Recently, there’s been a focus on bitcoin and the “hottest coins on the market”, but conventional advice has always been to put money into tax advantaged accounts like the Roth IRA and invest in diversified low-fee index funds.
Why? Here’s a quick look at the S&P 500, which has been growing over the last 35+ years, beating hedge fund managers, and 8 of the largest 10 mutual funds are passive or index based.
But before we jump into things, let’s first address why invest at all.
In many of the conversations I’ve had with peers and fellow students, most put money management and investments off until later, waiting for the days when they would have more funds to actually invest, or they didn’t have the time to look through the US financial regulations or decide what to invest in.
I’ll address both of these issues, and lay out a concrete easy to follow way to start investing with little to no funds. For the sake of simplicity, I’ll assume you’re around the age of a typical college student.
Why it’s better to invest earlier instead of later:
In the US, there’s a special kind of retirement account called a Roth IRA. This account lets you put in money after taxes and lets you withdraw them and any interest or earnings in retirement without having to pay taxes on it. You can contribute a maximum of $5,500 a year, but only if you earn less than $118,000 a year before taxes. This means that later on in your career, you might not be able to contribute to the account, so it won’t matter how much you have.
Here’s some quick math from Steven Blum, a Yale alumni who holds annual panels on Financial Life after Yale ²
Over time, major stock indices continue to beat inflation by 7% (as they often have over long periods of time in the past). If all these assumptions were to hold (they won’t), so that (with a few nausea-inducing bumps) your savings remain hard at work for 40 years, growing in real purchasing power at an annual rate of 7%, your savings would grow from $20,000 to $20,000 * (1.07 ^ 40) ….. to roughly $300,000 in today’s purchasing power! If you were aiming for (say) $1,000,000 by the time you retired, just these early savings ($20,000) would — in this scenario — have gotten you 30% of the way to your goal!
Caveat: As with many retirement funds, there are fees to withdrawing money before you actually retire, so don’t put in any money that you might need sooner rather than later.
As for the question of how to get money to invest, there isn’t a solution that fits for everyone, but as our time until graduation draws steadily closer, our post-college salaries will also hopefully also be a way to either start paying back some debt or investing in savings.
What do I invest in?
Now, I’m not an economist or hedge fund manager. For that reason, I turn to the advice of people that do investing for a living.
“With all assets, I recommend that people invest in index funds because they’re transparent, understandable, and low-cost.” — David Swensen, who managed the Yale endowment from over $1 billion in 1985 to over $17 billion in 2009 ¹
“I buy the market through index funds. … The game of doing something active is fraught with loses…there’s no evidence that market timing works.” — Eugene Fama, Nobel Laureate in Economics³
The general consensus is that unless you’re willing to spend the time to look through financial disclosures and take risks, you’re better off just investing in a diversified low-fee index fund.
How do I invest?
Of the many low-cost diversified investment services out there, there are a couple that are the cheapest to use.
Option 1: Vanguard
There’s a reason why Vanguard has 8.5 times the money of its competitors combined. They charge some of the lowest rates for index funds/ETFs at 0.08% or less. You’ll have to do some more work to maintain your portfolio, but the low fees are definitely worth it.
You’ll be able to choose exactly what to invest in. This allows you to specify certain percentages of your funds going into certain sectors of the US or the world market.
The one drawback of Vanguard is that for some of their lowest-cost funds, you’ll need at least $3,000 to invest into those funds, with $10,000 to invest in the preferred shares. For this reason, it’s usually better to invest in the lower fees for ETFs on Vanguard, but watch out for the transaction fees. Don’t be tempted to buy and sell to rebalance too often. The experts recommended that once a year was enough.
Option 2: Wealthfront
Wealthfront is an example of a robo-advisor. You give them money to manage, along with a risk score and they will automatically decide an optimal distribution and execute the trade for you. You’ll never have to (or be able to) decide what to buy. You can only decide the risk score, which essentially determines how much of your portfolio is in risky holdings like stocks, versus safer ones like bonds. As with any investment though, you’ll need to be more risky to get better returns, and it’s much easier to be riskier when you’re younger.
I personally like Wealthfront the best since it manages your assets for free as long as they’re under the $15,000 cap, and I find that I typically won’t have more than around that much to invest as a college student for now anyway.
Their fee structure means that as long as you have under that amount, there are no fees. Afterwards, there’s a flat fee of 0.25%. However, most of Vanguard’s funds have a fee of <0.25%, which is why above $15,000 it’ll be better to switch to an account with Vanguard instead.
As for convenience, it’s one of the best, since you just decide a risk score out of 10, then leave your money for them to diversify automatically.
There are a bunch of other investment services out there including a similar robo-advisor Betterment with a longer trial period the more you invest, and more conventional types of investment that work with banks like Merrill Edge. I don’t recommend it, but there’s also active no-cost trading like RobinHood for people who disagree with Nobel laureates and think they can beat the market.
Which Account type do I get?
The first type of fund to open is a Roth IRA. As I mentioned earlier, under US Regulations, you’re able to contribute $5,500 every year. You can still contribute for 2017 until April! The gains on the investments won’t be taxed at all. I’ve learned recently that you’ll even be able to open such an account if you’re not a US citizen as long as you earn money in the US and have a SSN.
Not contributing up to the maximum means you’ll essentially be turning down interest-free money every year. It’s always better to max out your contributions to the Roth IRA before investing in a different account.
Compound interest means that you could earn up to 15 times what you put in today. That’s an incredible amount for retirement. The only downside is that you won’t be able to withdraw the money until you retire.
The other type of fund is a general investment account. You’ll be able to deposit and withdraw at will, but since ETFs will usually only have taxes on the gains when you sell the ETF, it’s advantageous to simply hold on to the ETF. You’ll want this type of account to deposit all of your investment holdings that aren’t captured by the limit on the Roth IRA.
Thanks for reading! This is my first non-tech related post. Feel free to leave a clap, comment below or read some of my other musings.