So, you want to invest. Fantastic! Ideally, you are young and ready to reap the returns (you know, 45 years from now), but it’s never too late to start putting money aside for retirement. Unless, you know, you’re already retired.
Want to read more on the benefits of investing early? Check out our article on the three major reasons you need to start investing in your 20s.
For this article, we’re going to assume that you want to invest the easiest way possible. With that in mind, we’re mostly going to be exploring automated services that manage your portfolio for you, with little to no interaction on your part. The goal is to make investing as easy as putting money in a piggy bank every month, but as rewarding as playing the market like it’s your job.
Before we start, here are a few important terms
Note that many of these terms have multiple meanings depending on the context. We’re going to give you the definition that makes the most sense for this article and matches up with the services we’ll be suggesting, but be aware that these words may mean different things in a different context.
Funds - A pool of money that’s professionally managed and invested in different asset classes. Though they are expressed in dollar amounts and you can deposit and withdraw much like bank accounts, the money is held in stocks and bonds and other assets, not cash.
Portfolio - Your holdings. They can comprise different funds, individual stocks, equity, etc., to give a certain type of return. Though all of your assets can comprise one portfolio, some services let you have multiple portfolios with different returns.
Stocks - A fractional ownership in a business. Most volatile asset, but also returns greater profits, with a return rate of about 9.8% per year (average since 1926).
Bonds - A contract to return a certain amount of money with interest. Safer asset with better growth than cash but less profits than stocks, at a return rate of approximately 6% per year (average since 1926).
Assets - The stuff you own. Your house, your car, your stocks and bonds, your savings account, your income, your computer, your refrigerator… you get the point.
Before you start, have a safety net
As we explained in our previous article on investing, cash loses value over time. Inflation is essentially a tax on cash holdings, which is why we advise that most of your cash go into investment funds. That doesn’t mean that you shouldn’t have some cash assets. Chris Nicholson from FutureAdvisor told us that they suggest having at least $10,000 in cash assets in a savings account. Another good rule of thumb is having a fund that amounts to three months of your current income.
This fund is meant to give you a cushion in case you lose your job. You might need if you lose your job due to a temporary illness or injury, either to replace lost income or pay for unexpected medical expenses. It should be easy to withdraw this money, hence the wisdom of the savings account.
Another possibility is putting this money in a low-risk investment fund. Betterment suggests a portfolio with 30 to 50% stocks, with the rest being made up of bonds. They also suggest adding a buffer of 30% to your safety net fund to account for the possibility of a market crash. If worse comes to worse, you’d still have your minimum amount needed for your safety net. Ideally, however, your safety net is growing at a steady rate year over year, and instead of sitting in a bank account and losing value, it’s actually making you money. Betterment then suggests taking the excess money you make and moving it to a portfolio geared towards retirement or wealth growth.
One note about taxes: returns from both savings accounts and investment funds are taxed, but taxes only kick in when you withdraw. Make sure you factor that in when withdrawing from either kind of account.
Now let’s put your money in an automated solution
Our suggestion to new investors who don’t know much about investing is to put your money in an automated service that is cheap, smart, and easy.
Why an automated solution? The biggest reason that you’ll probably make better returns than doing it yourself. If you try day trading and picking specific stocks, you’ll probably not going to beat the market. You also probably don’t have enough time in the day to be constantly micro-managing your portfolio like these services can. Not only that, but all of these services are easier and cheaper than having a financial advisor do it for you.
These automated solutions have a number of tricks up their sleeves that help them maximize returns, and for the most part, they do it completely behind the scenes with absolutely no interaction on your part. They also do everything they can to lower the amount of taxes you’d have to pay on your earnings. What, exactly, are they doing? Once you tell them the amount of risk you want to take and deposit your seed money, they construct a portfolio and start putting your money to work. They’re also constantly rebalancing your portfolio with dividends and your monthly deposits to make sure your portfolio stays in the risk profile you chose.
We’re going to separate these solutions into two different categories based on minimum balance requirements. Our first category, ideal for new investors just dipping their toes in, have no minimum balance requirements. The second category has minimum balance requirements that exceed $1,000.
No minimum balance requirement
You may have heard of Betterment (not just because we mentioned it earlier). Founded in 2008, it’s one of the most popular online investment advice and portfolio management services. It’s easy to use: you deposit money into it, they automatically divvy up that money between stocks and bonds, and you sit and watch the money roll in (over four decades or so).
Betterment also allows you to have multiple portfolios attached to a single account. Why is this important? Well, let’s think about that safety net fund you might have set up in the last step. The portfolio attached to that fund will have a radically different stock/blond split than a fund designed to build wealth. With Betterment, you can have both funds and their respective portfolios tied to the same account. You’ll be able to see them all on one dashboard and transfer money between them effortlessly.
If you’re looking for something even simpler than Betterment, check out Acorns. Acorns is limited to five portfolio options rated from conservative to aggressive. Unlike Betterment, you don’t get to manually adjust the percentage of stocks and bonds. It’s a five-sizes-fits-all approach to investment. But unlike anything else on the market, Acorns encourages you to invest incredibly small amounts of money.
Acorns’ unique feature, "Round-Ups," will monitor your checking account for purchases and "round-up" to the nearest dollar. Then, it will take the difference and deposit that amount into your investment fund. For example, if you bought a candy bar for $1.50, Acorns would take $.50 and put it in your investment fund. Over time, that money will add up, and you never have to remember to deposit money.
The service is very young, but we're not convinced that the service justifies the fees. If you want to explore investing, but don’t want to put a ton of money on the line, Acorns may be the service for you. Acorns exists only as an iPhone app right now, but they’re expanding to Android and the Web soon.
Has a minimum balance requirement
Wealthfront is very similar to Betterment in a lot of ways. Also founded in 2008, Wealthfront also automatically takes money from a fund to build a portfolio of stocks and bonds. However, there are a bunch of small differences between Wealthfront and Betterment.
Wealthfront has a minimum balance requirement of $5,000**, but it also doesn’t have any fees for accounts with less than $10,000 (Betterment charges 0.35% on accounts with less than $10,000). Wealthfront doesn’t support multiple portfolios on a single account, but its portfolios are also arguably stronger than Betterment (their portfolios include real estate and natural resources, which Betterment does not). If you have over $5,000 to start, we would suggest seriously considering Wealthfront’s offering.
**Update, February 2016: Wealthfront has decreased their minimum balance requirement to $500, putting it in reach for more investors.
If you want the kind of automatic service like Betterment or Wealthfront, but don’t want to open an account with them (or if you have already started funds at places like E-Trade or Schwab), you should look into FutureAdvisor. FutureAdvisor connects to third-party accounts and performs similar automated upkeep to Betterment or Wealthfront. Essentially, FutureAdvisor outsources the fund part of the fund-portfolio relationship. If you don’t trust your money with Betterment, Wealthfront, or Acorns, FutureAdvisor may be the solution for you.
The biggest downside to a new investor? You’ll need a fund with at least $10,000 before FutureAdvisor will take you on as a client.
Let’s say you want a more hands-on approach
First, a warning: while investing is never a sure-thing, placing your money in the digital hands of tools created to maximize profit and reduce risk is much safer than taking it into your own hands. Maintaining a DIY portfolio eats up time and has a potential to waste money, especially if you’re not sure what you’re doing. If you’re a first-time investor, we suggest one of the above services for both safety and ease of use.
But if you do want a more hands-on approach, either because you don’t trust those companies or you want to learn more about investing principles, there are a lot of options available. We suggest reading a lot about investing, either online at personal finance blogs or in books (Millennial Invest is a great resource, especially for first-time investors.) We also suggest joining a community like /r/investing over at Reddit that can help guide you.
You should also look into getting a financial advisor, someone who you can speak to face-to-face that will give you advice not only on your investments, but on all of your assets.
The importance of investing early
As we mentioned in our previous article on investing, the benefits of investing in your 20s are huge. No matter how much money you invest later in life, you just can’t catch up the amount that you’d earn if you started investing in your 20s. According to Patrick O'Shaughnessy at Millennial Invest, each dollar you invest at age 22 will be worth over $17 at the time of your retirement. We’ll do the math for you: invest $1,000 at age 22, it’ll be worth $17,000 when you retire. You’ll never get that much return on your investment at any other age.
Comments? Tips? Corrections?
Have more to add? Do you have a tip about a service we forgot? Did we mess something up? Let us know in the comments below.
Photo: Quinn Dombrowski
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