An anonymous caller left me a message recently saying, “Hi Laura, I’m new to the podcast, have not started investing yet, and age 36. So, I know that I’m late to the investing party, but I want to start now by opening a brokerage account. I’ve been trying to figure out the best option and hope you can create an episode about that.”
In this article, I’ll talk about the best time to start investing and help you know how you should invest by reviewing eight considerations for investing in a brokerage account. We’ll cover tips for choosing a firm, selecting investments, and managing money wisely based on your financial goals.
When is the best time to start investing?
If you’re like the anonymous caller and feel like you’re getting a late start to investing, I want to assure you that you’re not! There is no wrong time to start investing because everyone is on a unique financial journey. I didn’t start investing regularly until my early 30s when my husband and I successfully sold a business and had a nice profit we needed to put somewhere.
Many procrastinate investing because they think it’s too complicated, risky, or time-consuming. So, congratulations to the caller for asking the question and getting serious about your financial future. I’ll explain exactly how to get started as an investor.
How should you invest?
Here are eight things you should know about investing in a brokerage account.
- You should have a financial safety net.
Before you invest money in a taxable brokerage account or a tax-advantaged retirement account, be sure you have healthy savings. Remember that saving and investing are different.
You save money to preserve it for short-term needs, like emergencies or buying a car in a few years. Savings should never be invested–keep it entirely safe in an FDIC-insured savings or money market account so it can never lose value. If you have a hardship like losing your job or business income or having unexpected medical bills, having a cash reserve will be a lifeline and keep you from relying on debt.
A good emergency savings target is three to six months’ worth of your living expenses (such as housing, food, utilities, and debt payments). For example, if your living expenses total $4,000 each month, make a goal to build up a minimum of $12,000 in savings.
However, investing is best for goals you want to achieve in at least three to five years. They might include buying a home, paying for a child’s college, and retiring. With investing, you put money into financial instruments, like mutual funds, expecting future growth. Investing isn’t appropriate for short-term goals because market values can fluctuate wildly within short periods and could plummet when you need the money.
Investing requires some risk, but without it, you aren’t likely to earn enough growth to achieve significant financial goals, such as retiring. A good rule of thumb is to invest a minimum of 10% to 15% of your gross income for retirement every year.
- You should invest sooner rather than later.
I always say that starting small is better than not at all when it comes to investing. No matter how much or little money you have, it’s better to start investing sooner so your money begins growing. Consider two people who invest the same monthly amount and receive the same average annual return.
The first is Sarah, who begins investing at age 35 and stops at age 65. Over those 30 years, she invests $400 a month and receives an average return of 7%. When she’s ready to retire, her account balance is less than $500,000.
The second investor is James, who begins investing at age 25 and stops at age 65. He also invests $400 a month and receives the same average return of 7%. But James ends up with just over $1 million after those 40 years.
By starting to invest ten years earlier than Sarah, James retires as a millionaire, with over $500,000 more to spend, even though he only invested $48,000 more ($400 x 12 months x 10 years) than Sarah. James has a much higher account balance because his money had more time to compound and grow.
So, even if you don’t have $400 a month to spare, start investing some amount right now. As you earn more money, you can invest more. And when you have a windfall, such as a cash gift, bonus, or tax refund, invest it, too.
Waiting for the perfect time to invest causes you to lose significant earnings. And trying to catch up later will be extremely challenging and costly. So, never forget that the sooner you start investing regularly, the more wealth you can build with less effort.
- You should maximize tax-advantaged accounts first.
The anonymous caller didn’t say whether they wanted to open a taxable or tax-advantaged account within a brokerage, such as an individual retirement account (IRA). Since they didn’t mention investing in a workplace retirement plan, I’ll assume they don’t have one or are self-employed.
Unlike retirement accounts, taxable brokerage accounts require you to pay tax annually on any capital gains (profits from selling an investment for more than its purchase price), interest, and dividend income. The tax amount depends on how long you own the investment and your tax bracket.
The upside of taxable accounts is getting a lot of flexibility. Unlike retirement accounts, they don’t have income requirements, annual contribution limits, early withdrawal penalties (before age 59.5), or required minimum distributions. Nor do they have any protections from creditors under federal (and some state) law, like some types of workplace retirement plans.
Both taxable and tax-advantaged retirement accounts allow you to choose various securities, but taxable accounts typically have the broadest range of options. When you purchase investments using a retirement account, such as an IRA or a SEP-IRA (for the self-employed), you build wealth for retirement and reduce taxes.
So, I recommend that the anonymous caller open up a retirement account and maximize it first before putting money in a taxable brokerage account.
ALSO READ: 10 IRA Facts Everyone Should Know
- You should know the retirement account rules.
Everyone with earned income (even minors) qualifies for a traditional IRA. You make pre-tax contributions and defer taxation until you make withdrawals in retirement. There are no income limits to qualify. If you’re married and file taxes jointly but have no income, you can invest based on your spouse’s income.
For 2023, you can contribute up to $6,500 or $7,500 if you’re over age 50 to a traditional IRA. The annual contribution limit is the same for a Roth IRA, but comes with a qualifying income limit. For 2023, you must earn less than $153,000 as an individual taxpayer or $228,000 as a married couple filing taxes jointly to make Roth IRA contributions.
With a Roth IRA, you must pay tax upfront on your contributions; however, you can make tax-free withdrawals of your original contributions and account earnings in retirement, which is a fantastic benefit!
In addition to investing through a traditional or Roth IRA, you have more account choices when you’re self-employed. Two popular accounts are a SEP-IRA and a solo 401(k), which have higher contribution limits, such as up to $66,000, based on how much you earn and your age.
Now is an excellent time to adjust your savings plan to take advantage of them in the New Year. Listen as Laura reviews ten changes to various tax-advantaged accounts starting in 2024. Listen in the player below.
- You should choose a diversified investment portfolio.
Buying and selling individual securities, like stocks and bonds, isn’t a wise strategy for the average investor. That’s because no one can predict whether their values will go up or down. While no other mainstream investment outperforms stocks, their prices can be volatile, rising and falling daily.
A better strategy is to invest in one or more diversified funds, which bundle investments, such as stocks, bonds, assets, and additional securities, making them convenient for investors to purchase. They may focus on one asset class, such as large domestic companies, or a mix of them.
Investment funds are incredibly diversified because they comprise hundreds or thousands of underlying securities, like stocks, bonds, currencies, and real estate. Diversifying allows you to earn higher average returns while reducing risk. If some securities within a fund lose value, some will hold steady or increase in value, which minimizes your potential losses.
Since the 1920s, the historical average return of the stock market has been approximately 10%. So, if you have decades to go before you retire, consider investing a large percentage of your portfolio in stock funds. Stock prices will indeed fluctuate during the short term, but prices are likely to increase over the long term, giving you an excellent return on your investment.
But even if you only earned an average 7% return on your investments, you’d have a nest egg worth just over $1 million after investing $400 a month for 40 years, like James in my previous example. If you put that money in a high-yield savings account instead, saving $400 a month for 40 years with a meager 3% return would result in about $370,000.
Having more than one retirement plan can change the tax rules and benefits you receive. Laura explains what you need to know and how to get most most out of multiple retirement accounts in the same year. Listen in the player below.
- You should understand investment funds.
In addition to stock funds, there are different types and categories of funds you should be familiar with.
Mutual funds are a collection of assets managed by a fund professional. Buying and selling shares in a mutual fund are restricted to the end of the trading day when the fund’s net asset value gets calculated.
Exchange-traded funds (ETFs) are similar to mutual funds in that they are baskets of assets. However, they trade like individual stocks, meaning you can buy or sell ETF shares throughout the day and should expect price fluctuations.
Index funds are mutual funds that usually come with low fees and may comprise thousands of underlying investments. Index funds aim to match or outperform a specific index, such as the Standard & Poor’s 500 Index or Dow Jones Industrial Average.
Target date funds are mutual funds that automatically reset the mix of assets in their portfolio according to your set time frame, such as when you plan to retire.
Be aware that funds come with different fees, known as an expense ratio. For example, a 1% expense ratio means that 1% of the fund’s assets will be used for paying yearly expenses, such as management and advertising. Generally, choosing lower-cost funds, such as ETFs and index funds, is best to avoid unnecessary costs that eat away at your returns.
- You should choose a brokerage based on your needs.
Choosing the right brokerage can make a huge difference in your investing experience. First, consider whether you’ll want a taxable account, retirement account, or both. Make sure the firm offers the type of retirement account you want, such as an IRA or a solo 401(k) for the self-employed.
Then consider your investing preferences, such as choosing your own investments, using a robo-advisor, or getting help from an advisor. Some brokerages offer free advice, and others charge for assistance.
A robo-advisor manages your portfolio automatically based on features you select, such as your stated risk tolerance, age, and goals. It’s an algorithm recommending a diversified portfolio, typically a mix of five to ten exchange-traded funds (ETFs).
It can rebalance the portfolio, ensuring your desired asset allocation gets maintained over time.
Because trading is automated, robo-advising platforms typically charge lower fees than human advisors. However, some brokerages, like Betterment, offer a hybrid model where you can consult with a human professional for more advanced financial planning advice.
You should consider a firm’s investing fees based on the type of advice you want or need. Do they have a great app and user experience that makes investing intuitive and enjoyable? Can you reach someone if you have questions? Do they have additional services, such as banking products, that you might use?
As with any financial decision, do your homework to compare brokerages and consider your unique circumstances and preferences.
ALSO LISTEN: 7 Best Places to Save After Maxing Out a 401(k)
- You should ignore what you can’t control as an investor.
Drops in the stock market are uncontrollable, so don’t drive yourself crazy by focusing on unavoidable actual or potential losses in your investments. Instead, stay focused on building wealth over the long term using a buy-and-hold strategy.
What happens in the financial markets from day to day only matters if you need to liquidate your investments during the same period. In other words, ignore media hype and stock tips from friends and never make rash decisions, such as selling your investments when their value drops.
Your goal should be to get investment growth over decades, not month-to-month or even year-to-year. Remember that money you need or want to spend in the short term should be saved, not invested.
If you’re unsure how to choose investments, don’t hesitate to seek advice from your benefits department at work, an account representative, or an independent financial advisor. And if you don’t understand a financial professional’s explanations or recommendations, keep asking questions until you do. You’ll be glad you did, especially when you build a healthy nest egg that gives you peace of mind and financial security.