Investing can be challenging—and even totally overwhelming. So what is the best way to invest?
First, the jargon can be a lot to absorb: target-date funds, index funds, mutual funds, exchange-traded funds, hedge funds, Roth IRAs, 401(k), 403(b), 529s, strategic asset allocation, tactical asset allocation, asset location, and tax-loss harvesting…. We could keep going, but your eyes have probably glossed over already.
The path of least resistance is often to just save money in a “high-yield savings account” and leave it at that. In fact, this is a great idea if you’re still building up an initial emergency fund.
However, if you have already created a good reserve of cash in a savings account, it may be a mistake not to start investing additional money. Cash accounts earn about 1% these days and inflation is roughly 2%—investing may help you outpace inflation over time in a way cash alone cannot.
What is investing?
Saving and investing are unique things, and it is important to know the difference. Saving is a general concept, where you set aside money for personal goals—it can be in cash or securities. Investing is putting a portion of those savings to work by exchanging risk for return, and hopefully outpacing inflation to meet your long-term goals. That could mean investing in the stock market or something else.
As a simple example: If you put $50,000 in a 1% cash savings account for the next 25 years, you’d end up with around just a little more than $64,000 at a constant rate of return. But if you put that same $50,000 in an investment account with a 5% annual return, you have approximately $174,000 in 25 years.
The first stop on the investment journey is likely your 401(k)—and hopefully, you’re already diverting a percentage of your paycheck into one. Typically your employer will offer you a 401(k) plan, and you’ll have a selection of funds to choose from; if you’re just getting started using a target-date fund is a good place to start. Then there is the kind of investing you might do in addition to that. Below we’ll go over two of the popular ways to start investing—doing it yourself and robo-advised portfolios.
Doing It Yourself
If you are passionate about investing—you like to spend time researching and tracking your investments—and you want to minimize your fees, then self-directed brokerage with Fidelity, Schwab, eTrade, Vanguard or even Robinhood are all options.
With all these platforms you can trade single stocks or buy shares of funds. You can also access different types of accounts at most of them, including traditional IRAs, Roth IRA, 529 plans, and plain vanilla investment accounts.
To be successful, you need to establish an investing plan on your own and stick with it over decades when the stock market is up and down—and sometimes way down.
The big drawback with this approach stems from the fact that you are on your own—and your emotions might not always work in your favor. Research shows that self-directed investors often get sucked into two traps—trying to beat the market by picking stocks or time the market by buying on the dips and selling near peaks.
Picking single stocks to “beat the market” is not theoretically impossible, but it is almost impossible to do consistently successfully over time. When picking stocks you should be aware that you are playing the most competitive game in the world with the most highly compensated professionals (hedge fund managers) playing against you.
Additionally, when picking stocks you may face a host of other things that could hurt your overall performance: First, you make be taking on unnecessary risk as your portfolio may not be well diversified; next, you might have trading fees which can drag on your investment returns; last, you will likely be paying short-term capital gains taxes if you’re doing a lot of trading.
Even if you’re not planning on single-stock picking, but simply assembling your own portfolio of funds—you’ll need to do things like diversify your fund selection and rebalance your portfolio over time.
If you decide to invest on your own, educate yourself first. A few popular investing books include Burton Malkiel’s book A Random Walk Down Wall Street, Jeremy Siegel’s Stocks for the Long Run and John Bogle’s The Little Book of Common Sense Investing.
Doing It With a Little Help from Robots
If your investing style could be described as “set it and forget it” and you’d rather not spend a lot of time managing your investments, using an automated investing service, aka robo-advisor, could be a better option for you.
The leading independent services Betterment and Wealthfront are a good solution for both new and experienced investors alike. Startup Ellevest is another service that’s aimed at women investors and also uses a predetermined portfolio adjusted to your goals. Charles Schwab’s Intelligent Portfolios is another option in this space.
All of these services offer a pre-determined portfolio that has a mix of stocks and bonds. Depending on the length of time you anticipating investing your money, the service customizes a portfolio with the appropriate mix of stocks and bonds.
You cannot pick stocks or the funds yourself, but you can access regular investing accounts, along with Roth and traditional IRAs. Both Wealthfront and Betterment offer a host of additional high-tech tools (asset location and tax-loss harvesting) that help you be as tax-savvy as possible; Wealthfront also offers 529 accounts.
Overall, they are easy to use with low minimums and fees and the “robo” will handle nearly all aspects of your portfolio management.
What is right for one person isn’t right for everyone. Get yourself educated and consider what solution will work well for you over decades—and then stick to it.