UPDATED: April 21, 2022
A great investment program doesn’t require elaborate spreadsheets, complicated calculations, or outsized returns. It does require consistency and discipline. The most important thing is getting started today. Even if you have a small amount to invest, get started. You can ramp up your savings later.
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Small Wins Can Equal Big Progress
Before making your first investment, the Proper Cents Guide to getting your finances in order will help you build an investment plan that’s right for you. Don’t pay attention to what others are doing. Filter out the noise. This is a “you” plan designed for your own unique money circumstances and goals.
What are You Trying to Accomplish?
To make progress, you need to know where you’re trying to go. We call it identifying the game you are playing. Do you want to retire early? Are you aiming for financial independence? Are you saving for a new house?
You get the idea.
When you clearly outline what you want to accomplish, you can build an investment plan that is consistent with your overarching goals.
How Much Should You Invest?
You want to balance having enough money today vs. funding your investment plan. Refer to your budget to find what is available to invest.
You want to avoid under-saving and blowing the money on stuff you don’t need. On the flip side, investing money you need to live off could put you in a cash flow bind. You should treat money invested, especially in retirement plans (401k, IRAs) as long-term funds that you will not touch until age 59.5 or retirement..
It’s okay to start small. If you only have an extra $5 a week to spare, that’s enough to get you started. You can always increase or decrease your investments over time as your financial priorities shift and life circumstances change.
Once you figure out how much to invest, either lump sum or recurring contributions, try to automate future savings.
For example, if you want to save $500 per month, set up a recurring contribution that automatically sends the money to your investment account. You want to make investing friction-less and easy.
How do you Feel about risk?
Building an investment plan that mirrors the way you feel about risk is part art and part science.
Here are things that might make your investment portfolio aggressive:
- 10+ years until you need the funds
- Stable employment
- Dual income household
- Fully funded emergency fund
Here are things that might make your investment portfolio conservative:
- You could need the funds within the next 1-3 years
- Volatile employment income
- Single earner
- Little or no emergency fund
Investment personality is that “art” portion of building your risk profile. For example, Mary could check the box on all of the above aggressive investment portfolio characteristics, but she loses sleep seeing her investment balances decrease. Mary’s financial situation would allow her to take risks, but her personality doesn’t jive with an aggressive investment portfolio.
Where Should you Invest?
It depends on how much time you want to put into building and maintaining your investment plan. Doing it yourself is the lowest cost option, but the most time intensive. You have to build, trade, and tweak the portfolio. This works well if you have a genuine interest in investing and the time to pull the levers. This does not work well if you tend to make emotional money decisions.
Hire a Financial Advisor
This is the highest cost option, but once the advisor is up and running, the time commitment is minimal. If you choose the advisor route, make sure you work with a fiduciary advisor.
Things to do Prior to Hiring a Financial Advisor:
- Review the advisor firm's ADV for disclosures on conflicts of interest, revenue sharing agreements, assets under management, and number of clients.
- Have a clear picture of advisor fees, expenses ratios, commission, and other fees. It’s your right to know what you are paying for financial advice.
- Run a search on investor.gov for disciplinary action against the advisors you’re considering. Any marks or a pattern of poor behavior is a red flag.
- Inquire about licenses, continuing education, and professional designations. You want an advisor that shows a commitment to their craft. The Certified Financial Planner (CFP) and Chartered Financial Analyst (CFA) marks are two respected designations.
- Understand the advisor's investment process. You don’t have to get in the weeds on every detail, but you want a high level understanding of how they make buy/sell decisions, manage risk, tax efficiency, and overall investment philosophy.
- Transparency is key. Once you hire an advisor, make sure you have access to portfolio holdings, performance, activity, and fee information (usually through a web or mobile app client portal).
Hybrid Approach (Personal Capital)
This type of arrangement is usually 100% online, meaning you’ll never meet the advisor in-person. The hybrid model emphasizes lower costs and sleek technology to drive investment advice.
If you’re comfortable with working remotely and have straightforward investment needs, this could be a good fit.
If you prefer a personal relationship and aren’t comfortable working with someone you don’t know, a hybrid approach might not be a good fit.
What Type of Accounts Should You Invest In?
Before we look at the types of investments available, it’s critical to understand the account(s) in which the underlying assets will be held.
Some investment accounts use after-tax dollars and are accessible to the investor at any time. Other accounts restrict funds until a certain age or circumstance, meaning investors will get hit with a penalty if they try to pull money out prematurely.
Employer-Sponsored Retirement Accounts
Retirement accounts enable investors to save money, often with significant tax incentives, to use after age 59.5 or in retirement.
Common employer-sponsored retirement accounts are the 401(k), 457, and 403(b). There are similar options for self-employed individuals like a Solo 401(k), SEP IRA, and SIMPLE IRA.
If you’re interested in investing for retirement, it’s critical to review the savings options available through your company. Reach out to your company HR department for information on employer matches and other benefits. A significant benefit of employer-sponsored retirement accounts is that the money is invested before you see it in your paycheck. Since you don’t see the money go out the door, you’re less likely to miss it.
Retirement savings should be thought of as long-term investments. If you’re under the age of 59.5, there are potentially penalties and taxes to pay if you tap retirement funds prematurely.
You’ll also want to ask questions about investment options to determine if you can choose or if the plan offers mutual funds, managed model portfolios, or target date funds..
Individual Retirement Accounts (IRA)
IRAs are retirement accounts that are not explicitly tied to an employer. The most common are the traditional IRA and Roth IRA. The critical difference between a Traditional and Roth account is that a Roth account allows for after-tax contributions and tax-free growth.
A Traditional IRA account allows for pre-tax contributions, tax-deferred growth, and becomes taxable once you distribute the funds after age 59.5. Traditional IRA and Roth IRA contribution limits are either $6,000 if you are under 50 or $7,000 if you are 50 or older. High-income earners might not qualify to contribute to a Roth IRA. You can check the Roth income phase-out and restrictions on the IRS website.
The same premature distribution rules apply for Traditional IRAs for those under the age of 59.5.
Roth IRAs offer more flexibility if you need to take out your original contributions. For example, Debbie has been contributing $1,000 to a Roth IRA for five years. After some growth, her current balance is $8,000. Debbie can take out her original investment, $5,000, penalty and tax-free.
A taxable brokerage account is an investment account opened by an individual that uses after-tax dollars to invest. These accounts are subject to capital gains taxes on realized gains. For example, Cecil buys XYZ stock at $100. One year later, Cecil sells XYZ stock for $500. Cecil would have a long-term capital gain of $400 ($500 - $100). Dividends and bond interest payments could potentially be taxable as well.
After-tax brokerage accounts offer the most flexibility. There are no income requirements or limitations, contribution limits, mandatory distributions, and premature withdrawal penalties.
Child Education Accounts
A 529 college savings plan is an option available to those who want to save money for a child’s education (your own, a family member, or a close friend). The benefit to the investor is a a possible state tax deduction and the investments grow tax-deferred. If the child uses the funds for qualified college expenses, the funds can be distributed tax-free.
That is a tax-efficient way to help pay for education.
There are a wide range of state-specific plans depending on where you live. Most 529 plans can be opened with little-to-no cost through an online investment company.
What Types of Investments are Available?
You’ve outlined your goals, risk tolerance, and the account types you want to utilize. Now comes the fun part, building a portfolio.
Investments can be broken down into several broad categories:
When you invest in a single company stock, you’re buying an ownership interest in the underlying company. You will profit if share prices go up, and you could potentially lose everything if a company goes under. Individual stock investing tends to be riskier, but also offers incredible returns if you manage to choose the right company..
Until recently, an investor had to buy a full share of a company stock. For some companies, this could be an expensive endeavor. Due to the rise of fractional share investing, now you can buy $5 or $10 worth of a share. That means you could become an owner in Tesla, Apple, or Google for a fraction of the cost of purchasing a whole share, and take part in the growth as well.
Bonds have traditionally been viewed as a safe and steady asset class that allow investors to hedge portfolio risk, while providing income. Bond investors are lending money to an entity i.e. government, company, or municipality (city, county, state) in exchange for interest and return of principal over a fixed time period.
Bonds are fixed-income investments that offer much lower risk and return profiles.
Exchange-traded funds or ETFs are baskets of investments, sometimes containing hundreds or of individual assets. They offer broad exposure compared to individual stocks or bonds, while adding diversification benefits to a portfolio.
Exchange-traded funds may also track a broader market index (S&P 500), a specific sector (energy, real estate), or a commodity (natural gas, precious metals). ETFs offer low fees and greater tax efficiency than mutual funds, due to their passive management style and unique structure.
Just like individual stocks, ETFs trade in real-time.
Similar to an ETF, index funds are portfolios of stocks or bonds that track a broader market index. Index funds differ from ETFs in that they can have a minimum investment amount to make a purchase (sometimes as much as $3,000), and they only trade once per day based on net asset value.
Index funds are passively managed. This means there is very little overhead for companies to offer index funds to investors. Therefore, many index funds offer their products to investors for minimal costs.
Since index funds track a broad market index, the securities that exist within an index fund only change when the index components change. However, index changes can result in capital gains distributions to shareholders if held in a non-retirement account.
In our opinion, mutual funds are best owned in a retirement account (401k, IRA).
Actively Managed Mutual Funds
Mutual funds are the actively managed counterpart to ETFs and index funds. A mutual fund is overseen by a portfolio manager responsible for the fund’s performance.
The portfolio manager will try to identify stocks or bonds that will outperform the broader market or index. Due to the higher volume of trading, active mutual funds are expensive and less tax-efficient compared to index funds or ETFs.
While cryptocurrency is not a traditional investment, it’s worth mentioning as it continues to grow in popularity. Operated on a distributed ledger technology called blockchain, cryptocurrencies have various uses and are beginning to make their way into mainstream institutional and retail portfolios.
How Do You Begin?
All you need is your identity, a bank account, and a phone, you’re ready to get started. The below steps take you through beginning to invest from account creation to re-balancing.
- Choose a Company, ETF, or Mutual Fund: Beginner investors can download an app like Robinhood and begin purchasing fractional shares of stocks, bonds, or cryptocurrency. If you’d like to take a more traditional route, you can sign up for an account with a reputable brokerage company like Vanguard, Schwab, or Fidelity.
- Link to a Funding Source: Many people set up a direct ACH from a bank account to quickly transfer funds for investing. If you’re choosing to opt-in to a company retirement account, reach out to your human resources department to set up recurring paycheck deductions.
- Frequency: Do you plan to invest weekly, monthly, one lump sum annually? Dollar-cost averaging, which is the strategy of dividing up an annual investment at regular predetermined intervals throughout the year, has been shown to reduce risk. When you invest a set amount on the first of the month, you spread the risk of market volatility evenly across the calendar year. That means you might buy at a peak some months and in a valley others, which is likely to even out over the long term.
- Pick a Portfolio Allocation: Some investors say to hold bonds in your portfolio as a percentage equivalent to your age. For example, a 30-year-old’s portfolio would be 30% bonds, 70% stocks. If you’ve got a long time horizon before you need the money, you can afford to be a bit more aggressive and stay the course through potential market volatility.
- Set it and Forget it: Once you’ve developed your investment strategy, automate it and don’t touch it until you need it. It can be tempting to jump back in and buy or sell based on if the market is up or down, but often that can result in missed opportunities and heartache.
- Re-balancing: As investments change in value and dividends get reinvested over time, your asset allocation can fall out of balance. For example, let’s say your portfolio had 30% bonds and 70% stocks at the beginning of the year. If the stocks saw outsized returns, you may now be looking at a ratio of closer to 20% bonds and 80% stocks. When you re-balance, you’d either sell off some stocks to purchase bonds or simply set your investments to buy more bonds over the first few months of the year until you get back to your original allocation.
Basic Investing Principles
New investors can be inundated with information that makes it tough to decide on an investment and get started. These basic investing principles cover what a beginner investor needs to know before dipping their toe into the stock market waters.
Do Your Research
You wouldn’t buy an expensive product without checking out reviews first, and you shouldn’t start to invest without doing your research first. Now that you understand the types of investments available, you can begin to consider where you may want to allocate funds.
The most important element of research is to make sure that you understand potential investments before you jump in. Sometimes the best way to do that is to compare several options in which you’re most interested.
Some people prefer to track the pros and cons of potential investments on paper or a spreadsheet. These options enable you to do a side by side comparison of fees, historical returns, and projected returns. There are also plenty of tools online that will allow you to research stocks if you want to take a more hands on approach. .
Build a Diversified Portfolio
While it can be tempting to allocate all of your funds towards a particular investment that has posted great returns, diversification is a foundational principle of investing. By allocating your capital across different assets, you can mitigate risk and avoid catastrophic losses during a market downturn.
For example, an investor with a large allocation to large-cap technology stocks, might balance out their portfolio with small-cap stocks, international stocks, and U.S. Treasury bonds. .
Timing the Market vs. Time in the Market
Savvy investors know the secret to long-term success is following a steady, dedicated plan over the long term. Investors who try to time the market make are setting themselves up for failure.
Waiting for the perfect opportunity to buy an asset at the lowest price possible or sell it when it peaks is an exercise in futility. By selling when you think something is at its peak and removing yourself from the game, you miss out on long-term growth and are less likely to put your money back in once you’ve taken it out. Slow and steady investors tend to win the stock market race.
Keep Fees Low
Some investments, like mutual funds, assess higher fees in return for active management. Remember that any fees you pay when buying or selling your investments mean less money in your pocket. Passively managed ETFs have come into favor mainly because of their low fees and easy entry for beginner investors.
If your investments or advisor assess fees, make sure you understand how much you’re paying and what you’re getting in return. One of the worst things you can do is to continue to pay high fees and not receive a benefit.
There is no time like the present to get started investing. While nobody knows what the market may do today, allowing your money to compound over decades is one of the best paths available to build wealth.
Stick to the Plan
If you fail to plan, you plan to fail.
Nothing could be more accurate when it comes to investing. While some investors may seem like they’re throwing around money with no rhyme or reason, most understand their risk aversion, money limitations, and how they will react or not react given certain market circumstances.
The market has been known to fluctuate, but generally trends upwards over time. When you’re investing in the market, assuming you’re not looking to be a day trader, you’re usually looking for returns over a longer investment period. Investing for the long term positions you to reap all the benefits of compound interest.
It’s imperative to create an investing strategy and to refer back to it in times of market volatility. If the market is crashing, it might seem like a good time to scrap your strategy and sell, sell, sell. But doing so may mean you cash out at a lower price per share, and you might miss the rebound.
Automation is Your Friend
Once you decide which investments you’d like to get into, automate your contributions. If you choose to use an employer-sponsored retirement plan, this becomes quite simple as most contributions are taken directly out of your paycheck. But if you’ve decided to open an IRA or taxable brokerage account, you may want to set a recurring monthly contribution to keep your investments on schedule. A “set it and forget it” investment strategy enables you to continuously invest and get the best of both the highs and the lows over time.
It’s Okay to Ask for Help
If you’re hesitant to get into the market with limited knowledge, you may find that seeking professional assistance is the best path forward. If you’re planning to work with a financial advisor, make sure they are a fiduciary, which means they legally have to put your interests first when making any investment decisions or recommendations.
A financial advisor can help you determine what type of investment strategy will benefit you over the long-term. They can also offer assistance with retirement planning, tax planning, and basic personal finance questions.
Investing is no longer an activity reserved for the wealthy or elite. Anyone with a smartphone and a few dollars can become an investor. Regular systematic investing is one of the best ways to increase wealth, there’s no reason why you can’t get started today. Do your research and seek out help if you need it, but remember that the longer you wait, the less time your money has to compound and grow.