Last week I made a case for why you need to start investing, even if you have a fear of investing in small amounts because you do not think you have enough savings to do so. The other big fear I mentioned, but did not dive in to, involved the “how” of investing.
Before going in to the how, a few disclaimers, as chirpers will chirp:
- the ideal investment strategy for beginning investors can easily apply to both retirement accounts (401Ks, IRAs) and non-retirement accounts.
- before investing in a non-retirement account, you should definitely make sure to capture 100% of your employer’s 401K match. This is free money, and probably better than any return you will be able to achieve on your own.
- investing in the market is not for everyone. You must have patience and a long-term outlook to succeed.
- the strategy I’m about to highlight is how I personally would start from scratch, if I were to do so. It is not a recommendation I think everyone should follow as I am not an investment adviser and the market could absolutely tank in the next year, so you should definitely study up from other sources before you start investing – and even then you could get your ass handed to you. There is always risk in investing, as there is in driving a car, eating a hot dog, or blowing your nose.
The Beginning Investor Dilemmas
Beginners who have smaller savings levels usually have one, or a combination of the following concerns:
a. “I don’t have enough to start an account”
b. “it logistically doesn’t make sense with the trading fees on smaller contribution levels”
c. “I don’t know what to invest in”
Investing outside of a 401K on your own is not only easier than you think, but you probably do have enough to start an account if you are not in debt and there are ways to avoid excessive trading fees on smaller contribution levels.
If you’re doing it the right way, figuring out what to invest in is easy as well.
I’ll address each of these concerns so that you can feel a lot more comfortable about getting out there and investing.
“I Don’t have Enough Savings to Start an Investment Account”
In my guide to starting an online broker account, I highlighted the minimum opening deposit accounts at each of the major online brokers and any account fees. They are as follows:
- Fidelity: $0 to open
- Schwab: $0 to open
- Vanguard: $0 to open. Vanguard charges a $20 account fee if you have less than $10,000 in assets (can get this waived if you sign up for e-delivery)
Before you go and sign up for one, read the next section.
“It Logistically Doesn’t Make Sense to Invest with the Trading Fees on Smaller Contribution Levels”
This concern makes a lot of sense if you are thinking about trading in and out of investments or buying mutual or index funds, as most beginning investors do. Yes, if you are contributing $50 a month and have a trading fee of $4.95, that’s an obscene fee rate of almost 10% of your investment. Do this every time you add additional funds, and you are on the fast track to the poor house.
Even buying into a mutual fund can bring excessive fees at smaller contribution levels. Most require minimum deposits of $1,000 to $3,000 and higher, and then charge a buy-in fee of $10-$20 or more.
This is why I’m a big fan of passive index investing via ETFs. Today, there are a number of discount brokers with free ETF trading, including: Vanguard, Fidelity, and Schwab. Any time you buy or sell one of the specified ETFs with these brokers, you don’t pay a trading fee. This means that if you want to diversify in the beginning and/or contribute small amounts every month to dollar cost average, you can do so, without excessive trading fees eating in to your returns.
Any one of these discount brokers is a good place to start for those with small contribution levels who don’t want to be beaten down by excessive trading fees.
One of the greatest investing minds of all time, Warren Buffet, has said, “if you buy index funds, over time, that’s probably the best investment most people can make.”
Index funds and ETFs are virtually interchangeable because they both follow the same indexes – I’ve highlighted the differences between ETFs and index funds in the past. For a beginning investor, all you really need to worry about is price. I generally think ETFs are better for beginners because they allow them to start out with lower amounts, there is no fee to buy them (if you are following the free ETF trading strategy I previously highlighted in the free ETF trading article), and their management fees are usually less than index funds (but you should compare before buying).
“I Don’t Know what to Invest in”
This is another reason why I am a big fan of passive index investing, particularly when it pertains to beginning investors.
With passive investing, you choose an index fund or ETF that has assets in stocks/bonds that are part of a certain index. You choose the ETF or fund, but you don’t choose individual stocks or bonds. Doing the latter is a losing game for most institutional investors, and certainly most beginning investors.
And with ETFs, you are automatically diversified as indexes follow dozens, sometimes hundreds, and even thousands of individual stocks and/or bonds. Buy an ETF and you are owning a small piece of all of them. That’s diversification of risk.
ETFs that follow broad indexes like the S&P 500, international market indices, the total world market, and real estate are a good starting point. I’m not going to give you specific ETFs – you’ll have to do a little bit of work on your own.
Before investing, do you homework. Check out the books The Bogleheads’ Guide to Investing (from Vanguard founder John Bogle), Investing For Dummies, and whatever else you can get your hands on from the library. I’m also a big fan of Kiplinger’s Magazine.
How to Invest in Small Amounts Discussion:
- If you’re a beginning investor or have a small amount to invest, what has your investment strategy been?
- What is your favorite online broker and why?
- What ETFs, index funds, or other investments do you own?