Starting to invest in the stock market can seem terrifying since most of what is portrayed about investing is dramatic. There are stock market crashes, extreme swings in stock prices, and investors losing fortunes! These highly publicized, dramatic events make entering the world of stock market investing seem more like entering the Wild West.
Based on this coverage, it’s no wonder you feel so stressed about starting to invest in stocks, but if you want to get rich or just simply retire one day, you better start. The good news for you is that becoming a successful investor is actually quite simple. You don’t have to keep track of what the stock market is doing, know anything about the financials of individual companies, or worry about losing everything. With these 3 tips, you’ll be able to open an investment account, develop a super simple and low-stress investment strategy, and feel confident that you can start investing in the stock market today.
Tip 1: Invest in a Retirement Account
Retirement accounts are the simplest way to start investing in stocks. They offer great tax benefits and can be easily automated so you never have to worry about tweaking your investments or tracking how they’re doing. They are the ultimate account to use if you want to utilize a ‘set it and forget it’ investment strategy.
These accounts are perfect for beginner investors because contrary to what you may believe, investing in the stock market is a long game. The difficulty that comes to mind when you think of investing is probably more in line with trading. Trading means that you try to time to market, or buy stocks at their lowest price and sell them at their highest price. To be a successful trader, you need to keep up with a litany of things like what’s happening with the companies you’re invested in, how the market sector they’re in is performing, if there are problems in the country where they perform their operations, what the current economic conditions are, and the list goes on. If this sounds like a lot of work, that’s because it is. Just the thought of keeping up with all of this is daunting and is exactly what turns many people away from investing.
That is why you should ditch the idea of trading and become an investor instead. Investors regularly invest money in a broad range of companies and leave their money invested for years or even decades. They can do this because in general, the stock market goes up over time. That means you can invest in a diversified set of companies, not worry at all about current market fluctuations, and you will still make money. The simplest way to use this strategy to start investing is with a retirement account.
Types of Retirement Accounts
The best option, if it is available to you, is a 401K. That’s because employers will often match a portion of your contributions. That means that if you contribute to you’re 401K, your employer will also contribute to it. Usually, this is written like this, “Employer will contribute 50% up to 5%.” That means that if you contribute up to 5% of your salary to your 401K, your employer will also contribute 50% of what you contribute. To help you understand why this is so amazing, let’s look at some numbers.
- Employee salary: $50k
- Employee annual contribution: 5% or $2,500
- Employer annual contribution: 50% of $2,500 or $1,250
In this example, you can see that contributing to your 401K gave you a $1,250 raise, and you didn’t even have to take on any ‘additional duties as may be assigned’! This is what makes 401Ks so amazing. If your employer offers a 401K and a company match, at a minimum you should set your contribution level to receive the maximum match from your employer. In our example, that was 5%.
If you don’t have a 401K as an option, or you want to open another account in addition to your 401K, opening an IRA is your best option. There are two types of IRAs, a traditional IRA and a Roth IRA.
The difference between the two is how they’re taxed. Like a 401K, traditional IRA contributions are pre-tax. That means that the money is deposited into your 401K before payroll taxes are deducted from your paycheck, and instead, you pay the taxes later when you withdraw the money during retirement. Roth IRA contributions on the other hand are after-tax. That means that the payroll taxes are deducted now, and you don’t pay any additional taxes on your earnings when you withdraw the money later in retirement.
One advantage IRAs have over 401Ks is that they offer a wider selection of investment options. Since 401Ks are employer-sponsored, your employer hand selects the funds that you are offered. With IRAs, you aren’t limited to what your employer selects and instead can invest in a much wider array of options.
Each of these types of retirement accounts varies slightly, but unless you’re trying to build a strategic tax advantage by using one account over another, you shouldn’t stress too much about which account is the absolute best option for you. Pick the one that is the easiest for you to open TODAY and open it.
What Funds to Select
Once you choose an account type, then comes the fun part, which stocks you invest your money in. The easiest solution for this is to use a target-date fund.
These are the Holy Grail when it comes to effortless stock market investing because they do all of the work for you, forever. When you invest in a target-date fund, it will allocate your money appropriately for your age. It uses your age to determine your asset allocation because of how you should manage the risk of your portfolio over time.
When you’re younger, you should invest in riskier assets because they typically provide a higher return on investment. Unfortunately, with greater risk also comes a greater chance of losing money. When your retirement is far into the future, any losses you experience now can easily be recovered before you need to start using your money in retirement, so it is worth it to invest in riskier assets to try to maximize your return. However, as you approach retirement, you have less and less time to recoup any losses, so you should shift your money into less risky investments to preserve the higher returns you received when you were younger. I know this sounds like a lot of work, but don’t worry, your target-date fund is going to do all of this work for you.
That is why target-date funds are the easiest way to invest. You can literally buy a target-date fund and never look at it again until you retire, and be confident that you will make money because your target-date fund will be managing your investment strategy for you. It can’t get any easier, or better than that.
Tip 2: Avoid Fees
When opening your account, your provider is probably going to offer you a lot of different account options, so which one should you choose?
When it comes to using a passive investing strategy, like a target-date fund, you do not need anything fancy. Accounts like a full-service brokerage account offer lots of investor perks and advising services, and while that all sounds nice, it’s also expensive. Since your target date fund is going to do all of the hard work for you, there is no need to pay extra for any of these “perks”. Your best bet is to choose the lowest fee account your provider offers.
Even the lowest fee account you can find will most likely charge you an admin fee, or something similar. These are usually only $25 or so a year, but that $25 still eats into your returns! Getting these fees waived is often as simple as signing up for paperless statements. If you don’t see a way to waive this fee when you’re opening your account, give your provider a call and they can help you get your fee waived.
While going to these lengths to get a fee waived may seem petty, fees are an investor’s archenemy. They may seem small at first, but over time fees can lead to significant reductions in your returns. On top of your admin fee, the funds that you choose to invest in will also charge management fees, often called expense ratios. Passively managed funds, like target-date funds, offer much lower expense ratios than actively managed funds. Remember all of the work that goes into trading? Trading is active management, so when you invest in active funds, the fund manager charges you a higher fee for all of their extra work.
To put into perspective how detrimental fees are to your earnings, here is a real-life example. If a millennial invests $10k a year into their retirement account for 30 years and receives a 7% annual return, they will have $1,010,730 after 30 years. If this money is invested in a low fee target-date fund with an expense ratio of .15%, they will only end up paying a total of $28,250 in fees. Instead if they invest their money in a high-cost mutual fund with an expense ratio of 2%, they will end up paying a total of $313,122 in fees. That is almost $300k of earnings that they lost to fees! So make sure to invest in the lowest fee options you can because while it may seem petty right now, lowering your fees will save you A LOT of money in the long run.
Tip 3: Use Dollar Cost Averaging
Dollar-cost averaging is just a fancy way of saying to make regular contributions. 401Ks are automatically set up to do this since you make a contribution to your account every time you get paid. IRAs on the other hand are not automatically set up to do this, so if you’ll be investing using an IRA you’ll need to set up regular contributions manually.
To do this, choose an interval and a contribution amount that you’re comfortable with, and start contributing ASAP. No amount is too small to start with. Contributing $20/month still makes you an investor, and still gets you closer to your retirement goals. Once you get more comfortable with investing or start making more money, you can increase your contributions. For now, the important thing is that you’re starting to invest!!
Dollar-cost averaging is the best way to invest because again, it does all of the work for you. You don’t have to worry about making investing a priority, checking your account every month, or remembering to transfer your money consistently. You just set up your automatic contributions, forget about your account, and go on about your life.
And now you’re an INVESTOR!! While investing in the stock market seems daunting, using target-date funds and automating your contributions makes investing extremely easy. You no longer have to be fearful of the time it will take to learn which stocks you should pick, or worry that your lack of knowledge will cause you to lose it all. You’ve done all of the work upfront to maximize your returns and become a successful investor. Since there’s no work left to be done, it’s time to sit back, relax, and enjoy your newfound investor lifestyle.