Are you ready to start investing but have no idea where to start? My number one tip for beginners on getting started investing is to invest in stock market index funds. Index funds track the major market indexes, such as the S&P 500 (which consists of the top 500 companies on the New York Stock Exchange), or you can even track the total market. If you are new to investing and are not sure about which companies or funds to invest in, low cost broad-based index funds are a great place to start. Even if you are not new to investing, index funds are a solid investment, because while it is possible to beat the market in the short-term, it is much more difficult, even for experienced traders and analysts, to beat the market averages over the long term. Historically, the stock market returns an average of 7% to 10%, depending on the length of the time period used. Check out the figures yourself by visiting the interactive S&P 500 Historical Annual Returns Chart.
If you are interested in reading a lengthy defense of this strategy, considering picking up A Random Walk Down Wall Street: The Time-Tested Strategy for Successful Investing, by Burton G Malkiel. If you are looking at investing in mutual funds that cover the S&P 500, consider researching these funds:
- Fidelity 500 Index Fund (FXAIX)
- Schwab S&P 500 Index Fund (SWPPX)
- Vanguard 500 Index Fund (VFINX)
Disclosure: I am long on VFINX and SWPPX.
These mutual funds have low expenses ratios, with FXAIX at .015% (yes, that is correct!), SWPPX at .02% and VFINX at .14%. This isn’t always the case for mutual funds. One handy tool to use upon hearing a recommendation for a mutual fund with a higher expense ratio is the Mutual Fund to ETF Converter at ETFdb.com. Here are three mutual funds that have investments focused on the Russell 2000, an index made up of 2000 small cap companies (those with a market capitalization between $300 million and $2 billion):
- Fidelity Small Cap Enhanced Index Fund (FCPEX)
- Ivy ProShares Russell 2000 Dividend Growers Index Fund (IRUAX)
- Value Line Small Cap Opportunities Fund (VLEOX)
The expense ratios for these are higher than those I listed for the S&P 500 funds, with FCPEX at .64%, IRUAX at .9%, and VLEOX at 1.21% Using the Mutual Fund to ETF converter, you can find ETFs that invest in a similar way to the mutual funds, but which will have lower expense ratios. Keep in mind the ETFs will be passively managed, if that matters to you. Though if you read Malkiel’s book, you will learn that passively managed (an oxymoron!) funds tend to perform just as well or better than actively managed funds over time.
The following table shows some alternatives that are generated when running the converter for the most expensive of these funds, VLEOX. The expense ratios for these similar ETFs are much lower, with IWM at .19%, VTWO at .15%, and SPSM at a very reasonable .05%. Consider investing in one of these ETFs instead of VLEOX in order to save money on fees. I know it looks like a small percentage, but the more money you have invested in a fund and the longer you hold the investment, the larger the chunk of money you are spending on fees over time. Plus, when that money is going toward fees, instead of staying in your account, you are losing the opportunity to invest that money in something else.
Remember that shares in mutual funds and ETFs can lose value just like those of an individual company. While your risk is spread out among multiple companies when you are invested in a fund, your investment can still decrease. Also, past returns are not an indication of future returns, be careful in your financial planning regarding extrapolating returns based on past performance and use the more conservative percentages when making estimates.
The standard advice of “buy low and sell high” also applies for ETFs and mutual funds. I avoid buying a fund when it is at its 52-week high in price! But I don’t wait for a fund to reach it’s 52-week low either (if it happens to be there, fine). I tend to buy when funds dip down a little — it seems that there is a good entry point every few months. Having said that, there is a well-known phrase in investing that “time in the market is better than timing the market.” I wouldn’t wait for several months for the fund you want to drop down to a low price. The longer time period that you intend to hold the investment, the less the buy price matters. If you will be holding the fund until your retirement in 20, 30 or 40 years, a dollar per share up or down on the purchase price is not as significant as if you are only holding for a year or two. With index funds, your strategy should be to buy and hold for a long period of time (many years or decades).
When you are doing your research, you will find analysts recommending prices at which they would enter a position on the fund. It can be helpful to read the comments sections of articles, especially about specific funds, as you will then see the range at which other people think a fund is at a fair value to buy (and whether or not there is a consensus on the author’s valuation). As always though, consider the source when you are making investment decisions!
I’ve explained about index funds, but how do you invest in them? You will need to open a brokerage account. When you are starting out, you should open an account with a reputable company that charges minimal fees. If you have a lot of money to invest, I would strongly recommend opening an account at E*Trade or TD Ameritrade (I have been happy with my experiences with both companies and feel comfortable personally recommend them). For anyone reading this from outside of the US, I know TD Ameritrade will allow non US citizens to open accounts. There are regularly incentives for opening accounts, including cash bonuses and a certain number of free trades for a set time period. They also each have a selection of ETFs that can be traded commission free.
There are other great companies for brokerage accounts too. Before you open any account, do a quick Google search for “best online brokerage accounts” and you will find multiple up-to-date articles highlighting various companies and their current promotional offers. Here is Nerdwallet’s roundup of “Best Online Stock Brokerages” that includes a nice discussion at the end of how to pick a brokerage.
In the last couple years there has been a trend for mobile investment apps, such as Robinhood and M1 Finance. These are a nice way for a beginner with smaller amounts of money to invest to get started. The apps are simplified for ease of use and offer commission-free trading. They also offer referral bonuses if you encourage your friends to sign up. If you use my referral bonus to sign up for Robinhood, we both get one free stock. Once you have your account, you are given your own personal link to share with your friends, and so you can receive additional stocks if your friends sign up after following your link. M1 Finance has a similar promotion system, except instead of one free stock, you and your friend each receive $10. You can open an M1 Finance account using my referral link to get your first bonus.
Which platform you want to use is dependent on how you want to use it.
- I can say from experience that both E*Trade and TD Ameritrade are robust accounts, allowing you the ability to trade as much and as often as you want.
- E*Trade and TD Ameritrade each offer a selection of ETFs commission free, but otherwise trades are $6.95 each. You’ll likely get some free trades as a bonus when you open an account.
- TD Ameritrade also has an impressively well put together investing education section.
- In the Robinhood account, commissions are free for buying and selling, but you can’t use DRIP (automatically re-invest your dividends), you just get paid dividends in cash.
- The M1 Finance portfolio pie is an interesting approach and you can also trade commission free, but they only buy and sell during one trading window each day. You can’t set limit orders (name your buy or sell price) and you have less control as to exactly when and at what price the transaction takes place.
- M1 Finance doesn’t quite have a DRIP, but dividends received can be auto reinvested across all of your portfolio according to the percentages you have set per each investment. You won’t be able to effectively day trade with such an account.
If you want the most robust account, go with an account at a brokerage such as E*Trade, TD Ameritrade, Fidelity or Charles Schwab. If you want to do more simple trading and minimize fees, go with Robinhood or M1 Finance or even Vanguard.