, step-by-step guidance through creating your personal investment plan, check out the guide Investing Made Simple.

If you have a 401(k) with a match, start there

This advice is nothing new, but you hear it so often because it’s true. If your employer offers a 401(k) and will match a percent of your contributions, that’s far and away the best investment return you could receive.

A typical matching program is something like matching 50% of your contributions up to 6% of your salary. In plain English, that means that if your salary is $50,000 and you contribute $3,000 to your 401(k) (6% of your salary), your company will put in another $1,500 (50% of your contribution). Any additional contributions you make will not be matched.

The reason this is so great is that it’s an immediate and guaranteed return on your investment. In the long run, you might expect the stock market to return somewhere around 8% per year. But that’s not guaranteed. Any employer match will almost certainly be more than an 8% return (it’s 50% in the example above), and it will likely be much more stable than the stock market. (Though you should be aware of any vesting rules, which are the subject of another post).

Even if you know nothing about investing and have no idea what investments to choose within your 401(k), this is such an easy win that it makes sense to get it set up as soon as possible. As you learn more about investing (see below), you can tweak your specific investment choices. But don’t delay signing up for this option if you have it.

Learn a little about investing

So now you’ve either set up your 401(k) contribution to take advantage of your employer match, or you either don’t have a 401(k) or simply don’t have a match. What next?

Before making any big moves, it makes sense to do a little learning and a little planning. Don’t worry, you don’t have to become Warren Buffett or learn how to trade stocks during your lunch break. But having some understanding of the basic principles of investing will help you make better choices and will ultimately help you earn higher returns.

I would start with my beginner’s guide to index investing. That post has pretty much everything you need to know about the investment approach I use myself, and has links to a lot of other useful articles as well.

Beyond this site, there are many other places to get some great investment advice. Head over to the Oblivious Investor and start with the “Investing 101” menu at the top of the page. That site is full of down-to-earth and incredibly powerful investment advice.

I would also check out the Bogleheads site, starting with their investing start-up kit. They have an extensive wiki you can read through as well as an active forum where you can ask for advice specific to your situation.

This paper is an excellent overview on how to set up your own investment plan, or on how to hire an advisor if that’s your preference: Guide to Transparent Investing.

If you’re more into books, my first recommendation would be either The Bogleheads’ Guide to Investing or The Bogleheads’ Guide to Retirement Planning. If you’d like something a little more advanced, I would recommend David Swensen’s Unconventional Success.

Remember, the goal here is not to learn everything. It’s to get enough of an understanding of the basic principles that you can make decisions you feel comfortable with.

Make a simple investment plan

Once you’ve got a little bit of knowledge, you’ll want to write out an investment plan. Again, this doesn’t have to be incredibly complicated. But you can take the lessons you’ve learned above and apply them to come up with a few guidelines for yourself:

1. Specify what it is that you’re investing for. For most people starting out, the primary financial goal they’re investing for is retirement. But your situation might be different. Defining your goals will help you make some of the decisions we’ll talk about next. Here’s a process you can use to do it: 6 steps towards creating your ideal life.

2. How much do you want to contribute? Use my simple guide to get a ballpark amount that you’d like to be investing on a regular basis. You don’t have to start out making this full contribution, but knowing where you’d like to get to and starting somewhere along that path will be helpful.

3. What’s your asset allocation? You asset allocation is the mix of investments you’d like to use. There is a lot of information about this in that guide to index investing, so I would go back there to help figure this out. Deciding on this ahead of time will help you make your specific investment choices later on.

4. Specify any other factors that matter to you. One factor that really mattered in creating our own investment plan was keeping costs low, since all of the research shows that cost is a powerful driver of investment returns. You might have other things that are important to you. If so, make sure to write them down as part of your plan.

Here’s an example of an investment plan if you’d like something to work off of: My personal investment plan.

Next steps

If you put your mind to it, you can probably accomplish all of this within the span of a few weeks. Remember that your initial investment returns are relatively unimportant to the long-term outcome, so the most important thing is to get enough of an understanding that you feel comfortable and then to just get started.

In next week’s Part 2, I’ll talk about the steps you can take to implement your investment plan in the simplest, most effective way possible, even if you’re not starting with a lot of money.

Click here for Part 2.

Full disclosure: The links to books within this post are affiliate links and will earn me money if you purchase the product. As always, I only include affiliate links for products I actually use and have proven helpful for me personally.