The most common, and possibly the best financial advice anyone will give you is to start investing and saving for retirement early. However, as simple as this might sound, someone without a ton of knowledge about the subject will probably have several key questions, the most important one being… how?
Luckily for this generation, the financial services industry has changed dramatically over the course of the last twenty years. Products and services that used to be standard across the board have been revolutionized by new technology which has created endless options and opportunities for those willing to save.
Starting to invest and save money for retirement at a younger age will set you up for a solid future, and can be beneficial in the short-term as well. Putting money away into an investing or retirement account when you are still in college or freshly graduated will help you develop the habit of doing so. Throughout your professional career, as you make more and more money, you will already be in the habit of putting some away. Starting early will also let you enjoy the benefit of compounding interest, which is the interest earned on interest earned.
Saving money at an early age, specifically if you just put it away into an investment account, could also help you when it is time to make a large purchase. If you are in the market for a new car, you could use the cash you have put away for a down payment, or to buy the entire car outright. Besides aiding you in the car buying process, having money in an investing account could help you buy your first home. When it comes time to put that 20% down for your new house, you’ll be thanking yourself for starting to save early.
Another way to use the money you have put away is by taking a loan out of your 401(k). This option, which some 401(k) providers allow, works like any other loan requiring that you pay interest on the principal, even though it is just to yourself.
Investment Options – Low Involvement
When it comes time to actually start putting money away, there are many different options depending on your intended level of involvement. If you are just getting started, then one of the following might be your best bet. Don’t let anyone ever tell you that you don’t have enough money to start investing; some of the products described below can be started with less than $10!
The majority of the workforce today is offered defined contribution plans such as a 401(k) through their employer. In this type of plan, which does not promise you a specific payment upon retirement as a defined benefit plan would, the employee contributes a percent of their pretax income which may or may not be matched by their employer. The employees shoulder the investment risk and the value of the account will fluctuate due to changes in the market value of the investments. When the employee becomes of the age to withdrawal their funds, the distributions will be taxed as ordinary income at the same income tax rate as your paycheck.
These are a great way to start saving up money towards retirement because the money is not necessarily in your ‘possession.’ If you wanted to withdraw any of the funds before you come of age it will cost you when it comes time to pay your taxes.
This type of investment vehicle has a relatively low-level of involvement for those just starting off. Many times, the company you work for will have a guidance list of funds you can choose to invest in, and this list will most likely be comprised of mutual funds. As you get older you will want to spend more time picking the right investments, and it might be beneficial to seek professional help managing the portfolio allocation.
The biggest decision you have to make when investing in a 401(k), or other employer sponsored retirement account, is deciding what percent of your pretax income you want to contribute. Remember, you should be balancing retirement savings with paying off debt – something that is very important if you are a recent graduate and have student loans to pay off. Additionally, if your employer will only match up to a certain percent of your salary, it might make sense to only contribute the amount they are willing to match until you are more financially stable and can afford to contribute more.
Individual Retirement Accounts – Traditional and Roth
Traditional and Roth IRAs are types of savings accounts that are designed to help you save for retirement. Both of these are great for any individual who wants to open an account for retirement but are not offered an employer sponsored benefit plan. Even for those with retirement accounts offered through work, opening an additional retirement account might be in your best interests.
The general purpose of these two accounts is similar, but the funds contributed are taxed differently. For traditional IRAs the contributions are usually tax-deductible, and all transactions and earnings within the IRA are tax deferred. In comparison, Roth IRA contributions are made with after-tax funds. This article goes into greater depth of the ways these accounts are taxed.
Opening one of these accounts is super easy and can be funded with as little as $500. The first step that must be taken is to decide if you should open a traditional or Roth IRA. Next, pick the funds that you want to hold, which can range from stocks and bonds to funds called all-in-one funds which will automatically rebalance themselves, and gradually become more conservative as you get closer to retirement age.
Robo-advisors are digital platforms that utilize automated, algorithm-driven financial planning services to clients with little-to-no human supervision. The applications gather information from the client about their financial situation, such as age, income level, and expected retirement date, and then allocates the funds/contributions accordingly. Many of these services exist, the most well-known ones being: Acorns, Betterment, Wealthfront, and Schwab Intelligent Portfolios.
The main advantage of using a robo-advisor is that they are extremely low-cost and it is very simple to start. Most of the platforms charge 1 to 5 basis points of the client’s total account balance, or a flat fee such as a dollar a month. Additionally, some of these services are completely free for students, and are willing to give you money if you refer new clients.
Besides the attractiveness of the cost, these services are very simple to use. Upon downloading the app to your smart phone or opening an account online, you are asked several questions which will help the software determine your ideal investment objective. From there, just fund the account and let the program do the rest. Some of these accounts need a minimum deposit in order to start (Schwab Intelligent Portfolio has a $5,000 minimum) but many can be opened with any dollar amount.
Some of these services offer automated contributions and can invest all of your spare change – just link a checking account. The app will round-up your purchases to the nearest dollar and invest the difference.
These services offer exposure to all facets of the capital market such as equities, fixed income, real estate, and foreign markets through the use of ETFs. If you were to try to replicate the holdings it would cost a lot more. The combination of low-cost and ease of use make these services very attractive for those who want to invest in the market but do not want to take on the responsibility of asset allocation and trading.
Investment Options – Higher Involvement
Besides the low involvement investment options that are mentioned above, some investment vehicles that require more involvement but are still geared towards those with less trading experience, also exist.
Brokerage accounts are a type of taxable account that you open with a stock brokerage firm. You deposit or transfer cash into this account and use the funds to invest in many different types of investments. Some of the assets brokerage accounts can hold include: common stocks, preferred stocks, bonds, REITs, mutual funds, ETFs, and MLPs.
There are many considerations when deciding what firm you should open your account with, such as commission, account fees, how often you place trades, as well as account minimums. If you were to open a more traditional brokerage account, look into TD Ameritrade, E*TRADE, and Scottrade – these all offer clean interfaces and have low fees which are two characteristics advantageous for the beginning investor. Remember, you shouldn’t just pick any broker and sign up for an account, figure out what features are the best for you and make your selection based on that. The best broker for one person is often completely different for the next person.
‘New Age’ Brokerage Account
If you want to have more control over your investments but do not want to open a traditional brokerage account there are some services on the market for you. Robinhood is a free-trading app that’s ideal for investors that do not need a full-service online trading platform but would like to execute trades by themselves. Instead of paying anywhere from $5-$10 a trade, Robinhood does not charge even one cent for trade commission or fees. These types of apps might not be the best for everyone, as traditional brokerage services offer more to the investor such as research tools and company analysis. However, if you want an inexpensive way to start trading, then definitely look into it.
The Best Time is Now
Starting an investment or retirement account as early as you can is one of the most important steps anyone can take in their financial life. If you are contributing to an employer sponsored plan or decide to open an IRA, make sure you are taking full advantage of employer matches and the tax benefits. For starting an investment account on your own, you have no excuses to put this off as you can choose from a wide range of investment accounts, fund the account with as little as one dollar, and in some situations not have to pay an annual fee. Take the time to plan for your financial future now.