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Learning how to invest in index funds is easy when you have the right guidance and knowledge. Below are 5 steps to start investing smartly and quickly on your own:
- Decide on the Right Investment Account
- Select an Online Broker
- Determine your Initial Deposit
- Choose your Blend of Investment Vehicles
- Set an Ongoing Strategy and Maintenance Plan
Disclaimer: Just Start Investing is not a certified financial advisor. This post lays out the steps to get started and the investing principles that we practice.
Another Note: This simple and high level guide gives you only the necessary information to learn how to invest in index funds. If you are interested in getting more in depth on certain topics, there are links throughout this post that provide more information.
Step 1: Decide on the Right Investment Account
In general, when starting to invest in index funds, most people opt to max out tax-advantaged accounts (like Roth IRAs) and then deposit additional funds into a personal brokerage account.
Listed below are the most common types of investment accounts. You can get all the details on investment accounts here if you need further help deciding where to start.
- Personal Brokerage Account: A basic and flexible account with few limitations (but also no tax benefits).
- No tax benefits
- No limits to contributions
- Traditional IRA (or 401k): Retirement accounts that provide tax benefits when contributing funds.
- Can contribute pre-tax
- Limited annual contributions ($19,000 for 401k, $6,000 for IRAs)
- Roth IRA: A retirement account that provides tax benefits when withdrawing earnings.
- Can withdraw earnings without taxes (after age 59.5)
- Limited annual contributions ($6,000 for IRAs)
This is not an exhaustive list, but they are the top choices for beginners.
How JSI Invests: First, we max out employer contributions in a 401k. Second, we max out contributions to a Roth IRA. Third, we deposit additional funds into a Personal Brokerage Account.
Step 2: Select an Online Broker
- Traditional Brokers: Give you more self control over your investments, as you select exactly which vehicles to invest in (while keeping costs very low if you go with Vanguard or Schwab).
- Pros: Low fees; 100% control over your investments
- Con: Requires slightly more oversight and attention
- Robo-Advisors: Online platforms that do 99% of the work for you. In most cases, you complete a set of questions before opening an account and the advisor will automatically select investment vehicles for you based on your answers.
- Pros: Easy to use; tax-loss harvesting capabilities (which is complicated and can sometimes save you money)
- Con: Slightly more expensive
Top Traditional Brokers:
How JSI Invests: Follow this step by step guide to open an account and start investing with Schwab today (JSI uses Schwab to invest). You can use Schwab to open IRAs, personal brokerage accounts, and other types of accounts as needed.
Step 3: Determine your Initial Deposit
Only you can decide the right amount of money to deposit into investing accounts based on your income and monthly expenses. It’s best to first understand your goals and then set a savings and investing plan to reach them.
As stated above, it is usually wise to first max out tax advantaged accounts (i.e. a Roth IRA and 401k) and then contribute leftover savings to a personal brokerage account.
At the end of the day, it is important to note that you must invest what you are comfortable with and do not invest money you need for every day expenses.
How JSI Invests: In order, first we contribute 5-10% (or more) to a 401k. Then, we put the annual $6,000 into a Roth IRA. Last, any additional funds go into a personal brokerage account. It’s key to find a budget that works for you and maximizes your saving ability.
Step 4: Choose your Blend of Investment Vehicles
There are a few asset classes and investment vehicles to choose from when starting to invest in index funds. Asset classes are broad categories and types of investments, like stocks and bonds. Investment vehicles are specific investments that you buy and sell.
Asset classes: Types of investments.
- Equities / Stocks – pieces of individual companies.
- Bonds – a loan that you issue to a company, government, etc.
- Real Estate – physical property.
- Cash – money on hand or in a bank account.
Investment Vehicles: Where you invest your money.
- Individual Stocks – buying pieces of individual companies, like Apple (AAPL) and Walmart (WMT).
- Mutual Funds – A group of assets (typically stocks, but can be bonds and other vehicles) that you can purchase by pooling money with other investors (i.e. VTSAX). Allows for easy diversification, but are usually actively managed by fund managers, which leads to higher costs.
- ETFs & Index Funds – A group of assets (typically stocks, but can be bonds and other vehicles) that you can purchase by pooling money with other investors (i.e. SCHX). Allows for easy diversification, and mirror various markets/funds (like the S&P 500) without active management.
- Bonds – Bonds can be invested in individually or through ETFs and various funds. They offer a lower return (typically 2-3% annual) and are deemed as safer investments than stocks (you will get paid unless the underlying entity behind the bond defaults).
How JSI Invests: In low cost bond and stock index funds or ETFs. Below is our approximate blend of investments (keep in mind we are planning on being invested for a long time horizon):
- 60%: Large Cap Stock ETF/Index Fund
- 20%: Small / Mid Cap Stock ETF/Index Fund
- 10%: International Stock ETF/Index Fund
- 5%: Bond ETF/Index Fund
- 5%: REIT ETF/Index Fund
Step 5: Set an Ongoing Strategy and Maintenance Plan
Setting an ongoing strategy and maintenance plan is important for all investors. While you don’t need to check on your investments daily (and you probably shouldn’t), you should still be depositing funds monthly and rebalancing your portfolio annually.
How JSI Invests: There are two things we do ongoing:
- Annually: Rebalance the portfolio to ensure the weight of equities vs fixed income is in line with set goals, as needed.
- Monthly: Deposit money. Based on an ongoing savings plan that fits our monthly income and expenses.
Want more guidance on how to invest in index funds? Get started today by following this step by step guide to start investing with Charles Schwab or get set up with Betterment.