My bad debt is gone… now what?
People often ask me how to get started investing once they’ve paid off their high-interest debt. My usual answer: Open an IRA, and start building a diversified portfolio of low-cost index funds.
The catch, of course, is that many index fund companies have large minimum investments. Fidelity index funds have a $10,000 minimum investment, and Vanguard index funds require $3,000 up front.
Matt’s note: Betterment offers a great way to invest and have no minimum balance requirement. Read my Betterment Review for more info.
What if you don’t have $10,000 laying around? Or even $3,000? What if you’re at a point right now where it takes serious work to save/invest $100 each month?
1. Get That Employer Match!
First things first: If your employer offers matching contributions to your 401(k), that’s absolutely Investing Priority #1. An immediate, guaranteed 100% return is not something to pass up.
On occasion, people tell me that they’re not comfortable investing in their 401(k) because they don’t want to put any money at risk in the stock market. To that, I have two replies:
- You can probably invest in your 401(k) without putting money in the stock market. I have yet to see a 401(k) plan that doesn’t offer a low-risk investment option such as a money market fund or short-term government bond fund.
- For most investors, it’s borderline impossible to reach their financial goals without allocating at least a portion of their portfolio toward stocks.
2. Schwab’s Commission-Free ETFs
Schwab recently began offering no-commission ETFs.
A little background: Exchange-Traded Funds (ETFs) are essentially index funds that can be bought and sold like regular stocks. They typically carry even lower expense ratios than index funds, but you must pay a brokerage commission when you buy or sell shares of them.
The fact that Schwab doesn’t charge a commission on their new ETFs (if you buy them in a Schwab account) makes them a great way to get started investing.
The catch is that their commission-free list doesn’t include any bond ETFs, and bonds are an essential part of a diversified portfolio. So be prepared to fork over a $12.95 commission every time you want to add to the bond portion of your portfolio.
One last point about Schwab: They require a $1,000 minimum initial investment to open an IRA unless you set up a monthly contribution of at least $100. (Automating your investing is a great idea anyway, so this shouldn’t be much of a drawback.)
Here’s the page to open an IRA at Schwab.
3. Vanguard’s STAR Fund
A third option is Vanguard’s STAR Fund, which has a minimum investment of only $1,000 as opposed to $3,000 like other Vanguard funds. The STAR Fund carries a low expense ratio of just 0.32% and a fairly conservative allocation with 62% of its portfolio in stocks and 38% in bonds.
It can be a great way to get started until you’ve accumulated enough to branch out into other Vanguard funds.
Here’s the page to open an IRA at Vanguard.
Just Get Started.
Any of the above options should work well–as should a whole host of other investment plans. The most important thing to know is that when you’re just beginning to invest, how much you invest is more important than how you invest. So get started!
About the Author: Mike Piper is the author of Investing Made Simple. He also blogs at The Oblivious Investor.
Thanks, Matt, for hosting this guest post. 🙂
As a quick update: Literally the day after I submitted this article, Schwab announced that they’re reducing their stock trade commissions to $8.95 rather than $12.95 (effective 1/19/2010). So option #2 above just got a little better!
Outstanding advice for the many people coming out of the recent debt mess! Sometimes it’s hard to get started when you have only a small amount to start with, but these are excellent suggestions.
I think the tension for a lot of people though is, do we put $1000 into some sort of investment, or into an emergency fund? If funds are that tight, the EM looks like the better choice.
Great question/comment Kevin.
Regarding putting money toward savings or investments, I suggest putting money toward investments only if our Emergency Fund is already funded to our liking. For my wife and I the amount of EF savings we are comfortable with before investing is $18,000, which is 6 months of expenses for us.
Here are several articles I wrote on this very subject:
I’m in complete agreement to have an emergency fund before investing in higher risk investments. Like Matt, my wife and I go with 6 months of expenses. (Though if I weren’t self-employed, we’d probably go lower.)
In the interest of discussion, The Incidental Economist has a thought-provoking article on why many people’s emergency funds are too large: http://theincidentaleconomist.com/rationality-of-emergency-funds/
Great stuff! #2 is a really great option and pretty easy to maintain! Thanks Mike!
I didn’t know about the Scwab deal on ETFs – good to know… I would also add sharebuilder to the list, they are now owned by ING, and they are one of the cheapest ways I’ve found for new investors to get started…
Good point about Sharebuilder! They can be a great place to start an automatic investment program.
I have accounts with Schwab, Vanguard, and ING Sharebuilder. I am only using Schwab at the moment because of their low cost barriers to entry.
I would advise people starting out to use Schwab as a broker and purchase either Schwab ETFs or Index Funds in an IRA account. Then… when the investment is built up enough to transfer to a Vanguard account, they can choose to do that or stay w/Schwab.
Paying off your house can also be a great investment, for most people gaining a guaranteed 4%-8%. Also remember to have a liquid Emergency fund before investing money in the market.
Another good option is Sound Mind Investing Fund, a mutual fund that follows the Sound Mind Investing Newsletter’s Upgrading strategy, allowing you to open an IRA with them and add small amounts every month to one fund while having a portfolio balanced across the entire market. It does have a $2500 minimum for an IRA, unless you set up an auto contribution of $100/month, then it is only $1000/min.
http://www.smifund.com/
Yep, paying off a mortgage can be a great idea if your after-tax interest rate is such that it’s likely to prove better than other options.
As to SMIFX, it certainly has a decent track record. On the other hand, I’d be wary about investing in a fund with an expense ratio of 1.22% (approximately 1% per year more than a US equity index fund) and portfolio turnover of 141%, given that those two figures have been shown to be the most reliable predictors of future performance.
Great info Mike. My company offers a 403(b) and shamefully, I haven’t investigated it fully to see what I’m missing. I’ll be fixing that soon enough, though.
On another note, I’ve ignored the $50 promotion that Sharebuilder has been running because I want to pay my debts first. Sharebuilder would be my first choice since I’m saving with ING, but are there any comparable online brokerages out there?
Definitely take a look to see if your 403(b) includes a match. If it does, that’s probably priority #1 in terms of investing after paying off debt. If it doesn’t, then an IRA is probably a better option first.
As to where to open an IRA: Sharebuilder can be a good choice, as can Schwab as I mentioned above. Once you have larger amounts to invest, going directly to Vanguard makes a lot of sense to me in terms of minimizing costs.
Either way, I wouldn’t let a $50 promotion determine where you open your account. Go with the company that will have the lowest ongoing costs. If they happen to offer a bonus, neat. If not, no big deal.
Appreciate the tips, Mike!
The Vanguard STAR fund is new to me, I just went with one of their 10 year lifecycle funds which extra money that I have to begin getting into investing.
Hello,
I just wanted to advise that if you open an Investor’s Checking account with Schwab, this will wave the $1,000 minimum requirement for the brokerage account.
I have a quick question. How liquid should an emergency fund be? Should the entire thing be that liquid. I as because I was thinking a percentage of my emergency fund, say about 60%, into a 5-year CD. Is that a bad idea? I think there are some liquid CDs that allow two withdrawals without penalty. Any thoughts or comments would be helpful.
Thanks!
In my opinion, it depends on how big your emergency fund is and how likely you think it might be for you to have to tap into all of it.
If your EF is only $1,000, or even a couple months of expenses, I’d suggest that the whole thing be very liquid.
But if it’s, say, 6 month of expenses, it wouldn’t seem terribly crazy to me to put a portion of it in something like a longer-term CD, provided that you could get to the money in case you need to.
It’s also worth considering the size of the difference in rates. How much more do you stand to earn by using the 5-year CD? Is that enough to make it worth giving up some liquidity?
Good primer for someone like me who plans to start investing more this year.. thanks!
Jackie,
If you want to take advantage of long term CD rates in your emergency fund, you need to build a CD ladder. Buy a 6 month CD, a one year CD, an 18 month CD, etc, out to five years at the same time. When the 6 month matures, buy a 5 year CD. When the one year matures, buy a 5 year CD, etc. Eventually you end up with your entire emergency fund invested in 10, 5 year CD’s with one coming due every 6 months, which may be liquid enough for most people. It also allows you to take advantage of rising rates.
Personally, for the moment even most 5 year cd’s aren’t paying enough extra to make me move from my perfectly liquid ALLY MMA, but you asked. For the moment, the very best rates (%4+) can be found in “high-yield” checking accounts. Most of which have a high minimum balance, and require a significant number of debit card transactions every month. I don’t have one because I don’t like debit cards, but if you want the best rate and are willing to do the research, there are two places you can look:
http://www.highyieldcheckingdeals.com/
http://www.checkingfinder.com/
I think ‘just get started’ is the best piece of advice of all.
So many people coming out of debt have a following wind of living within their means, managing their money and so on, and the willpower to make what they believe happen.
By moving your debt payments into investment payments the day you can, you tap into this, and don’t get used to have too much money about.
Before you know it compound interest is working for you, not against you. 🙂
This is so very true.
While I think that people who spend several years or more digging themselves out of debt should definitely reward themselves for each milestone reached… they most certainly should not get “used to” a raised standard of living. Since they are most likely already behind on their retirement investing, they should definitely just shift all recaptured cash flow toward their IRAs, 401k’s, 403b’s, or wherever else they may be able to invest.
Great comment Monevator, this may very well be the subject of an upcoming article!
Try e-Trade. They have a a lot of no-load, no-transaction fee mutual fund options. And a lot of them have no minimum purchase. I have my Roth IRA at e-trade.
I used to use e-Trade but dumped them for Schwab. I have several reasons why, all of which are to lengthy to get into in an article comment. I’m glad they are working out for you though… no-load/no-transaction is good.
Investing sure is complicated. Seems to me that that the old adage is true. It takes money to make money. I will learn more about it someday when I get to that baby step.