So, you’re ready to jump into investing and working on your first million…. the only question you might have now is how to start investing! It’s may seem very complicated, but if you start slow, I promise you that it’ll slowly start making sense.
The most important factors in your investing success are time and normal contributions. You should start investing as early as possible, regardless of the amount. Excuses not to start are easy to find, but you should do everything you can to begin contributing on a regular basis and investing for the long term.
I’ll give you an example that shows the importance of learning how to start investing early. Let’s say your goal is $1 million dollars (read like Dr. Evil) by the time you’re 65… believe it or not, someday you will be 65! I’ll assume an 8% market return.
If you start investing at age 25, you’ll need to invest $300/month to hit your $1 million by 65. If you start at age 35, you’ll need to invest $750 a month to hit the same $1 million dollar target. If you start at age 45, you’ll need to invest over $1,500 per month!! Check out millionaire chart in the money tools that expands these scenarios further.
If you get paid every two weeks, that’s $150 gone from your paycheck if you’re 25. Can you handle that?
After you learn how to start investing, you must maximize the advantages offered to you. I’ve created a chart to help you determine where to start investing. It’s mostly dependent on what your employer offers as a retirement program. If they don’t offer anything, your best bet is to move to Tier 2.
Retirement accounts are nothing more than ‘vehicles’ where you put investments. The Tier 1 and Tier 2 accounts are all considered retirement accounts. The Tier 1 accounts are offered through your employer. If you work for a corporation, the most likely option is a 401k or Roth 401k. If you work for the government, you’ll probably have a 403b.
Many Tier 1 accounts offer the unique benefit of matched contributions. For example, many companies will match a pre-determined amount of your 401k. My first company matched .50 on each $1 up to 6% of my salary. This is free money, and you should take advantage of it. In my example, I would receive a full company match if I invested at least 6% every paycheck.
Tier 1 accounts also offer tax advantages. Most of them are pre-tax accounts. This means you put the money in before it’s taxed; your money is pulled from your paycheck before the government can even touch it! However, they will tax it when you retire and pull it out of the account.
The Tier 1 Roth 401k is a post-tax account, meaning you contribute income that is already taxed. The “Roth” title means your money will grow tax free and you can also withdrawal it tax free. This can be very advantageous for young investors because you effectively ‘guarantee’ the amount you will pay on taxes because you’re paying them now. The assumption is that most of us will pay higher taxes when we’re older, due to a combination of possibly increased income and higher taxes.
If you don’t have access to invest in any Tier 1 accounts, then you should automatically move to Tier 2 accounts. Tier 2 accounts offer advantages of their own, but they generally aren’t as advantageous as matched Tier 1 accounts. Tier 2 accounts can be opened by any individual who has a source of income.
Tier 2 accounts consist of IRAs and Roth IRAs. IRA stands for individual retirement account. They don’t allow you to contribute as much per year as most Tier 1 accounts. The regular IRA uses pre-tax money, but the Roth IRA uses post-tax money as mentioned before.
Many people will choose to contribute to a Roth IRA before a Tier 1 account that isn’t matched. That’s because the Roth IRA offers tax-free growth and withdrawals along with more flexible withdrawal requirements. Once you put your money in a Tier 1 account, it’s stuck until retirement unless you want to pull it out early and pay taxes and a penalty on it. Cashing out a 401k is generally a bad idea unless it’s a true emergency. Even if you switch jobs, you should roll your 401k into an IRA before you cash it out.
Anyone can open a Tier 3 account. They don’t offer any tax advantages, but it does allow you invest.
For a quick one-pager on how to start investing, reference the Investment Accounts cheatsheet within the Money Tools section to determine contribution amounts, tax specifics, and withdrawal information for all of the tiers. Each type of account is a little different in what they allow.
If you work for a company or the government, you can work with your HR department to determine how to start investing. If you don’t have access to a Tier 1 account, you’ll typically want to open a Tier 2 account through any normal brokers that you typically hear about on TV or the Internet.
Once you open the account, the first thing you’ll need to do is put money in it! You can then fill them with many different investments, such as stocks, mutual funds, and bonds. If possible, try to contribute 10% – 15% of your income.
The type of investments you purchase is up to you. Stocks are considered the riskiest because you aren’t as diversified if you only buy one or a few stocks (all of your money is in one basket). Mutual funds are a collection of individual stocks that are ‘bucketed’ together. You buy a share of a mutual fund and get a piece of the many different stocks included. This increases your diversification and lowers your risk.
If you’re not willing to put time into researching companies, your best bet is to probably go with mutual funds or exchanged traded funds (ETFs). ETFs are similar to mutual funds but can be purchased and traded like stocks. You can buy an ETF that mimics the major averages (DOW, NASDAQ, etc) or other investment types (gold, high tech companies, etc).
When buying mutual funds, do some work to explore annual fees and load fees. This will determine how much you pay to get into the fund and the amount you’ll pay annually. I like Vanguard funds because they’re known for having some of the lowest fees. Another advantage of ETFs is that they’re fee free.
The best way to learn how to start investing is to start today, but you should enter slowly. Don’t expect to learn everything in one day because it takes time. Also, don’t expect to get rich overnight because that usually leads to you losing money!
Now, do you know how to start investing?? Do you have any questions related to the information above? If so, feel free to leave them in the comments section.