So you’ve followed The Ultimate Flowchart and you have a budget. You save up 3-6 months of expenses for an emergency fund, and now you’re sitting pretty. What next?
When I finished with school I had knowledge piled up in my head: I knew how to calculate fluid velocity in a pipe, the fracture toughness of a material, and how to make a drill-powered bike. But in my sixteen years of education I did not have a single class in financial literacy.
However, once you get down to it, it is quite simple to invest. How long will it take you? About 20 minutes of actual work.
Disclaimer: I am not a financial professional. This post details my personal strategy for choosing my own investment options. Do your own research before making investment choices.
Number one on the list of biggest financial regrets: not starting early enough. So let’s do this.
Choose a brokerage provider
Choosing a brokerage provider is like choosing a bank: they all pretty much do the same thing. Don’t get hung up on this step. There are three main providers, and they are all fine. I will summarize my main findings from when I did the research between them.
Schwab: has brick and mortar locations, access to financial advisors, and most importantly access to low-cost index funds
Fidelity: also has brick and mortar locations, access to financial advisors, and better user experience for the apps, access to low-cost index funds
Vanguard: pioneered low-cost index fund model, online-only, a bit of a clunky interface.
I went with Vanguard in the end simply because I didn’t mind working with an older interface and at the time there were more options for funds. Right now in terms of options I think they all offer similar funds so pick one and move on.
Roth IRA or Traditional IRA?
You are now opening up an account called an IRA, just like you would open up a savings or checking account at the bank. This is also simple, although wading through the information can feel stressful at first. Let me break it down.
It boils down to what you think your income bracket will be when you start withdrawing funds. If it will be higher (for most people it will be as you will most likely be earning more in your fifties than your twenties) then Roth IRA is the best choice. If it will be lower (like for people in early retirement!) then Traditional IRA is the way to go. If you want to read an in depth analysis for early retirees I highly recommend madfientist’s Traditional IRA vs Roth IRA breakdown for further reading.
When you break it down:
- If you are near the income limit for a Roth IRA, the limits are based off of your modified adjusted gross income (MAGI) you can calculate this by starting with your gross income and subtracting deductions.
- Some people are worried about investing because they think the money will be locked away forever. Even though the preference might be that you leave the money alone, there is still psychological benefit to knowing that you could take the money out in an emergency. Contributions to a Roth IRA can be withdrawn at any time, tax-free and penalty free. Five years after your first contribution and age 59½, earnings withdrawals are tax-free, too.
Put money into your new IRA account
I have a couple screenshots of the process at Vanguard. It should only take a couple minutes to set up, especially if you have your bank info all handy.
Just follow the steps. You have now put money in a “money market account.”
Many people make the mistake of stopping here. DO NOT STOP HERE. You have one more step!
Invest the money! Get that money earnin’ you more money
It might take a couple days for the money to get into your IRA, so set an alarm and make sure you complete the next step, otherwise you’ll miss out on the whole point of an IRA — tax-free growth! Compound interest! Your money making money, so later you don’t have to make money!
Money doesn’t grow on trees, but it grows in your IRA – Me
This is the part where you could get analysis paralysis. Where things like asset allocation and your risk profile come into play. Where you can choose from hundreds of different funds.
If you want the “someone please just tell me what to do to get started,” version:
- Invest ~20% in a bond fund like VBMFX (Fidelity: FTBFX — for Schwab: SWLVX)
- Invest ~80% in a stock fund like VTSMX (Fidelity: FSTMX– for Schwab: SWTSX)
How did I get to that boiled-down one-size-fits-most approach? When I first started, I wanted to do it right. I read up on the differences between ETFs and mutual funds (the answer is not that much, you can trade ETFs easier and they don’t have the same minimum contribution limits as mutual funds) I scanned suggestions of “coffeehouse porfolios” with 7-10 different ETFs and went through each one trying to get a sense of their performance. I had no idea what it all really meant, small-cap, large-cap, baseball-cap (you could have said that and I wouldn’t have batted an eye, I was so overwhelmed).
In the end it left me with a stitched together portfolio with some uninvested money because you can’t buy parts of an ETF. Since then I’ve been waiting for a year to pass in order to consolidate them all into a simple portfolio with just a couple mutual funds. It wasn’t worth the hassle. I could have lumped it all into a single retirement-date fund and been better off (which is another method I recommend if you want to be completely hands-off, it rebalances for you as you get closer to your retirement age!)
If you’re a beginner just starting out, go for the simple approach. You have the time to go back and tweak as you like, the important thing is to at least get the funds set up. Later you can do your reading and adjust based on your goals, but this is just to get the ball rolling.
You have finished an overwhelming, seemingly herculean task! Even though it can be extremely tempting to pay someone to figure it all out for you, you have saved yourself thousands of dollars just by doing it yourself. It took about 20 minutes worth of actual work and a couple days of waiting time, and now you’re all set up. From here, you can set up regular investments pulled from your bank or even straight from your paycheck to automate the task.