The amount of information available on investing can be overwhelming and it can be difficult to know where to begin.  It does not have to be complicated.  Anyone can (and should) start investing, whether it’s for retirement of some other purpose.  You can get started today with four simple steps.

Step 1: Write down your investment objective

Clearly defining your investment purpose will help you select the right type of investment account and investments. Some questions to consider:

  • Are you investing for a specific purpose such as retirement or a college fund for children?
  • When do you expect to use the money (short or long-term)?
  • What is your risk tolerance?

I recommend writing down your investment objective so that you can refer to it later.  This will be useful to ensure that you remain focused on your objective.  Knowing why you are investing will help you select the right types of accounts and investments in the next steps.

For example, here’s my investment objective:

To grow my wealth over the long-term (20+ years) to the point where my average annual returns will exceed my annual living expenses in retirement.

Step 2: Select the right type of investment account

There are different types of investment accounts for different purposes.  Your investment objective will guide you in selecting the right type of investment account.  If your objective is saving and investing for retirement then you may have a few different options to choose from.  However if your objective is focused on something more specific like investing for a child’s college then there are other more specialized options.  Each type of account has different benefits, restrictions, and uses. Here’s a summary:

Retirement-focused account types:

TypeEmployer retirement account (401k, 403b)Roth IRATraditional IRASimplified Employee Pension Plan (SEP) IRA
DescriptionEmployer provided retirement accountsRetirement account open to most people with earned income
Retirement account open to most people with earned incomeA specialized IRA for self-employed individuals
Primary useRetirementRetirementRetirementRetirement
Restrictions on who can have an account (2018)Only available when offered by an employerOnly available to individuals earning less than $135,000 modified adjusted gross income or couples that file jointly with less than $199,000 MAGI (contribution limits are reduced beginning at $120,000 for individuals and $189,000 for couples filing jointly)Anyone with earned income can contribute to a Traditional IRA, but contributions may not be tax deductible depending on MAGI. Single filers are completely phased out at $72,000 and couples filing jointly at $119,000. Additional information from the IRS is located hereMust be self employed (or work for a business that offers SEP IRAs as its retirement plan), must be 21 years old, have worked for business in 3 of last 5 years, and earned a minimum of $600. Additional info from the IRS is located here
Pre/post-taxPre-tax (sometimes also post-tax if plan offers a “Roth” option)Post-taxPre-taxPre-tax
Annual contribution limits (2018)$18,500$5,500 (combined Roth and traditional)$5,500 (combined Roth and traditional)Lesser of 25% total compensation or $55,000
BenefitContributions are tax deductible
Investments grow without being taxed until distribution
(Note, Roth 401k accounts have the same benefits as Roth IRAs)
Distributions are tax-free (when conditions are met) and investments grow without being taxedContributions are tax deductible
Investments grow without being taxed until distribution
Contributions are tax deductible
Investments grow without being taxed until distribution

Other account types:

TypeRegular brokerage accountHealth Savings Account (HSA)College savings plans (“529 plans”)
Description All-purpose investment accountTax-advantaged healthcare expense savings vehicleTax-advantaged college savings vehicle (administered by states)
Primary useAnythingSavings for healthcare expensesSavings for college expenses
Restrictions on who can have an account (2018)No restrictionsOnly available when offered by an employerVaries by state
Pre/post-taxPost-taxPre-taxPre-tax
Annual contribution limits (2018)No limits$3,450 (individual), $6,900 (family)Varies by state
BenefitNo restrictions on how funds can be spentContributions are tax deductible
Investments grow without being taxed
Distributions are tax-free when spent on qualifying healthcare expenses
Contributions are tax deductible
Investments grow without being taxed
Distributions are tax-free when spent on qualifying college expenses

Employer-provided retirement accounts (401k, 403b)

If you’re investing for retirement, there are a number of options.  Many employers offer some type of retirement account (generally a 401k or 403b).  Some employers even offer “matching” programs where they will “match” funds you put into your account for retirement.  You should always contribute enough to receive this full match.  If you contribute anything less you are losing out on free money in your retirement account.

Simplified Employee Pension Plan (SEP) IRA

If you are self employed (or your employer offers a SEP IRA), a SEP IRA may be a good option that provides you with some tax benefits in the form of deductions.

Roth and Traditional IRAs

Roth and Traditional IRAs are also good options for many investors because of their tax benefits.  Deciding between the two is a question of whether you’d like to pay your taxes now or later.  With Roth IRAs you deposit money you’ve already payed taxes on.  Your investments can grow and you will never pay taxes on the the account gains (when distribution requirements are met).  With a traditional IRAs, you are able to deduct what you invest from your earned income and invest the pretax funds, only ever paying taxes on what you withdraw in the future.  Some high income earners are ineligible for IRAs.  See the table above for income limits.

Regular brokerage accounts

Regular brokerage accounts should generally be your last option after all other tax-advantaged account options are exhausted.  With regular brokerage accounts you have to deposit money you’ve already paid taxes on then pay taxes on investment gains and dividends.  For that reason you’ll pay more in taxes than you would have in other types of accounts.  This will reduce the benefits of compounding because you pay taxes for the year in which investments are sold.

Health Savings Accounts (HSAs)

Some employers have Health Savings Accounts (HSA) which are a great savings and investment tool.  These accounts allow employees to save pre-tax in the account and spend the money on healthcare related expenses.  Using these accounts allows you to avoid taxes for money spent on healthcare expenses.  Additionally, the funds in the account can be invested in securities and the gains are tax free as well when spent on healthcare expenses as well.  Note, some employers provide FSAs (flexible spending accounts) which are very different from HSAs.  FSAs balances must be spent within the calendar year, while HSA balances never expire and can be taken with you even when you leave an employer.  As we all will eventually have healthcare expenses in our lifetimes, these accounts are a great option for saving and investing.

College savings plans (“529” plans)

As their name suggests, college savings plans are good options for saving for saving for college.  These programs generally allow you to invest pre-tax income for specific college expenses.  There are many different programs with different restrictions so you must research the details, but it is worth it as it can reduce your taxable income.

Step 3: Select a brokerage and open an account

If you decided to open a Roth IRA, Traditional IRA, SEP, college savings plan, or a regular brokerage account, You next step will be to select a brokerage to open an account and deposit funds.  For 401k/403b and HSA accounts you will not need to select a broker as they are serviced through a financial services provider that your employer has selected.

There are two primary types of brokerages, discount brokers and full service brokers.  I recommend discount brokers because their commission fees are low and most still provide great customer support without being full service.  Unless you are a very high net worth individual, commission fees really matter and can eat away at your investment returns, so it’s important to find a low-commission broker.

Here’s a summary of a few popular discount brokers below (and a good summary from NerdWallet here).  Personally, I use Schwab and have been very pleased with the ease of use, information, and all-around service.

AllyCharles SchwabFidelityTD AmeritradeRobinhood
Trade commission fee$4.95$4.95$4.95$6.95$0.00
Account minimum$0$0$1000$0$0

Step 4: Decide what to invest in (beginner options)

Now you should refer back to your investment objective.  You wrote it down, right?  Your objective should be long-term (10+ years).  The reason for this is because we can be fairly confident that investment securities (stocks, bonds, etc.) will grow given longer periods of time, however securities can lose value in short periods of time when they don’t have enough time to recover.  If you will need the money in the short term you should not invest in stocks or bonds, but should consider other options like high yield savings accounts, money market, accounts, CDs, and short-term bonds.

There are many theories on investing and portfolio strategy and countless books have been written on the topic.  Diversification is key to getting investment returns while reducing risk, however it doesn’t have to be complicated.  For beginning investors I recommend one of the following simple strategies to get started with a simple, diversified portfolio:

Target date mutual funds

This is probably the simplest option.  You pick a date that you want to use (or start using) the money and find the corresponding fund. For example, if you’re planning to retire in the year 2035 (about 17 years from 2018), then you would select a 2035 target date fund and allocate all of your investment to that fund.  These target date funds invest your money in a mix of stocks, bonds, and sometimes other assets in a mix that changes over time as you approach the target date.  This reduces your risk as you approach retirement without you having to worry about adjusting the investments in your portfolio.

When selecting a fund, look for ones with low fee ratios, such as the Vanguard, Fidelity, or Schwab families of target retirement date funds.  Note, I generally prefer ETFs over mutual funds due to generally lower expenses and greater liquidity, but mutual funds provide some good options when it comes to target retirement date securities.

Automated / robo advisers

Many brokerages (including discount brokerages) have tools that you can use to help recommend a portfolio of investments.  They will ask questions about you investment objectives, length of time, and risk tolerance and provide specific fund recommendations.  These tools provide a simple way to get a tailored and diversified portfolio.  Some will even automatically do the investing for you.  However, if it does not automatically purchase the investments then you will need to do it yourself, buying the investments in the correct proportions.  You should also check the ETF fees to ensure they are not too high.  I always recommend you find ETFs with fees lower than 1%, but preferably less than 0.4%.

60 / 40 portfolio

Another good option for beginning investors is the 60 / 40 portfolio.  It is comprised of 60% stocks and 40% bonds.  You can implement this portfolio by buying an stock index ETF with 60% of your investment funds and a bond index ETF with the remaining 40%.  The stock ETF should have hundreds or thousands of different stocks, and ideally a combination of both US and international stocks.  Some good examples are: SPY (US stocks), VT (US and international stocks), AGG (US bonds), and BND (US bonds).  The bond ETF should have a combination of medium and long term bonds, and potentially a mix of different types (US/international, government/corporate).  As always you should look for low fee ETFs.

Once you have selected an investment portfolio strategy, go ahead and purchase your investments and you will have become an investor!  If you need help purchasing your investments with your broker’s website, reach out to their help / support—they are very helpful.

A final word of advice

Try not to worry about your investments changing in value.  Investments will go up and down over time but have historically grown significantly when held for long periods of time.  Frequently checking the value of your investments on a daily or hourly basis will not help you invest for the long-term.  Making impulsive investment decisions and trying to time the market swings will more than likely be worse for your portfolio value in the long-term.

Congratulations on becoming an investor!

How to start investing (4 step beginner’s guide)
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6 thoughts on “How to start investing (4 step beginner’s guide)

  • November 24, 2018 at 9:25 am
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    Thanks for all the info! I have a 403b but we looking into a Roth IRA for my husband. This was very helpful thank you!

    Reply
    • November 25, 2018 at 1:06 pm
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      Thanks for reading! IRA (both Roth and traditional) are great investment accounts to save and invest with. Good luck!

      Reply
  • November 24, 2018 at 4:58 pm
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    A nice overview. Only comment is that I am 28 so 60/40 portfolio is quite conservative. 60/40 is more for when you are close to retirement or those who can’t tolerate risk.

    Reply
    • November 25, 2018 at 1:17 pm
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      Thanks for reading! Good points. I agree with you that a 60/40 portfolio may be too conservative for some investors. I think it really depends on age, risk tolerance (considered separately from age), and how active the investor would like to manage investments. Some investors, regardless of age, have low risk tolerance and/or they just don’t want to actively manage their portfolio over time. For those investors (or many beginners) who want to start a portfolio and leave it alone, I think a 60/40 portfolio is a great long-term investment option that can weather periods of time when bonds outperform equities.

      I’m just a few years older than you, and I don’t use a 60/40, but instead a global asset allocation across equities, bonds, and real assets (I’ll be writing an article about it soon).

      Reply

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