Getting started investing can feel overwhelming. Investing for retirement can seem impossible. You might need one to two million dollars to retire comfortably. When you hardly ever have an extra few thousand, a million dollars seems like a made-up, laughable number.
The power of compound interest is truly mind-boggling! In reality, you don’t have to save a million dollars to get a million dollars. “Come, again?” you might say. With enough time on your side, your money + compound interest will do 90% of the saving for you.
Dollars, invested well, are hard-working little guys and gals. They will do most of the work for you. The best thing you can give your dollars is time.
Let’s look at this example. Assuming 10% average market growth and 3% inflation (I know, I know, this year’s inflation is bonkers, but over the last 20 years it’s been really low.) With those two assumptions, your invested money will double about every 10 years.
Here’s where things get bizarre.
I had 100k invested by the time I was 25 years old. I invested that 100k into the market. So that’s my true savings.
But with compound interest that means:
By 35 it becomes 200k
By 45 it becomes 400k
By 55 it becomes 800k
By 65 it becomes 1.6 million in today’s dollars!
My 100k of savings will create an extra 1.5 million! It would be extremely hard for anyone to “save” 1.5 million. But invest your money and give it time, and compound interest is going to do 90+% of the work for you.
But I’m not 25! (Do every 20-something you know a favor and send this to them!). Ok, let’s say you’re 45 with 100k invested.
With compound interest that means:
By 55 it becomes 200k
By 65 it becomes 400k
By 75 it becomes 800k
If you can hold off on pulling from your investments until your 70s, you will have a very nice nest egg for your 70s, 80s, and beyond. Is 800k all you could ever hope and want for? “No.” But ask anyone retiring with $0, $800k is an enviable chunk of change.
Don’t mess it up!
I was scared to start investing. Most people I know are a little intimidated to start investing. We don’t want to mess it up. We don’t want to lose all our money. That’s totally understandable. You worked really hard for this money and don’t want it to vanish because of a silly mistake.
But want to know the hardest mistake to fix? The one that almost everyone does? Waiting to start.
In reality, you can make a TON of suboptimal choices and still end up with piles of money if you just start early enough. 90% of the regret for 90% of the people is waiting so long to start.
Every other mistake is a 2% problem. Invested in a Roth vs Traditional IRA? No biggie. Bought an expensive mutual fund vs a low-cost index fund? You’ll be fine. Set up your accounts with a company that has horrible customer service? You can switch later. All those are 2% problems. Waiting too long is a 90% problem.
Just to put your mind at ease, these are the top 4 mistakes to avoid. If you can avoid these, everything else is fixable.
- Waiting too long (yes, really!)
- Buying speculative things vs boring index funds. NTFs, crypto, ect. It’s not that these things are bad, they just shouldn’t be the foundation of your investments, it’s gambling.
- Buying one stock, especially a “hot” stock. One stock can (and does) go to zero. I remember many people losing their entire life savings in 2000 on a “can’t lose” stock they bought in 1999.
- Day Trading and buying on margin. If a company hasn’t hired you to be a day trader, you shouldn’t pretend to be one.
In reality, even if you did one of these 4 cardinal sins, once you come to your senses, you can recover from this too.
Below is my general description of what kinds of brokerage accounts, account types and assets you can buy and the benefits I see. This is how I describe it to my kids or people who feel clueless about the stock market. While not perfectly technically correct, this will give you the basic idea. AKA don’t feel the need to jump into the comments about why this description isn’t 100% super technically correct.
Super Simple Guide to Investing
Honestly, investing isn’t much more complicated than booking a vacation. If you can navigate buying a flight, booking a hotel and getting an Uber, you can handle the technical side of investing.
There are only 4 steps. And remember if you don’t pick the *perfect* option it’s a 2% problem. And it’s all fixable. Waiting to start is a 90% problem.
I’m going to use the analogy of making spaghetti. Getting started investing shouldn’t be any more complicated.
Brokerage Firm = cupboard that holds pots and pans
Investment Accounts = pots and pans
Assets = food/ingredients
Spaghetti talk: Find the cupboard that holds the pots and pan.
Investing talk: Pick a brokerage firm.
A brokerage firm is kind of like a bank. They hold your accounts (checking and savings) and sell products (like mortgages or CD’s) Don’t get hung up here. Just like banks, there are pros and cons to each, but they are 80% the same. The biggest difference for me is customer service. I used to recommend Vanguard, but the customer service became so ridiculously abysmal that I’m moving all my accounts somewhere else. And that’s the thing if you pick one and later decide it’s the “wrong” one for you, it’s not hard to change.
Right now my top two recommendations (and why I like them.)
- M1 Finance – I really like their customer service! The app is super easy to navigate. And you can take loans from your brokerage account (while keeping it 100% invested) at a really low rate, which I think is an incredible feature for people who want to take mini-retirements or retire early. They have a lot of cool features and a high yield checking account, which I also use. Learn more here.
- Fidelity – I have used them for my Donor Advised Fund. And I keep small brokerage accounts for my kids here. The app is great and very simple to make purchases and keep multiple accounts.
Spaghetti talk: Choose the pots and pans that make sense for your dish.
Investing talk: Pick your account type(s).
I’m sure you have heard all the names: 401k, IRA, TSP, brokerage, Roth. These are simply containers that will hold your investments or assets.
People can get stuck on which one is the best. Let me put your mind at ease, they are all good. So how to choose? There are three things to consider:
1. Which ones are available to you?
2. What makes the most sense for your goals and time frame?
3. And taxes. Are you using pre- or post-tax money?
Which one is available to me?
Everyone: Brokerage – Everyone with earned income (but not too much): IRA (Roth vs Traditional)
Employees: See what your employer offers, 401k is typical. But it could be a SEP IRA if it’s a small business, a TSP if you work for the government or a number of other options.
Self Employed: Depending on how many employees you have you might be able to use a solo 401k, SEP IRA, or Simple IRA.
These accounts are like checking or savings accounts. They are containers (pots and pans) they aren’t investments or assets. These are the things that will hold your investments. And like cooking spaghetti, each pot and pan has its own function. Some are better for somethings than others. Each of these accounts has some unique rules, advantages, and disadvantages. Other than the brokerage account, they all have a maximum you can contribute in a year.
If your workplace doesn’t offer a retirement plan, a brokerage and IRA are good places to start.
What account makes sense for your goals?
If you are saving for retirement, tax-advantaged retirement accounts make a lot of sense. If you are thinking about a more mid-term goal like a house down payment or mini-retirement in 5-10 years, a brokerage or Roth IRA are good options (you can pull contributions from your Roth after 5 years or use some of the earnings for a first-time house down payment.)
What about taxes?!?
You basically have two options to fund your accounts: pre-tax or post-tax money. Are you in a high tax bracket now and would like a little tax break this year, or would you like the money to grow and withdraw it all tax-free (Roth)? Both are good options. And most people put some money into both throughout their careers.
Because your brokerage account isn’t a “tax-advantaged retirement account”, you will use post-tax money, you will need to pay taxes on the dividends each year (generally about 4% of the total value), and you will have to pay taxes on the gains when you sell (generally at the 15% Capital Gains rate if you held it over 12 months.) “I’m going to pay taxes 3 times on this money!” Not really. You just pay taxes on the three types of money (contributions, dividends, growth), all at different times.
You can’t really mess this up, as long as you are 1. eligible for an account type and 2. don’t put in more than allowed. I’ve never heard someone bemoan maxing out their Traditional IRA in their 20’s when the Roth IRA would have been smarter. They are just happy they started!
Spaghetti talk: Pick out the ingredients.
Investing talk: Choose your assets.
Remember the accounts are simply containers, pots, and pans? Their true function is holding your ingredients. So now it’s time to pick out what you are going to put into your containers. This is when you really start cooking!
(*This could be investing mistake #5. Putting cash into your accounts but never buying stocks or bonds. Sometimes people think they are “investing in their 401k” but they are simply putting cash into the account and never purchasing the asset (stocks, bonds, index funds). If your account balance has never grown past your contributions, you should look carefully at your statement. You might be “investing” with cash. Or it might be the mistake made with our first Roth IRA when we “invested” with a CD. Not the most appropriate investment in a retirement account for people in their 20’s.)
First, what is a stock or the stock market? Simply put, a stock is owning a tiny fractional share of a company. As the value of that company and its earnings grow, the value of that fractional share grows. It’s like owning a rental property, the value of the home and the rent amount slowly grow over time. It’s not always linear and does fluctuate but historically it goes up over time. The stock market is where those fractional shares are bought and sold. The stock market is made up of publicly traded companies, essentially companies that the public can buy shares of. So your aunt’s bakery might be co-owned by four people, but a stranger (public) can’t buy shares (trade) of that company, so it won’t be part of the stock market.
Those are individual stocks for single companies like Disney or Starbucks. You also have the option of index funds or mutual funds. Both of those are like a mixed bag of Halloween candy. The size of each candy is much smaller, but you get a variety of candy. Mutual funds are a carefully selected mix of candy. Teams of really smart people work to curate these mixes.
Index funds, like the S&P 500, are a mix of all the top-performing assets in that group (different categories of assets have their own index funds like bonds, European stocks, or emerging market funds.) Index funds aren’t a hand-picked curation of stocks, instead, they are selected based on a complex formula that gives more weight to the top performers. As individual stocks go up and down, the index fund adjusts how much of that stock it holds.
Which one to choose, individual stocks, mutual funds, or index funds? Just to iterate, because people are so nervous to pick the wrong things, just starting to invest is a good choice. Choosing the “wrong” thing is better by a factor of 10 vs not investing. That said, here’s some pros and cons.
Individual stocks: So remember the 4 mistakes of investing? #3 picking the “hot” stock. #4 Day trading and trying to game the system. The trouble with picking individual stocks is there is a big temptation to make both these mistakes. The other downside is that it will take a ton of research, time, and emotional energy, and is overall more stressful. With an index fund, you aren’t responsible to adjust your holdings based on what the market is doing. The formula continually rebalances its holding. You can set it and forget it. Statistically, the people whose investments perform the best are dead people. Basically accounts that couldn’t make trades. The second-highest performing investors are people who forgot about their accounts. The more you meddle with your investments the worst they will do. When you hold individual stocks there is a huge temptation to meddle.
Mutual funds: I imagine the idea of a team of very smart people carefully curating your investments sounds appealing. And occasionally it is. But there are two downsides that cause these types of candy mix investments to underperform. One as humans, we aren’t very good at predicting the unexpected events that move the stock market the most. The book Psychology of Money does a great job explaining how just a few enormous (and hard to predict) events have shaped our economy.
And perhaps more significantly, fees. Because when a large group of very smart people works insane hours, they want to be compensated. And compensated well. They get paid in the form of a percentage of the asset you bought. So if you bought $100,000 of a mutual fund with a 1% fee, you would pay $1,000 a year to own that asset. Mind you, this is not the fee of the person who might have sold you the mutual fund. You might also pay them 1% or $1,000. Now 2% doesn’t seem that bad. But if your fund is earning 10%, then you are paying 20% of your earnings. The gut-punch of this is you pay that 2% no matter if the fund earns or loses money.
After you factor in fees, not many mutual funds outperform index funds. Index funds DO have some fees but they average 10% of the cost of mutual funds.
Hiring a financial planner is a longer conversation for another day. But in short, my biggest beef is when customers don’t realize how their financial planner is being compensated. There are lots of ways they earn money, and it’s important to understand that. It’s one of the many reasons I charge a simple upfront hourly rate for financial coaching. I don’t take a percentage or sell any products like insurance.
While it’s more painful for the customer to write a check, I feel that’s better than thousands of dollars being taken from your investments without you realizing it. By the time you have a million dollars invested, you might be paying $10,000 to your advisor and $10,000 for your mutual fund fees. You’ll never see a bill for those fees, it will just magically be taken out of your accounts. $20,000 might be a good value, depending on the service provided, but I think you should at least be aware that’s how much you’re paying. Rant over.
Okay, so you decide you’re an index fund guy or girl. Here are some of the bread and butter index funds. While you can buy these with the corresponding brokerage, you can also buy them through a company like M1 Finance.
ZERO Total Market Fund (FZROX)
Fidelity S&P 500 (FXAIX)
ZERO International Fund ((FZILX)
ZERO Large Cap Fund (FNILX)
Total Stock Market (SWTSX)
Schwab S&P 500 (SWPPX)
Total International Fund (SWISX)
Schwab 1000 Fund (SNXFX)
Total Stock Market (VTSAX)
S&P 500 (VFIAX)
Total International Stock (VTIAX)
Total World Stock (VTWAX)
You can learn more about each of these index funds on that company’s website, including what stocks are their largest holding, past performance, and fund cost.
Another great resource about index investing is my friend, JL Collins book The Simple Path to Wealth.
See, easy as 1-2-3 with spaghetti: find a cupboard to hold the pots and pans, pick your pot or pan, add the ingredients. AKA pick a brokerage company, choose your account type, and buy assets.
If you pick the wrong brokerage, choose a less than ideal account type and buy a high-cost mutual fund, you’ll still be better off starting investing early than waiting. And ALL of that is fixable!
You don’t need $1,000s of dollars to start investing. The hardest part is starting. With M1 Finance you can buy a fraction of a share, so you can get started with $100. Your 80-year-old self will thank you!
If you feel 1-on-1 financial coaching or a financial review would be helpful for you, you can learn more here.