By now, I hope I’ve begun to convince you that investing is actually the easy part. The more challenging part is consistently coming up with money for your investments.
If you’ve been worried about the risks associated with investing, we covered that, too. At the end of the day, reasonable risk is the cost to invest.
Because of inflation, the reality is that it’s more risky to not invest than it is to invest. Take a look at what happened to our pretend friend Terry who chose to play it safe.
At a bare minimum, investing is a way to play offense and defense. Investing to do fun things later on is playing offense. Investing to counteract inflation is playing defense.
We’ve also previously covered three great ways to minimize investment risk:
- Invest early and often. Take advantage of the power of compound interest by starting early and being consistent. Over time, compound interest will lead to wealth.
- Minimize fees. One of the few things we can control when we invest is what we choose to pay in fees. Keep fees to a minimum to maximize your long term gains. Even a fee of only 1% can do significant damage to your future prosperity.
- Learn the language. Investing can seem intimidating when you hear phrases like “asset allocation” and “diversification.” Once you learn the language, you’ll realize that practicing asset allocation and diversification is actually not that hard.
With this backdrop in mind, there should be no more excuses for why you can’t start investing.
So today, we’re going to talk about the two main steps to get started investing.
How to start investing in 2 steps.
If you’ve never invested before, are you nervous about how complicated the process is going to be?
Don’t be.
To start investing, there are really only two main steps involved.
- Step 1: Open an account.
- Step 2: Pick the investments for inside that account.
There really isn’t much more to it.
But, don’t forget to complete both steps.
Step 1: Open an account.
The first step to investing is simply to open an account.
There are endless investment companies available where you can easily open an account online. Some of the more popular companies are Vanguard, Fidelity, and Charles Schwab.
I personally use Vanguard.
Once you’ve chosen an investment company, you’ll next select the type of investment account to open.
There are two main types of investment accounts and some other popular accounts I’ll highlight below.
Before you do anything else, you’ll need to decide what type of account matches your investment goals. Once you know the type of account that best suits you, you will need to open that account before moving on to step 2.
It really is that easy to start investing.
You don’t need a financial advisor or a broker to open an account. Like most things these days, as I mentioned above, you can easily open an account on-line by yourself.
In fact, most of us begin investing in employer-sponsored retirement accounts, like 401(k) plans. When you start a new job, your HR department will provide you detailed instructions on how to enroll.
So, what are the main types of investment accounts to choose from?
Tax-advantaged retirement accounts.
The most common tax-advantaged retirement accounts include 401(k) plans, Roth IRAs, and traditional IRAs. “IRA” stands for Individual Retirement Account.
We’ll soon take a deep dive into the advantages and disadvantages of each type of account.
As a whole, the primary difference between tax-advantaged retirement accounts and traditional brokerage accounts relates to taxes.
The government wants us to save for retirement. To encourage us to do so, retirement accounts come with major tax advantages. That’s why most investors begin investing in these types of retirement accounts.
Traditional brokerage accounts do not have the same tax advantages.
In addition, tax-advantaged retirement accounts, like a 401(k) plan, are commonly offered by employers. That makes it easy for employees to invest.
You may be wondering: with these great tax advantages, why would someone open a traditional brokerage account?
Let’s take a look.
Traditional brokerage (non-retirement) accounts.
There are two main reasons to open a traditional brokerage account.
First, tax-advantaged retirement accounts have caps in place for how much someone can invest per year.
While the government is happy to encourage investing for retirement, its generosity only goes so far. Uncle Sam still depends on tax revenue and can’t afford to give us an unlimited free pass.
Once you reach those caps, and still have money that you want to invest, you’ll need to open a traditional brokerage account.
Most investors try to max out their retirement accounts to receive the full tax advantages before moving on to investing in traditional brokerage accounts.
The second reason is that tax-advantaged retirement accounts are intended for long-term retirement planning.
If you withdraw from your account before reaching a certain age, typically 59 1/2, you’ll be subject to penalties and taxes.
Of course, Think and Talk Money readers know that there are other reasons to save and invest besides retirement.
You may be investing to buy a home in 10 years. Maybe you have reached financial independence and rely on your investment income to fund your life.
Whatever the case, traditional brokerage accounts provide flexibility for people to withdraw their money when they want to.
Other types of investment accounts.
Besides tax-advantaged retirement accounts and traditional brokerage accounts, there are two other popular investment accounts to highlight.
529 Savings Plans for College: 529 college savings plans are state-sponsored, tax-advantaged investment accounts. While there are certainly other ways to save for college, 529 plans are hard to beat because they typically offer triple tax benefits.
To read more, check out my in-depth post on 529 Plans for Sky High College Costs.
Health Savings Accounts (HSA): An HSA is a tax-advantaged account that you can use to pay for eligible medical expenses.
These accounts are typically linked to employer-sponsored health insurance plans. You can choose to invest your HSA contributions, similar to how you might invest in a 401(k) plan.
Like with 529 plans, the reason to invest in an HSA is to receive triple tax benefits that are hard to beat. Your contributions, earnings, and withdrawals are all tax-free if you follow some basic rules.
We’ll explore this further in a future post.
You are not limited to just one type of account.
To recap, the first step to investing is simply to open an account.
There are two main types of investment accounts to consider: tax-advantaged retirement accounts and traditional brokerage accounts.
There are also other investment accounts intended to help with specific goals, like saving for college or medical expenses.
For almost all investors, it makes sense to first open a tax-advantaged retirement account before considering the other types of accounts. For many of us, that means participating in our employer-sponsored 401(k) plan.
Keep in mind, you are not limited to just one investment account. Many investors have various accounts for different goals. My wife and I have multiple retirement accounts, 529 plans for each of our kids, an HSA, and others.
Once you’ve opened an account, you’re ready to move onto step 2. The next step is choose what investments you want inside that account.
Step 2: Pick the investments for inside that account.
Now that you have an account opened up, the next step is to pick what investments you want inside that account. By that, I mean selecting what mutual funds, index funds, individual stocks, or bonds you want to buy.
Each major investment company offers a variety of investments to choose from, including target retirement date funds that are as easy as it gets.
Picture the account you just opened as a bucket. Now, you need to fill that bucket with something.
What you fill that bucket with are your investments.
This second step is crucial. It’s also easily overlooked.
More often than you might think, when people new to investing complete step 1 by opening an account, they mistakenly believe that their job is done. That’s not the case.
When you first open an account (other than employer-sponsored plans), you will need to fund that account with a minimum required deposit.
The key to remember is that once you make that transfer, your money will sit in your new investment account, not earning much or any interest, until you choose how to invest it.
Until you complete this second step, your money sits in your account and you don’t reap the benefits of investing.
As a side note, you’ll likely need to complete this second step every time you make a transfer into your investment account. You can link your checking account to your new investment account to make transfers easier.
One other side note, I mentioned that employer-sponsored plans, like 401(k) plans, operate a little differently. That’s because when you first enroll in your 401(k) plan, you will make your investment selections right then and there.
Because your contributions are automatically deducted from your paycheck, they will automatically be invested in your preselected investment choices.
Don’t laugh about people forgetting to choose their investments.
When I first taught my financial wellness course to law students, I thoughtlessly made a joke about people who forget to complete this second step. At the time, it seemed obvious to me that once an account was opened, the next step was to select the investments.
Boy, was I wrong.
In that first class, a student raised her hand and said she had made that mistake before. Her money sat in her investment account, without earning any interest, for more than a year before she realized her mistake.
She was not laughing at my joke.
Nor was she the only person in my class who had made that mistake. It turned out nobody was really laughing.
Since that first class, I’ve realized that it’s actually a common mistake.
That’s why I now emphasize there are two steps to start investing. The first step is to open an account. The second step is to pick investments for that account.
And, guess what?
I recently made the exact same mistake.
My HSA had been with one provider for years before that provider changed. My money was automatically transferred over to the new provider.
However, somehow I missed the announcement that my money would not be invested until I chose the investments for that new account.
It took me about six months of earning no interest to realize what was going on.
That’s what I get for making a joke about step 2!
How do I pick the right investments to fill my account?
We recently discussed the importance of learning the language of investing. In that post, we talked about stocks, bonds, mutual funds, and index funds. When you’re selecting investments, you’re choosing between these types of options.
We also talked about the importance of asset allocation and diversification. These terms make investing seem more complicated than it really is.
Ultimately, you’ll need to do your homework or pay an advisor to do it for you. Before you make your decision, be sure to check out my previous posts on investing so you have a good understanding of your options.
Personally, I invest in index funds to keep my costs down and to ensure a certain level of diversification. If I don’t have the option to invest in a total stock market index fund, I invest in an S&P 500 index fund.
I also invest in target date retirement funds since these funds automatically rebalance for me as time goes on. It doesn’t get any easier than this.
Now you know how easy it is to start investing.
If you were ever hesitant to start investing in the past, now you should be feeling more confident in how to get the process started.
There are really only two steps:
- Open an account.
- Pick investments for that account.
It doesn’t have to be any more complicated than that.
As always, leave a comment below if I can answer any questions as you get started.
Leave a Reply