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If you understand the concept of index fund investing, you may be ready to invest but unsure about the mechanics of getting started. Learn the steps of this process.
Get Ready to Invest
Here are steps to consider:
Make sure you have money to invest
Verify that you have money in a checking or savings account or a steady source of income that gives you extra cash each month. And, before you get started investing, be sure you will not need your savings or extra income to pay bills.
Ideally, you’ll have enough to open an account with a brokerage firm and invest on a regular basis. Brokerage account minimums vary (some require no minimum to get started) and monthly purchases can run you as little as $25. You could certainly find a way to invest, for example, $100 on a one-time basis. But you’ll be more likely to build wealth if you can invest on a regular basis, such as buying shares of a mutual fund or ETF monthly.
Figure out what type of account you want to open
When you complete a brokerage account application, typically you’ll need to choose the type of account you want to open. Generally, if investing for your own future, you’ll open a regular brokerage account (taxable) or an IRA (tax-advantaged).
What I love about a regular taxable account is that there are few restrictions on putting money into the account or taking it out. Unlike IRAs, regular brokerage accounts don’t require achieving a certain amount of earned income (salary, hourly wages, freelance income, etc.) or keeping your income below a certain threshold. I can put as much or as little in the account as I want, depending on the minimums established by the brokerage firm. I’ll need to pay taxes on any dividends, mutual fund distributions, and capital gains that occur within a regular brokerage account.
In regard to an IRA, there are two kinds: Traditional and Roth. Generally, investors must have earned income to contribute to either of these accounts. Further, there are eligibility restrictions, contribution caps, and other rules, etc. for the Traditional IRA and the Roth IRA. Compared to a regular brokerage account, the advantage of the IRA is that investments held inside of these accounts grow tax-free. That is, when you sell a $1,000 investment for $2,000, you don’t owe any income tax on this capital gain.
Because of a couple of cool benefits, many people put money in a Roth IRA if they can. Depending on the circumstances, you may be able to withdraw your contributions from the Roth IRA without tax consequences. When you retire, you can take qualified distributions free of income taxes.
Select an online brokerage firm
There are a lot of great online brokerage firms from which to choose. For example, you might open an account with E*Trade, Fidelity, Schwab, or TD Ameritrade. Those firms allow you to invest in a variety of stocks, mutual funds, and ETFs at a relatively low cost starting with a relatively low account minimum.
As an aside, you could open an investment account with a company that is not a discount, online brokerage firm. You could invest with the investment arm of your bank. For example, if you have a checking account with Wells Fargo, then you might open an investment account with WellsTrade.
You might also consider newer, innovative firms such as Betterment and Motif Investing, each with unique advantages and drawbacks.
At Betterment, you choose a type of account and set a financial goal. The firm makes a recommendation in the form of a selection of ETFs for a diversified portfolio; you can choose to be more aggressive or more conservative but the basics are figured out for you. Similarly, Motif Investing offers Horizon Motifs (which are comprised of ETFs) as well as a catalog of motifs that allow investors to put money into stocks selected according to a big idea, theme, or motif.
In general, account funding is similar with these firms. However, depending on how you set up your accounts, Betterment is designed to immediately purchase shares (whereas other firms require you to fund your account and then initiate a purchase separately).
Choose investments for your account
If you are a beginning or passive investor, you might consider buying low-cost index mutual funds or index ETFs. ETFs are considered more tax-efficient than mutual funds but this distinction doesn’t matter much if you hold the investments within an IRA. So, a simple rule of thumb would be to buy mutual funds for IRAs and buy ETFs for regular brokerage accounts if you want to hold both in your portfolio.
Most brokerage firms help you find index funds among mutual funds and ETFs using screening tools. When using these tools and making a selection, consider checking annual expense ratios (these should be low) and fund management style (the style should be passive for true index funds), and compare actual performance with market indexes (these should be similar) to be sure you are truly getting an index fund. Also, you need to decide what index you want to track, such as the S&P 500 or Russell 3000.
Note that brokerage firms (and banks) often develop and sell their own brand of index funds. So, you might buy Fidelity funds from Fidelity, Schwab funds from Schwab, Vanguard funds from Vanguard, etc. This approach is often the simplest and cost-effective.
Fund the investment account
After confirming that money is available to invest, choosing a brokerage firm, and opening a brokerage account, the next big step is funding the investment account. Here’s what to do:
- Decide what checking or savings account will serve as the account to which you transfer funds to and from the brokerage account
- Get your bank’s routing number and the number of your checking or savings account
- Make sure you have online access to your banking information, such as bank balances, deposits, and withdrawals
- Open an account with your favorite online brokerage firm, such as E*Trade, Fidelity, Schwab, TD Ameritrade, etc. if you haven’t already done so
- Establish a link between your brokerage account and your bank account
- Initiate a transfer from your bank to the brokerage firm to fund your account
Note that #4 is typically the most involved. Launch this process within the brokerage account’s dashboard. Look for webpages such as “move money,” “transfer money,” or “enroll account.” Respond to prompts that involve entering your bank’s routing number and your bank account number. Then, check your bank account online to find the trial deposits made by your brokerage firm (usually, these numbers will be something like $0.22 or $0.34). Next, enter the trial deposits on the broker’s website to verify a) you are the owner of the bank account and b) you authorize transactions between the brokerage and bank accounts.
Hopefully, setting up the link to facilitate an ACH transfer (not a wire transfer) between the bank and brokerage firm is easy. But if you have problems (I was once stumped by one of the major firms because its process was more cumbersome than others), call a customer service representative to help you deal with the problem.
Alternatively, fund your account by bringing a check to a branch if your brokerage firm has offices in your town. You may also be able to mail a check, account deposit form, and other necessary documents to the brokerage firm.
I like the convenience of online transfers. By setting up this link, I can readily buy more shares of the index fund I select, initiate a position in a new index fund, start or discontinue automatic investing, and transfer funds from the brokerage firm to my bank account.
Finally, to get started, decide what you want to buy and be sure you have the funds to cover the purchase of your selected investment. If you choose a mutual fund, you’ll need to make sure you have enough money to make an initial investment plus any transaction charges. If you choose an ETF, you’ll need to have enough money to purchase one share plus any transaction charges. Many index funds don’t carry transaction charges but check to make sure.
To execute the transaction, find the mutual fund or ETF listing (such as SWPPX for Scwhab S&P 500 Index Fund) and follow the prompts. Typically, you’ll click on “buy” or “trade,” enter the amount you want to buy (a dollar amount or number of shares), and then confirm the order. An order may be filled immediately (for ETFs, if you purchase at the market price) or after the close of the trading day (for mutual funds).
That’s it! I’ve gone into detail for those who may be interested in the finer points of getting started in investing. After you’ve opened an account and set up the banking connection, buying and selling shares is easy.