So you have heard about investing and want to get in. You know that investing can add to your income, provide a safety net, let you effectively pay less for things throughout your life, and, eventually, make you rich. But, how do you actually make your first investments and start investing? In this article we’ll go through the very basics of what is needed to get into investing.
Before you start, however, make sure that you’re ready. In particular, make sure that you have an emergency fund in place to handle surprise expenses that may come up. You don’t want to buy into your first fund then need to turn around and sell it, possibly at a loss, because you need the money to fix your car. A basic emergency fund is $1000, which might be enough if you’re a college student and could ask parents for help if something big happened.
A full emergency fund is 3 to 6 month’s worth of expenses to cover you should you lose your job and need to find another. This will typically be on the order of $10,000. If you really want to get into financial shape, pick up a copy of FIREd by Fifty: How to Create the Cash Flow You Need to Retire Early and pull together a cash flow plan. That is where you figure out how much money you need to be putting away for things like necessities, retirement, and future expenses, covering not only your needs now but in the next few years and even the next decades. You also figure out exactly how much money you need to be investing each year to reach financial goals. Then you’ll know you have all of the bases covered.
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FIREd by Fifty: How to Create the Cash Flow You Need to Retire Early
How much money will you need?
The amount of money you’ll need to start investing isn’t astronomical, but not insignificant either. Depending on the brokerage firm you go with, you’ll typically need between $3000 and $10,000. You’ll also find that some of the firms won’t really want your business unless you have a lot of money, so you’ll want to find those that do. Vanguard and Charles Schwab are both good choices. (Note, I don’t get any sort of commission from either of these firms. They are just really the best choices for small investors because they are inexpensive and have a lot of funds to choose from. They are also friendly and welcoming for small accounts, plus they have good websites.)
In general, the more money you have to invest, the less you’ll end up paying per share. Like other things, you do better when you buy in bulk since there is a minimum fee that covers the first N-thousand dollars and then a percentage is charged after that. If you buy $100 worth of stock or $1000 you might end up paying $30 regardless, so you’d pay 30% versus 3% if you invest in small amounts.
This isn’t to say that you shouldn’t invest if you don’t have much money to start. Once you get started, you can often get additional shares for free in the same stocks through things like Dividend Reinvestment Plans
Setting up a brokerage account
The first thing you’ll need to start investing, after you have pulled enough money to make your first investment, is to set up a brokerage account. A brokerage is a company that has access to the trading floor and through whom you’ll acquire your shares. Basically, you tell a broker what you want to buy, and he or she goes out and buys it for you. In exchange for this service, he/she charges a fee called a brokerage fee or a commission. In some cases, such as when you’re buying mutual funds through a group like Charles Schwab or Vanguard, you won’t pay a fee when you buy or sell the funds, but you will be charged a fee through the mutual fund each year to cover costs. This is part of the “expenses” for the fund.
A broker may also help recommend stocks and funds to buy to you. Do not think that a broker will take care of your investments for you. This is someone you pay to make and recommend trades, not someone you pay to handle your money for you. You need to have a plan and be deciding what to buy and sell, perhaps with some advice from a broker, yourself. Brokers are often driven by their firms to make money through fees, so they may sell you things because they make a big commission, not because it is the best thing for you to own. They also make more money when you trade, so they may always be encouraging you to buy and sell, trying to time the markets, but you will do better if you trade infrequently. Remember that no one cares as much about you and your financial future as the one staring at you in the mirror each morning.
The easiest way to get started in investing is to buy mutual funds. You can learn more about mutual funds in Mutual Funds, Index Funds, and ETFs (Oh, My!). In a mutual fund, you pool your money together with that of others to buy a set of stocks (or other investments). A fund manager takes care of all of this, for which you pay him a fee. (You’ll find that fees are a common theme. People don’t work for free. Learn more about management fees in Hidden Fees in your Mutual Funds.)
One of the best mutual fund types to buy is the index fund because they have lower fees than other funds and have been shown to outperform funds that have high fees over long periods of time. Probably the biggest provider of index mutual funds is Vanguard. This is a great choice of broker a first-time investor (or even a seasoned investor). Another good choice with low fees and a good selection of funds is Charles Schwab.
Setting up an account is easy. Just go to the website and look for a link or button for opening an account. The one for Vanguard is shown below. Just click the link and start adding information. It will take about 15 minutes to get everything set up.
Both firms will also have people available to help you through phone or chat along the way. You’ll need to provide contact information and other typical banking information. As a side note, be really sure to provide information on beneficiaries (who gets your money should you die). If you have your beneficiaries listed, it will be very easy for them to get your account transferred over to them should something happen. They could have the money within a week or two. If not, it can be a huge process that may take years.
New investors should check out both of these brokerage firm options and see which one works best for them. It is really a matter of what is offered in terms of types of accounts and what the account minimums are, what the fees are for the type of investing you’re planning to do, and what features they have that you’ll need like check writing, money market funds, online access, etc…. Note that you can buy most funds and all individual stocks through either brokerage firm. Take a little time to see what they offer and what the requirements are. Depending when you’re planning to invest, sometimes one firm may have a special where they offer a lower minimum or something. Take a little time. But realize that you won’t go wrong with either choice.
Funding your account
Once you have your account open, you’ll need to fund it. This means sending in a check or transferring money online electronically. Again, there are people to help you through chat or via phone. You will typically need to send in a fairly large amount to start, like $3000 or $5000. After that, you’ll be able to send in small amounts as you want, like $50 from each paycheck. You may be able to send in smaller amounts to start if you setup automatic deposits from your bank account or paycheck after that.
To find out how much you’ll need to send in to start, look through the minimum investments for some of the mutual funds in which you have interest. For example, going to the Vanguard funds list site and looking at the S&P500 index fund, you can see that the minimum investment is $3000. After that, you can buy in whatever increments you want.
Alternatively, you could buy shares of the corresponding ETF. The one for the Vanguard S&P500 Fund is described here. At the time of this writing, it was selling for about $300 per share, so you could buy a single share for $300. If you wanted to buy more, however, you’d need to come up with enough to buy another share (again somewhere around $300, depending on what happened to the share price in the meantime). The same would go if you wanted to sell – you would need to sell in even share increments.
Note that this is the advantage of buying the mutual fund instead of buying the ETF: You can send whatever amount in that you want to the mutual fund and buy more shares once you’ve made the initial investment, but you can only buy and sell ETFs in increments of a share. This is not a big deal if you have $10,000 to invest, but can make a big difference if you’re sending in $25 at a time.
What should you buy?
Over time, you’ll want to build up a portfolio that is invested in different segments of the markets. You’ll want to own large stocks, small stocks, US stock, foreign stocks, tech stocks, bank stocks, consumer stocks, etc…. You get the idea. Rather than trying to guess what segment of the market will do well at any particular time, the simplest thing to do is to just buy everything since that way you’ll always have your money in whatever is doing well at the time. Because the whole market is always slowly going upwards (as there are more people to buy and produce things and people get more efficient at producing all of the time), you’ll be making money over long periods of time if you just own everything. And don’t worry that you’re getting sub-par returns. History has shown that most people do better buying everything and just holding on than trying to time the markets.
When you start out, it is easiest to just pick one market segment and jump in. A good first choice is a large cap stock fund. These typically have the word “Large Cap” in their name. You can also look at the prospectus, which starts out with a statement on what the fund objectives are, including what types of stocks the fund buys. There it will specify if they invest in large cap stocks. You can also look in the prospectus or fund description for the style box, as shown below. Here, this style box, which is for the Vanguard S&P500 Index Fund, shows that the fund invests in large stocks and invests in both growth stocks and value stocks since it is a blended fund. As you build a portfolio, you’ll want to slowly add funds covering all of the boxes in the style box.
Note, you’ll want to own both value and growth stocks, the left and the right sides of the style box. If you buy blended funds, however, they include both value and growth stocks, so buying the S&P500 fund is actually like buying the whole top row of the style box. You could therefore buy a small cap blended fund to cover the bottom of the box and a mid-cap blended fund to cover the middle and by doing so, cover the entire box with three funds. For a simple strategy that uses just three index funds to build up a portfolio that covers all of the bases, check out The Bogleheads’ Guide to the Three-Fund Portfolio
Buy Index Funds
Studies have shown that the biggest determiner on total return is fund cost. As long as you buy funds that cover a large portion of the market they’re in, which is most funds you can buy, a fund that charges a lower fee each year will do better over time than one that charges a large one. Funds typically charge a percentage of the amount invested each year, called an expense ratio. Fees of 1% or more were once fairly common, but today you can get index funds that charge less than 0.50% or even 0.25%. You should be able to find the fees that a fund charges from the description and the prospectus. For example, here’s the Vanguard S&P500 Fund Admiral Shares description:
This is an index fund with a really low cost. If you invested $1000, you’d only pay $.4o per year in fees! Compare this with a fund that charges 1.5% per year, where you would pay $15 per year in fees. While these may seem like small amounts, they make a big difference over time. This is why we like to use index funds.
As a final note on fees, while it is unlikely you’ll encounter them, there are some funds that charge what is called a load. There may be a load to buy in and/or a load to leave the fund. A load is just a fee that is charged, perhaps because the expense ratio is lowered in exchange, or perhaps just because they can. These tend to be funds that are sold to you by a broker and the person selling it to you probably gets part of the load as a commission for selling the fund to you. Unless the fund is in a very specialized part of the market that you can’t get into through an index fund, there is no reason to ever pay a load. If someone tries to sell you a fund with a load, politely tell them no thanks, recommend a copy of The Bogleheads’ Guide to Investing
After the first investment
So, let’s say that you save up $3000 and buy into the Vanguard Large Cap Stock Index Fund. Next, you may want to save up another $3000 and invest it in The Vanguard Small Cap Index Fund. You will now own funds investing in the top and bottom parts of the style box. You could later add a Mid Cap fund, which would cover the center of the box. From there, you could keep adding money to each of the funds, building up your portfolio. At some point you would also want to add fixed income/bonds, real estate through REITs, and international stocks. Again, you can find low-cost index funds that cover each of these segments of the markets. For example, there is the Vanguard Total Bond Index, the Vanguuard REIT Index, and the Vanguard Total International Equities Index.
Well, that’s how you get started, but it is only a start. After you’ve gotten your feet wet and are ready to learn more about investing, check out The SmallIvy Book of Investing or the Boglehead’s Guide to Investing to learn how to fine-tune your portfolio. The SmallIvy Book of Investing also covers how you can also learn how to invest in individual stocks and other securities.
(If you enjoy The Small Investor and want to support the cause, or you just want to learn how to become financially independent, please consider picking up a copy of my new book, FIREd by Fifty: How to Create the Cash Flow You Need to Retire Early This is the instruction manual on how to become financially independent.)
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Disclaimer: This blog is not meant to give financial planning or tax advice. It gives general information on investment strategy, picking stocks, and generally managing money to build wealth. It is not a solicitation to buy or sell stocks or any security. Financial planning advice should be sought from a certified financial planner, which the author is not. Tax advice should be sought from a CPA. All investments involve risk and the reader as urged to consider risks carefully and seek the advice of experts if needed before investing.
