Welcome to part 2 of “The Lazy Person’s Guide to Building Wealth.” If you missed part 1, get caught up here. If you’ve ever been curious about investing in the stock market but are honestly puzzled about how to get started, this guide is for you. If you question whether investing in the stock market is a realm reserved only for Wall Street moguls or the already rich, this guide is also for you. By the end of it, you’ll have everything you need to know to start investing.
But first, why should you invest?
Let’s start with this fundamental question. The most cliche answer is that you’ll have “financial freedom” if you build wealth. What does that mean? Wealth, like many things in life, is a spectrum. On one end, wealth affords you less stress and less financial fragility. On the other end, you can provide family and community support and leverage opportunities when other investment options come along. And somewhere in the middle, when you build wealth, you build optionality and flexibility into your life.
Investing is simple
I promise that investing is simple. Although, it didn’t used to be. Not that long ago, you needed to know a guy, literally, a guy who was a stockbroker to invest your money. The world of building wealth existed inside walled gardens, but that has drastically changed.
Investing is as easy as online shopping these days. It’s a lot like it.
Step 0: Before you invest in the stock market, make sure you have a cash emergency fund
But before investing, let’s look at a couple of prerequisites. First, it’s essential to recognize that you should only invest money you don’t need in the short term, like the cash you need to pay your bills.
Beyond the cash in your checking account for everyday life, you also need a cash cushion in the form of an emergency fund savings account. No, your investments are not your emergency fund because you don’t want to be in a position where you need to sell your investments for cash in an emergency. You need to have some money on hand in a savings account.
Give your money a goal.
Remember in part 1 when I said Investing is all about risk and reward? And the more risk you take, the more potential reward?
Let’s take this a little further. The amount of risk you’ll take is determined by your risk tolerance, but it’s also dictated by time: when you’ll need the money. When you need the money, it is determined by what your goal is.
I’ll give two common examples of financial goals with two different timeframes.
An example of a long-term goal is retirement. Let’s say you need 1.2 million dollars in 40 years.
An example of a short-term goal is a down payment for a house. Let’s say you need $70,000 in 5 years. (This may not be remotely realistic for some of you like you need two or three times that amount, but that’s an entirely different post).
With the retirement goal, you can afford to ride the ups and downs of your retirement investment portfolio. For a shorter-term goal, you can afford less risk. Your asset allocation, an investment strategy that balances risk and reward, should reflect those investment objectives.
Think about an investment goal and investment strategies with this imperfect analogy: You probably own multiple shirts. You likely have some everyday T-shirts and a shirt for a more formal occasion.
You buy or decide to buy or wear each shirt based on your goals: feeling comfortable working out and looking nice at a wedding are different goals that require other shirts. Different investment strategies are necessary for different investing goals.
Step 1: Decide where to buy investments.
Like shopping online, you’ll need to decide where to buy investments. The “investment store” is called a brokerage firm. And just like shopping online, you can use an online broker.
The ones I recommend are among the most popular and trusted: Betterment, Fidelity, and Vanguard are all online brokers where beginning investors can start investing.
For the sake of simplicity, let’s just look at investing for retirement as our example. Why? Retirement is the most common way an investing beginner starts their investing journey.
And when it comes to retirement, and again, keeping things simple, most folks will have two options when it comes to retirement accounts.
Option 1: You have access to an employer-sponsored plan.
As a benefit, some employers offer a retirement plan. For example, a 401 k is an employer-sponsored plan (or a 403 b if you’re a teacher or work for a nonprofit). If your employer offers this benefit, consider using the plan as one of your investment accounts, especially if your employer offers a match.
An employer match is essentially "free money" that the employer contributes to employee retirement funds if employees also contribute. The specifics vary widely from one company to another. Still, the general idea is the same: if you put a certain percentage of your salary into your 401 k, your employer will also put in some money, up to a certain amount or percentage. If your employer offers this, take advantage of the free money and invest money in the plan.
Option 2: You don’t have access to an employer-sponsored plan.
If you don’t have access to an employer-sponsored retirement account, or maybe you’re self-employed, don’t worry. You can still open up your investment account.
An Individual Retirement Account (IRA) is used to invest retirement money. Although there is more than one type of individual retirement account, let’s focus on the traditional one to keep things simple.
Retirement Accounts Offer Tax Benefits
Besides the main benefit of potentially being able to retire, retirement accounts specifically have tax advantages. With a traditional IRA and 401 k, not only do you contribute pre-tax dollars to your retirement accounts, but you don’t pay taxes on your investment gains until you’re retired and begin drawing down your.
Step 2: Open the account
Let’s say your job has a 401 k plan that you can participate in. You’ll either need to opt in or opt-out. Opting in means you must take action to enroll (email HR!). Opting out means your employer will automatically invest a portion of your paycheck into your 401 k. It might be 5% of your check.
Some employers have a probation period before you can participate. For example, you may need to be employed for 90 days before you can enroll.
If you don’t have access to an employer-sponsored retirement plan, you can open your IRA at one of the online brokers mentioned above (Betterment, Fidelity, and Vanguard).
Step 3: Choose investments
Don’t worry; you don’t have to pick individual stocks. Investing in the stock market is shockingly simple.
The easiest way to get started investing is to invest in funds. Many 401 k plans offer a specific type of investment vehicles geared towards retirement investing called target date funds.
What’s a fund?
If buying individual stocks is like ordering a la carte, investing through a fund is like ordering a combo plate, like a happy meal or omakase (a meal at a Japanese restaurant consisting of dishes selected by the chef).
In other words, when you invest in a fund, you get various investments without having to actively pick individual stocks and bonds.
In the example of a target date fund, your retirement funds will be invested in a diversified portfolio according to your investing goals, which are your projected retirement age and risk tolerance level.
A note about risk tolerance
While your investing timeframe and risk tolerance are related, it’s important to note that some folks might have a higher risk tolerance than others. Assessing your risk tolerance is something that gets done when you open up your IRA or when you’re signing up for your 401 k. Your risk tolerance does get factored into your investment recommendations.
Why funds?
A fund allows you to invest in a diversified portfolio of investments. When you invest in a fund, you’ll invest in stocks fixed income investments, like bonds. A fund can also hold funds. So you end up investing in a fund of funds. For example, some target date funds may consist of mutual funds, exchange-traded funds, and index funds.
Let’s look at a quick breakdown of the available types of funds:
Mutual funds
Most mutual funds are actively managed, which means an investment or financial advisor buys stocks and bonds based on the active fund manager's investment objectives. Often, a mutual fund will have a minimum investment requirement and will overall be costlier because you’re paying for the price of wealth management via a fund manager.
Index funds
Index investing is a type of passively managed fund. They follow the indexes like the S&P 500, the Dow Jones, or another market index. By matching their holdings, index funds act as a mirror.
Exchange-traded funds
ETFs are just like index funds, but ETFs can be bought and sold at any point that markets are open during a regular trading day, just like individual stocks.
However, index funds can only be bought and sold once daily, after regular trading hours. You can order but expect to wait to get filled.
My retirement investing is done at Betterment. Since Betterment only offers ETFs, I invest strictly in ETFs and benefit from the low cost of robo advisors. I input my investment goals (retirement), and robo advisors generate investment advice on how to invest my money.
Step 4: Decide how much of every paycheck you will invest
Before you start investing, also called making contributions, figure out what you can afford to contribute with each paycheck. Historical personal finance advice says to invest 10% of your income towards retirement. If you can afford that, please do that.
If you can afford more, please do that. I’d say aim for 20% or even 30%. It’s a lot, I know. I’m sorry the world is like this. But I’d rather you know the truth now so you can start aiming for this goal sooner than later.
What if you don’t have a 401 k plan available and you’re investing for retirement via an IRA? You’ll need to contribute to your retirement account each time you get paid. I bet you can do this automatically because technology is fucking great. But it won’t bum me out if you do it manually, too. Perhaps when you sit down for your weekly finance time?
Investing a portion of every dollar you earn is very fucking important. I cannot emphasize how fucking important this step is, but maybe using profanity can help me get my message across.
Repeat Step 4: Every time you get paid, buy investments
Again, I cannot emphasize how important this part is. Every time you get paid, buy investments.
Think about it like this: put your investments on a subscription. Like many of us buy toilet paper or face wash, you can do this with your investments. Put it on autopilot and make it non-negotiable.
Make sure you’re investing the cash.
There are some horror stories I’ve read and heard about where folks have been putting money into their IRA for years – I’m talking five to ten years, consistently – but they missed a very crucial step, which is to actually invest their money. You might be wondering how this is possible.
When you sign up for your 401 k, make sure you actually choose what you’re investing in. If, for some reason, there is no target date fund available, all 401 k plans have a financial advisor that services the plan. HR should be able to get you that person's contact information, and you can speak with them about how to invest your money and confirm that it’s actually being invested.
The same thing goes with the IRA. When logged in and looking at your account, ensure it shows it’s invested. If it shows that you only have one holding that isn’t a target date fund, that’s a red flag. You should see the words target date fund or multiple holdings. Again, even robo-advisor platforms have financial advisors you can talk to. Use the help if you need it.