Investing Ep. 3: A Whole New World
In the last episode, we looked at some of the fundamental investment principles, from asset classes to building a diversified portfolio based on your specific situation. With these concepts in hand, we have a better understanding of what to invest in. In our final episode of the Investing mini-series, we'll be giving concrete examples of how to start investing today. We'll give you a break-down of a few common tools so that you'll be able to jump into the investing world with confidence 💪
Investing Tools 🛠
Most investing tools can be thought of like checking accounts that allow you to use that money to invest. The goal when using one of these tools is to figure out (a) how to build your target portfolio and (b) how to move the money from the "checking account" to the assets underlying the portfolio.
Investing tools typically vary along 2 primary dimensions:
Involvement ⏱: This is essentially how much time you have to spend to do steps (a) and (b), from learning how to use the tool to maintaining your accounts. The tools with higher involvement also have higher flexibility, meaning you can do more advanced investing techniques or invest in more eclectic assets.
Cost 💸: With any product/service, there comes a price-tag. There are many pricing schemes out there, but broadly there are 2 types of fees to look out for: management and trading-related. Management fees are usually a % of the money in an account, and are usually present when the tool does a lot for you (e.g. advising fees). Trading-related fees are present in all tools, and are the fees associated with the underlying assets you're investing in (e.g. fees on buying/selling stocks, holding money in ETFs, etc.)
Involvement and Cost usually are inversely related: the less involvement, the more you'll have to pay. This is what broadly separates the 2 basic types of investing approaches: DIY and Hands-off. The hands-off approach requires less from investors but usually charges for having magic under-the-hood to do a good job of taking care of (a), (b), or both. Likewise, if you DIY, more of the work goes on you, but there's potential to save money on various fees.*
* Note: This is assuming you know what you're doing. Remember that trading-related fees are associated with the underlying assets, so if you're not careful, you could rack up a lot of trading fees.
DIY Investing 💪
Involvement ⏱: High
When we say DIY investing we really mean implementing the investment principles in our last episode on your own. The benefit of this approach is having the freedom to build portfolios from the ground up and have complete control over how/when you buy/sell your assets. So understanding those principles is key.
Cost 💸: Low
While it is free to open a Roth IRA, the main costs you'll face here are with the commission brokerages charge on ETFs and the operating expense ratio (OER). The OER is a percentage of your fund assets the brokerage will take to cover their operating expenses.
Let's take a look at what DIY investing could look like on Charles Schwab* (popular brokerage). Let's say I want to open up a retirement account in the form of a Roth IRA (if you're not sure what a Roth IRA is, check out our article on retirement accounts).
* Note: Charles Schwab is being used as an example because YNB has experience using it. This doesn't mean we endorse Charles Schwab; choose the brokerage that's right-for-you!
Applying for a Roth IRA Account*
On Schwab, to open up a Roth IRA retirement account you go under Products → Individual IRAs → Roth IRA, and then you are taken to the following screen.
* Note: for demo purposes only; I won't actually be making trades but will rather show you how to do it.
Click on the green start button to begin your application and you go through a few different screens to complete the process. It takes about 10 mins and you'll need the documents mentioned.
After you go through that process, the last step of creating an account is funding it 💰. This is where you'll connect a savings or checking account to transfer money to then invest with through your Roth IRA. Once you have successfully created an account, your home page when you login should look something like this:
Buying Stocks & Bonds
Woohoo! Now you can start investing. So let's say I thought out my risk tolerance and since I am saving for retirement, I decided to go with a 70/30 split between stocks and bonds. I also decided to invest through ETFs to take advantage of asset allocation and diversification. Let's say I want to invest ~$100 today, how would I do that?
Under the Trade menu item, I click on Stocks & ETFs to see this view:
Schwab offers its own ETFs which have their own names. SCHX is a US Large Cap ETF. Since I'm going for a 70/30 split, I plan to buy 1 share. You can use their calculator tool to automatically figure out how many shares you should buy based on how much you want to spend.
I select market order which requests the best price available and guarantees the buy however the price could change in the time that I place the order and when it actually goes through. On the next page, you can review your order before actually placing it. If you don't have sufficient funds in your account, you will not be able to place the order.
Now that I've invested ~70% in stocks, I want to invest the remaining money in bonds to diversify my portfolio. To do that, I go back to the same Stocks & ETFs window since I want to invest in Bond ETFs. Schwab's SCHQ is a Long Term US Treasury Bond ETF. If you're curious about why I chose US Long Term Stocks and US Treasury Bonds, check out our section on Asset Correlation in the last episode on investing.
Once again, I fill out the action, quantity, and order type fields. I know that I'm going over my budget of $100 here but that's okay since I can't buy a partial stock or bond ETF on Schwab. Once again I'll review my order before placing it by clicking on that big green button.
Managing your Portfolio
A nice tool that Schwab offers is under the Portfolio Performance tab under Accounts. Here you'll see the following view:
Since this is a demonstration you can see that I have no money funded and therefore the pie chart on the left is all one color. If you click on Portfolio Setup you can set your Target Asset Allocation after taking a questionnaire that helps Schwab understand your risk tolerance. I previously set up my allocation to be aggressive which you can see in the pie chart on the right. Because I opted for an aggressive allocation, Schwab doesn't recommend any bonds (fixed income).
If I did make the trades above, the chart on the left would show my portfolio and reveal the 55/45 split instead of the 70/30 I aimed for. Therefore, this tool is great to determine where I should invest my next $100 to bring it closer to my target allocation. It is also helpful in determining when you need to rebalance by showing you the difference in dollar amounts between your target and current allocations.
That's it! To summarize: after making an account, the process is funding your account and then investing in the stocks/bonds based on the asset allocation and diversification you want. If you're going down the DIY approach, you'll have to log back in and make trades every time you want to invest and check on your asset allocation and rebalance accordingly.
If you aren't a fan of spending time rebalancing your portfolio or figuring out if your portfolio is properly diversified, there are several approaches that can automate a lot of the investment concepts for you.
Hands-off investing is using a tool that typically makes the investing process easy. They usually build a portfolio for you based on your preferences and help you maintain investment principles (e.g. diversification, rebalancing, etc.) either automatically or with the help of other humans.
Target-Date Retirement Funds 🗓
Involvement ⏱: Low
Target-date funds are mutual funds (i.e. pools of money that invest in a set portfolio managed by humans) that is defined by the year in which the investors in the fund intend to retire. You'll usually find target date funds in increments of 5 years, and are listed with symbols similar to stock tickers (e.g. VTIVX, which is for people who're set to retire around 2045). The idea with these funds is that as you age, you'll want to get a progressively safer asset allocation. These funds implement this strategy for you: each fund starts off riskier (more stocks), and progressively becomes less risky (more bonds) as you get closer to retirement (how fast it does is called the "glide path").
Pretty much every major brokerage (e.g. Schwab, Vanguard, Fidelty, etc.) has a target-date fund, each of them having differences in the underlying assets they invest in, their glide path, and whether or not funds will be managed after the retirement date (through funds vs. to funds).
Cost 💸: Low
As was mentioned in the DIY section, the fees associated with funds will be the expense ratio. In 2016, the average expense ratio for target date funds was 0.51%. This is an average though, because fees ranged from as low as 0.1% to 1.5% (VTIVX, for example, has an expense ratio of 0.15%).
Let's take a look at how to buy a Schwab target date fund through Schwab!
Investing in Schwab Target Fund
Under Trade on Schwab, you'll see a section called "Invest in Mutual Funds" which will bring you to this window. By searching for "schwab target" I see a number of different options. The year in the name refers to the year in which you would retire. Let's say I'm retiring in about 40 years. My target date fund would be the 2060 Fund (SWPRX).
After selecting the SWPRX fund and selecting Buy, I'm taken to the next screen where I can fill out how much I want to invest and what reinvestment strategy I want to use. I put in $100 and select Dividends and Capital Gains. Refer to episode 1 if you forget what those terms mean, but reinvesting both dividends and capital gains can really pay off in the long run because of the power of compounding. More below on why you should/shouldn't reinvest dividends.
Next, I review my order and then place it! That's it 😃 If you set up auto-deposits and make sure that you have enough money in your funding account, everything else is pretty much on auto-pilot!
Involvement ⏱: Low
Robo-advisors are tech-companies that use math to manage your investments automatically. Popular robo-advisors include Betterment, Wealthfront, Wealthsimple, Ellevest, and more. While the user-experience and pricing of these different robo-advisors may vary, their basic functionality stays pretty consistent.
Cost 💸: Medium
Robo-advisors have both management and trading fees. Since many robo-advisors buy ETFs as the underlying assets of their portfolios, you'll also be paying the expense ratios associated with those ETFs (average is 0.44%, but there's a lot of variance, ranging from 0.02% to >1.5%).
The management fee (also called "advisory fee") is how much you'll have to pay the robo-advisor company for managing your funds. Fees can range from about 0.0% to 0.75%, with the average being about 0.25%. The amount you pay in advisor fees is based on how much money you have invested in the robo-advisor, and is usually calculated annually.
The lowest cost target date fund will definitely be cheaper than the lowest cost robo-advisor (since there are no management fees), but which one you go with will depend on your situation. If all you need is a "one-size-fits-all" place to put your money at the lowest possible price, target-date funds may be right for you. If you want more personalization and added features that are useful to some people (e.g. tax-loss harvesting), then you might find it worth it to go with a robo-advisor.
Let's step through how you might use Betterment* for hands-off investing:
* Note: Betterment is being used as an example because YNB has experience using it. This doesn't mean we endorse Betterment; Choose the robo-advisor that's right-for-you!
Choosing a Goal
Let's assume that you've already made a Betterment account (which will involve filling out a questionnaire for Betterment to understand your situation, from age to annual income). To get started investing, we have to make an investment goal.
"Invest for a long-term goal" is any big-purchase that you hope to make in a long time (e.g. buy a house), and "Save cash and earn interest" is essentially a high-interest savings account. Let's say we wanted to start saving for retirement, we'd choose "Invest for Retirement"
The next step is to choose from the types of accounts we'd like to open. Since we're demonstrating with an existing account, 2 of the options are grayed out.
Individual taxable is like a regular brokerage account, and the various IRAs were discussed in the retirement accounts article. Let's say we wanted to open up a Traditional IRA.
Designing Your Portfolio
This allows us to confirm attributes about our portfolio. "Betterment portfolio" is the default algorithm Betterment uses to manage your portfolio (there are lots of potential algorithms, usually based on some well-researched techniques).
"56% stocks" is the recommended asset allocation that Betterment gave us based on our account/goal. However, let's say we personally felt that we could tolerate a higher risk portfolio than 56% stocks (Betterment only offers portfolios made of stocks/bonds). Let's see what options we can change in our portfolio allocation:
Moving the slider right increases the allocation of stocks, which in-turn update the "Projections" (how Betterment thinks your portfolio will perform in the long-run), "Holdings" (what specific assets will go into the portfolio and in what proportion) and "Allocation over Time" (if you have auto-adjust on, it'll progressively shift more assets into bonds, kind of like a "glide path" for target-date funds). Let's say after exploring the different views, we settle on a 70% stock allocation. Now we have to figure out how to fund our account!
Funding Your Account
The big question we're answering here is: how much money do we put into our Traditional IRA at what intervals? In this case, we're looking at $500 on the first of every month. This graph shows us, based on the portfolio that we selected, what we could expect to make in the long run (could vary based on how the market actually performs). We'll touch on investment frequency in a later section, but let's say this all checks out, so let's "Review deposit"!
Almost at the finish line! The last thing we need to do is set-up the source of our deposits. This will be your bank account (which you can add when you set-up your account). In this case, we'll be making deposits from Chase Bank to the Traditional IRA, and the next deposit will happen on May 1st.
If that all looks good, we can schedule our recurring deposit, and we're essentially done! Every 1st of the month, we'll add $500 to our Traditional IRA, and under-the-hood, Betterment will invest in the underlying assets specified in the portfolio we made, dealing with things like rebalancing, diversification, re-investing dividends, and more!
For the most part*, you don't have to check your Betterment account until you retire! Just make sure your connected account that is funding your investment account is properly funded, otherwise, you'll run into some nasty fees.
* Note: You will have to check your account when you file taxes each year.
The investing happens automatically. But if you want to, you could visit the various overview pages to see how your portfolio is actually doing, adjust your asset allocation/deposit frequency or amount, or open new accounts. There are more features that Betterment and other robo-advisors offer, but this is the core workflow: make a goal, specify your portfolio, fund your account. Similarly to the other strategies you rinse and repeat every time you want to invest more. So that begs the following question...
How often should I invest? 🤔
Great question! There is no right answer here, but the short answer to simplify your life would be to invest consistently on a monthly basis. A key idea to keep in mind is the ~principle~ of dollar-cost averaging. Let's say you wanted to max out your Roth IRA for 2020. Instead of putting in the $6,000 all at once, dollar cost averaging says it would be smarter to invest $500 every month. Why? This way you can reduce the impact of volatility on your performance. Instead of worrying about timing the market for when to put in the $6,000 if you invest $500 monthly, on average the price fluctuations won't hit you as hard. Especially now when the market volatility is really high.
Reinvesting Dividends 🤑
Because of the power of compound interest, reinvesting your dividends allows you to grow your wealth faster. It also has the following benefits:
Easy: can be automated through your brokerage and is easy to set up.
Cheap: you don't have to pay fees on the trades when reinvesting dividends.
Flexible: you can't typically buy fractional shares, but with your dividends, you can.
However, there are reasons to not do it as well:
If you are close to retirement, having the cash on hand is useful.
If you are going down the DIY approach, dividends can throw off your asset allocation pretty quickly.
Action Items ✨
You have all the tools you need to determine how you'll begin your investment journey. The first step is to determine which investment style fits your personality: DIY or hands-off?
Remember the important thing to do is to choose one and start somewhere. Decide on an investing schedule and stay as consistent as you can, even if it's as little as $50 a month. You'll thank yourself later after seeing the power of compound interest ✨
Do some reading to understand investing philosophies and the behind-the-scenes a little bit better. (some popular books include A Random Walk on Wall-Street, The Intelligent Investor, and anything Warren Buffett writes - check out some MoneyStories for other recommended reads)
Pick the brokerage you want to be your "command center" for executing your portfolio (popular options are Charles Schwab, Vanguard, Fidelity, Robinhood).
After that, the intuition you get from books, tips from investing blogs, or maybe collaborating with friends will help you maintain your investments as you near your goals: the sky is the limit!
If you want to be a hands-off investor, consider how involved you want to be. If you want a one-size-fits-all that can probably get you lower fees, investigate target-date funds (and do your research on the different funds out there and their fees!). If you want a bit of optionality and something that has more features/niceties, look into robo-advisors.
You'll want to go with the option that has the minimum features that you know will be useful for you, at the lowest price! When you're just starting out, it can help to open a few accounts just to see which interface you like better, because once you put enough money into those accounts, it'll be hard to switch, even if there are better options out there :)
Open up an account, fund it, and you're good to go!!
We've come a long way since Episode 1, and there's still a lot more to learn if you're interested (especially for DIY investing). Hopefully, this series has demystified a lot of what investing actually is and gives you the confidence to start doing it! Shoot us an email if you have questions!
Disclaimer: The content on Young, Not Broke is for informational and educational purposes only and should not be construed as professional financial advice. Should you need such advice, consult a licensed financial or tax advisor.