Today, I want to address the practical nuts and bolts steps required to invest as a do-it-yourselfer in as little time as possible. Here, I’ll tell you about lots of things you need to know to learn about investing in stocks.
I remember before I was a GED student, I really wanted to make money in an easy way, I tried everything, and I really made many mistakes, so I want to help you today avoid errors and my goal is to outline some guidelines you can use to participate in the market with minimal effort. We’ll walk through step by step what you need to do.
First, let’s talk about the easy way to invest for retirement. Maximize your employer’s 401(k) program match, certainly, but go beyond that as far as your monthly budget will allow. Challenge yourself to increase it little by little over time.
If you are putting 5% away this year, aim for 6% or 7% next year. That way, you won’t notice a dramatic change. You can contribute up to $17,000 in 2014 and an additional $5,500 if you are age 50 or older.
Talk to your HR department about the necessary paperwork to join your 401(k) program, if you are not currently participating. It should be just a simple one-page form to fill out. You may have the opportunity to choose between a Roth versus Traditional 401(k). At the end of the day, if you are contributing, you are fine choosing either path. 98% of the battle is won by actually putting the money into your retirement savings.
Roth = pay taxes now, don’t pay taxes later when money is withdrawn from your retirement account. Traditional = don’t pay taxes now, pay taxes when money is withdrawn from your retirement account. The actual math behind which path is better relies on assumed tax rates in the future but keep in mind that you shouldn’t invest in things you don’t understand. Politicians change things far too often to predict your personal tax rate 20 years into the future. The conservative play would be to place the money into the Roth account. Either way, do not worry about this.
Which investment do I choose? This is the real issue that keeps many from actually investing: they don’t know what to pick, so they avoid the issue. A relatively new concept has made this simple. It’s called the life cycle mutual fund or target retirement date mutual fund. It is widely available in 401(k) programs. For example, the T. Rowe Price Retirement 2030 fund is designed to be an appropriate investment for those retiring within a few years of 2030.
A target-date fund is a collection of other mutual funds rolled into one. This single fund will own other mutual funds to create the right investment mix over time. Based on the number of years until retirement, the fund will adjust itself. If you are far away from retirement, the fund will be focused on generating higher returns.
If you are close to retirement, the fund will be focused on protecting your money. You could put all of your retirement dollars there and the fund will do the behind the scenes work for you. Much of the power of this approach is the automatic nature of investing. See also this post about Early Retirement Benefits.
The money comes out of your paycheck before you see it. Continue to feed this automatic system. It takes the month to month wants and spending temptations out of the picture. Trying to save for a house or a new car? If you are trying to save money for a goal that is 5 years away or more, there is a great simple option available, called an index fund. Specifically, use an S&P 500 index fund. The Vanguard 500 Index Fund has averaged a 10.5% annual return since its inception in 1976. (Other companies offer index funds but we will use Vanguard as an example).
The process is similar to opening a bank account. You are simply doing it over the phone instead of in your local bank. To open an account, you’ll need to have your checking account number and bank’s routing number available. Go to www.vanguard.com to open an account or you can call a customer service representative to help walk you through the process at 877.662.7447. Set up an automatic monthly deduction to be invested in their S&P 500 index fund.
Since this is not retirement savings, ensure it is a regular account; it is not an IRA. The automatic investing concept still applies. Set an amount to be automatically deducted each month from your checking account and into your index fund account. You also have the option to add money to this account at your discretion. Whenever you need the cash, you can sell your shares of the fund and receive your money within approximately 3 business days. (If you do need the money within 5 years, I hate to say it, but a savings account at a bank is wisest.
The longer you are able to keep your money invested, the more mutual funds make sense.) Remember that once you do the work to set up your account, you can be hands-off with these investments. Of course, you want to stay informed as to how things are going, but this is as low maintenance as it gets, without letting your money wither and die in a checking or savings account. So, to summarize, use target retirement date mutual funds for retirement and index funds for non-retirement savings. You will accumulate significant wealth, with little active effort on your part, if you automatically allocate money to these vehicles each month.