I regularly see this question: "I have some extra money that I would love to invest. I really just don't know what to do with it. I don't know anything about investing."
I wanted to create a succinct response to this common sentiment. The purpose of this post is to be as brief as possible to get the point across. The article is for general knowledge only, and your investment decisions are ultimately up to you based on your individual situation.
When deciding what to do with money you'd like to save, there are three very common situations people are in. Those situations are:
This is money I want to save for retirement (over age 59.5)
I'm not saving for retirement, but this is money I'm not planning on using for a while, maybe 7 years or longer.
I want to save it, but I'm going to need it pretty soon.
Decide which of the 3 best applies to you, and then skip to that section.
(1) "This is money I want to save for retirement" (over age 59.5)
If you're saving for retirement, then consider these steps:
Pick the best type of account available to you
Fund the account
Invest the money into low-cost index funds
Now that you've started, spend some time learning about your investments and what strategy you want moving forward that is best for you.
Step 1 - Pick the best type of account available to you
Pick the best account available to you by using the long-term investing order of operations described in my other post: "Order of Investment Vehicles". Start at the beginning; if the option is available to you, then use that account; if it is not available, move on to the next account. The order goes like this:
When you've decided which account you want to use, if you don't already have an account open, you will need to open an account. To open an IRA or a taxable brokerage account, simply go to a trusted brokerage such as M1 Finance, Vanguard, or Fidelity and open an account through their website. To open a 401k, HSA, or 457b, you will need to talk to your HR or payroll department about how to do so.
For IRAs and taxable brokerage accounts, I like M1 Finance due to the ease of use and good investment options. You can sign up with this link to earn $30*.
Step 2 - Fund the Account
If you are using a workplace retirement account such as a 401k, then you'll have to set up deductions from your paycheck in order to fund these accounts. Talk to your HR or payroll department and they will help you set these up.
If you are using an IRA or taxable brokerage account, transfer money into the account by attaching your bank. This will make it easy to put money in the account when you want to. You can even set up regular automatic transfers if you are in a position to do so. If you need help connecting your bank to the account, here are directions from the brokerages:
Step 3 - Invest the money into low-cost index funds
If you are in a 401k or similar account through your workplace, you will probably have limited investment options. In general, you'll want to look for broad-based index funds. Examples of these types of funds include a "Total Stock Market Index Fund" or the "S&P 500".** These funds have the lowest fees, consistent past performance, and no risk of "going to zero" (losing all your money).
If you chose M1 for your IRA or taxable brokerage account, M1 will walk you through some questions to determine your situation and suggest a portfolio. You can either use that suggested portfolio, choose from a list of professional portfolios, or just pick your own investments. Paul Merriman has wonderful investment "pies" over at his website which is linked here*. If you like those, you can simply choose one and it can be your investment strategy -- M1 makes it easy!
If you didn't go with M1, you'll have to find the funds on your own. In general, you want to look for broad-based index funds. Examples include a "Total Stock Market Index Fund" or the "S&P 500". In Vanguard, that is VTI and Fidelity's is FSKAX (you can find these funds within M1 as well).** You can call Vanguard or Fidelity for help finding which funds meet your criteria. A fund like this keeps your investing fees low (less than 0.25%) while also keeping you well diversified, and there is no chance to "go to zero" (lose all your money). It's a great place to put money and sit back and forget about it for a couple decades while it earns you money. Be aware that funds like these follow the stock market as a whole, so there is "volatility", which means the value of your account will go up and down quickly and unpredictably. This is ok if you are investing for long periods of time, such as decades, because even though the stock market goes up and down, the general trend is up.
Here is a graph of the Dow Jones Industrial Average (which tracks the US stock market) since the year 2000. You can see the Dot-Com Bust in the early 2000s, the Great Depression of 2008, and the Coronavirus panic in 2020, along with smaller booms and busts along the way. Even with all these scary events, you can see that the stock market as a whole trends upward. You have to have the willpower to understand this and not sell your investments when their value goes down. As long as you are in a well-diversified index fund, it will recover eventually. Remember, you are in it for the long-run in your retirement account. So sit back and relax.
Step 4 - Now that you've started, spend some time learning about your investments and what strategy you want moving forward that is best for you
Getting started can be the hardest part sometimes. You've set yourself up with the right account and have invested in some good funds. Now that you've gotten going, take some time here and there to learn about investing in index funds. Read a blog or a book and listen to some podcasts or an audiobook. Since, you've already started, there is no rush; you can take your time and do this at a pace that is right for you. As you learn, consider what kind of strategy is right for you, and make some tweaks to make sure it fits what you want. If you would like, you can consult a financial advisor. Just make sure that this advisor is "fee-only", meaning you will be charged one set amount for the service they're providing. You do not want to be charged a percentage of your portfolio (also known as "Assets Under Management" or AUM) because AUM fees can really add up even if they may seem small.
Some good beginner investing resources are:
The Simple Path to Wealth by J.L. Collins (book)
Sound Investing by Paul Merriman (podcast)
Money for the Rest of Us by J. David Stein (book)
Risk Parity Radio by Frank Vasquez (podcast)
(2) "I'm not saving for retirement, but this is money I'm not planning on using for a while -- maybe 7 years or longer."
If you will not need the money for more than 7 years, then consider investing that money so that it can grow and earn you passive income to build your wealth. Take these steps:
Open a taxable brokerage account.
Transfer money into the account
Invest the money into low-cost index funds
Now that you've started, spend some time learning about your investments and what strategy you want moving forward that is best for you.
Step 1 - Open a taxable brokerage account.
To open a taxable brokerage account, simply go to a trusted brokerage such as M1 Finance, Vanguard, or Fidelity and open an account through their website. I like M1 Finance due to the ease of use and good investment options. If you'd like, you can sign up with this link to earn $30.
Step 2 - Transfer money into the account
Transfer money into the account by attaching your bank. This will make it easy to put money in the account when you want to. You can even set up regular automatic transfers if you are in a position to do so. If you need help connecting your bank to the account, here are directions from the brokerages:
Step 3 - Invest the money into low-cost index funds
If you chose M1, it will walk you through some questions to determine your situation and suggest a portfolio. You can either use that suggested portfolio, choose from a list of professional portfolios, or just pick your own investments. Paul Merriman has wonderful investment "pies" over at his website which is linked here. If you like those, you can simply choose one and it can be your investment strategy -- M1 makes it easy!
If you didn't go with M1, you'll have to find the funds on your own. In general, you want to look for broad-based index funds such as a "Total Stock Market Index Fund". In Vanguard, that is VTI and Fidelity's is FSKAX (you can find these funds within M1 as well).** You can call Vanguard or Fidelity for help finding which funds meet your criteria. A fund like this keeps your investing fees low (less than 0.25%) while also keeping you well diversified, and there is no chance to "go to zero" (lose all your money). It's a great place to put money and sit back and forget about it for a couple decades while it earns you money. Be aware that funds like these follow the stock market as a whole, so there is "volatility", which means the value of your account will go up and down quickly and unpredictably. This is ok if you are investing for long periods of time, such as decades, because even though the stock market goes up and down, the general trend is up.
Here is a graph of the Dow Jones Industrial Average (which tracks the US stock market) since the year 2000. You can see the Dot-Com Bust in the early 2000s, the Great Depression of 2008, and the Coronavirus panic in 2020, along with smaller booms and busts along the way. Even with all these scary events, you can see that the stock market as a whole trends upward. You have to have the willpower to understand this and not sell your investments when their value goes down. As long as you are in a well-diversified index fund, it will recover eventually.
There are two main differences between investing for retirement and investing in a taxable brokerage account:
Shorter investment horizon (may need/want the money sooner)
Capital Gains Taxes
Shorter Investment Horizon: Why "7 years or longer"?
Let's check out this chart graciously provided by Cody Garrett over at measuretwicemoney.com. It shows what has happened in the past if you were invested in the S&P 500 (an index fund of the largest 500 companies in the US). The "Time Horizon" column tells you how long the money was invested; "Range of Return" tells you the worst annualized return over that time and the best return over that time; the "Spread" tells you the difference between the worst performance and the best performance; and "Periods of Negative Returns" tells you how many of those time periods were in the negative. "Annualized Returns" means that's what percentage your investment earned (positive %) or lost (negative %) each year during that time.
What you can see in this graphic is an important point: the longer the money was invested, the more predictable the results were. You can tell this because the "spread" in returns gets smaller the longer the investment was held.
You can see that investing for 5 years or less had a meaningful chance of having a negative return (13% to 27% of 5-year or shorter investment timelines in the S&P 500 were negative). However, no 15-year period or longer has ever had a negative return. It is important to note that past performance is not a guarantee of future performance because the world is constantly changing and the factors that made the market behave like that in the past will be different in the future. However, we can still use it as a guide for what kind of risks there are when investing in the stock market. Because of this, I believe it is reasonable to suggest that an investment in something like the S&P 500, which closely follows the US Stock Market as a whole, is a good bet when investing for periods longer than about 7 years.
"If there is that risk of a negative return, then why invest it at all?"
The reason why you would invest something in the long term is to earn a passive income (money that you didn't have to actively work for). As you can see from the chart, past data shows that investments of 30 years or more have reliably returned 8% annually or more. For reference: $100,000 earning 8% each year for 30 years turns into $1,093,573 -- almost a million dollars in passive income over those 30 years. If you just had that money in a savings account, then none of that money would be yours.
For comparison, look at what happens to $10,000 invested for 10 years in the S&P 500 from 1926 to 2019.
At worst it lost about $1,315. At best, it gained $52,435. Not investing at all will guarantee that the amount of money stays the same. Considering inflation, your money is actually losing value while not earning.
(2) Capital Gains Taxes
Capital gains taxes are paid on the earnings that you make on your investments. This is something you have to consider in a taxable brokerage account that is not part of a retirement account. The important thing to note here are that:
You only pay the tax when you "realize" the gain. This essentially means when you sell the investment. If you're still holding the investment and it's going up, there won't be any taxes until you sell.
You only pay the taxes on the gains, not the entire investment. So if your $1,000 investment turns into $1,100, then you would only pay taxes on the $100 gain when you sell.
You will pay the taxes when you file your tax return, so remember to put some money aside from any investment that you sold for a gain.
Short term capital gains (investments held for less than a year) will be paid at your top marginal tax rate. Long term capital gains (held for a year or longer) will follow the capital gains tax brackets (linked). For most people, it will be 15%.
Step 4 - Now that you've started, spend some time learning about your investments and what strategy you want moving forward that is best for you.
Getting started can be the hardest part sometimes. You've set yourself up with the right account and have invested in some good funds. Now that you've gotten going, take some time here and there to learn about investing in index funds. Read a blog or a book and listen to some podcasts or an audiobook. Since, you've already started, there is no rush; you can take your time and do this at a pace that is right for you. As you learn, consider what kind of strategy is right for you, and make some tweaks to make sure it fits what you want. If you would like, you can consult a financial advisor. Just make sure that this advisor is "fee-only", meaning you will be charged one set amount for the service they're providing. You do not want to be charged a percentage of your portfolio (also known as "Assets Under Management" or AUM) because AUM fees can really add up even if they may seem small.
Some good beginner investing resources are:
The Simple Path to Wealth by J.L. Collins (book)
Sound Investing by Paul Merriman (podcast)
Money for the Rest of Us by J. David Stein (book)
Risk Parity Radio by Frank Vasquez (podcast)
(3) "I want to save it, but I'm going to need it pretty soon."
You have very few options here in terms of reliably earning money with little to no risk. The best thing to do here is put the money in a high-yield savings account (HYSA). You can find some HYSAs online such as Ally, Capital One 360, or Aspiration. You can reliably earn somewhere between 0.5% and 2%, and having your money in a savings account like this has the benefit of knowing that your money will be available when you need it.
You won't be earning as much as investing, but the risk of volatility (short-term unpredictability) of investing in something like stocks is too high for you if you need the money soon. You wouldn't want a market crash to happen right before you needed the money.
Disclaimers
* This link is my referral link. You will earn $30 if you use it to open an account at M1 Finance, and I will earn $30 as well. This is a conflict of interest when suggesting which brokerage to go with. However, I am not affiliated with M1 in any way, and I truly believe that it is the easiest way for investors to get started and have a quality investment strategy. I use it myself. Choose whichever brokerage you're most comfortable with.
** I am not a licensed investment advisor. I believe that low-cost index funds are the best way to go for almost every investor, and especially new investors. This is general advice, and it is up to you to decide ultimately which specific funds you would like to use, and which investments fit your personal needs and investment strategy.