Motley Fool Money - Before You Open an Investment Account

Episode Date: April 20, 2024

You just got a job and want to start investing. Now what? Robert Brokamp and Matt Frankel break down the choices facing new investors, and give some advice for long-term success. They discuss: - The three things needed to invest in individual stocks. - How to select a brokerage. - The fees that investors will encounter, and how to avoid some of them. Companies mentioned: HOOD, SOFI, SCHW Host: Robert Brokamp Guest: Matt Frankel Producer: Ricky Mulvey Engineer: Rick Engdahl Learn more about your ad choices. Visit megaphone.fm/adchoices

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I don't know about you, bro. with just friends and family, the most common investing question I get asked is I just started a new job. The 401k people gave me this 100-page booklet. What do I do? Right, exactly. I'm Ricky Mulvey, and that's Matt Frankel and Robert Brokamp, two of my colleagues who are importantly for this show, certified financial planners. Today's show is for you if you want to start investing, but maybe a little intimidated by the choices that you have. Every investor had to start somewhere. Whether it's a centa billionaire like Warren Buffett, or just one of the thousands of

of Americans who retire every day, these folks had to take an initial step to get on the road to financial independence. And that first step usually begins by opening an investment account. Sounds easy, but if you're relatively new to investing, the choices and the terminology can be a bit perplexing. But have no fear, because we're here to highlight four steps to opening your first account. And it all starts with step number one, decide the purpose and time frame of the account. Investors today certainly have a lot more choice than we did when we were getting started, right?

That is definitely true. When I opened my first investment account, I think there might have been like four choices. There was TD Ameritrade, E-Trade. It was so long ago, it wasn't even called TD Ameritrade then. But there were like four choices. And they all were pretty much the same in terms of how you entered orders, what commissions they charged, and everything like that. So a couple of things.

First decide the purpose of the account. Why are you investing? Do you want to just occasionally buy and sell stocks? Nothing wrong with that if that's what you want to do. Do you need to set up an account to invest for retirement? Do you need to set up an account to save for your kids to go to college? There's a bunch of different purposes. And a couple of points for beginners to keep in mind. One, don't put any money into the stock market that you need in the next, say, five years. Don't put any money into stocks that you can't afford to. to lose, period. But generally speaking, the market's going to overall going to go up over time. Portfolio stocks is going to do well over time. But don't put anything you need for a near-term need. I mentioned saving for college. If your kid's 14 right now, don't put their college fund in the stock market. If they're three, then maybe. So retirement accounts, regular brokerage accounts, which you'll also see referred to as taxable brokerage accounts are the way to save for non-retirement goals. And there are a bunch of different options within each category. There's a traditional IRA or Roth IRA. There's an individual investment account. You can open

a joint investment account. But generally, they can all be into those two categories, retirement accounts and non-retirement accounts. Yeah, and the key that remember there with the IRA, and it stands for individual retirement account, is that you get tax benefits by putting it into an IRA, but the trade-off is that if you take the money out before age 59.5, you may pay taxes and penalties. You definitely want to leave the money in the IRA that you can leave a loan until you reach retirement. That's why if you have another goal, such as maybe you're investing for a house one day or something else like that, you should choose the regular taxable brokerage account. Yeah, I would definitely agree with that. I mean,

retirement accounts are great. They're my biggest tax deduction every year. that's the same for a lot of Americans. Even if you have a 401k at work, you might not realize it, but all the money that you're putting into that is a tax deduction. It's not included in the number you get in your W2 usually has that already taken out of it. Retirement accounts are great in the tax benefits. You don't have to pay dividend tax every year. If you sell a stock for a profit, you don't have to pay capital gains tax at the end of the year. But as Bro just mentioned, that tradeoff is you can't take money out until you're 59.5 in most cases without getting a penalty for early withdrawals or unless you have some other sort of exemption.

Right, exactly. And so let's move on to step number two since you mentioned retirement accounts, and that is make the most of your work-sponsored retirement plan. And for most people, that's a 401K, but it could be your 403B or the federal thrift savings plan. And of course, people should start here because it's the number one goal for most Americans. Everyone wants to retire.

Yeah, so if you're having a tough time figuring out what to do with your workplace 401K. And honestly, I don't know about you, bro, with just friends and family, the most common investing question I get asked is I just started a new job. The 401K people gave me this 100-page booklet. What do I do? Right, exactly. The first thing is, take a breath. It's really not as complicated as that book might make it look. A couple important things about your 401K. Generally, your employer will offer what's called a 401k match. You have to decide a percentage of your paycheck that you want deferred into that account. Say, 5% of your pay. 6% of your pay, whatever it may be, and your employer usually will agree to match your contributions

up to a certain percentage of your paycheck. Under no circumstances should you contribute less than your employer is willing to match. When you take a 5% pay cut from your employer if they asked you? No, of course not. So why would you refuse an extra 5% of your compensation if they're willing to match that? And one statistic that alarms me every year is roughly 20,000. 25% of Americans do not take full advantage of their employer match. And so at bare minimum, you should be doing that. Choose your investments. This is what the 100-page book is mostly about.

It's like a five-page description on every investment fund that they offer in a lot of cases. It doesn't need to be that complicated. You have a menu, if you will, of index funds to choose from. And there are two main kinds. There are stock-based index funds and fixed income funds. And if you want, your plan usually has an advisor that can help you out with this. But generally speaking, you want most of your investments in stocks when you're young. You want to gradually shift it to bonds or fixed income when you're older. And they have these things called target

date retirement funds, which if you really have no clue what I just talked about for the past like five sentences, a target date retirement fund could be a great option for you. What a target date fund does is it does all the hard work for you. You figure out about what year you want to retire, 2040, 2045. They're usually in five-year increments. And if you invest in a target date fund with your approximate retirement date in mind, the fund itself will gradually shift your allocations from a stock mix to a fixed income mix gradually over time. It does all the heavy lifting for you. You don't even have to think about it. And it can be that easy. Yeah, it's a great way to start if you're not yet an expert in investing. I would say it's a

sort of a middle-of-the-road investment. So I wouldn't necessarily stay there forever, but it is an outstanding place to start. Another thing I'll highlight to is that more and more employers are automatically enrolling employees into the 401k, which make you feel like, oh, then I don't have to do anything. But often what happens is you are enrolled at a rate that is below the rate that you would get to take advantage of the full match. So you want to actively make sure that you're saving enough at least to get the match. And ideally, experts these days say you should be saving 10 to 15% of your income for retirement. And that would include the match as well.

So don't just be defaulted into the plan. It's good that they do that. But look at what they've defaulted you into to make sure that you are saving enough and have chosen the right investments. Now, there's one thing when you sign up for your 401K that often confuses people or they just ignore it. and that is filling out the beneficiary designations. Tell us a little bit about what those are, Matt. Yeah, so the beneficiary designations determine what will happen to the account if something happens to you. And something mortally important happens to you as if you pass away.

Right, exactly. I'll let Bro be morbid about it. But there's two types of beneficiaries you get to choose. There are what are called primary beneficiaries and what are called secondary or contingent beneficiaries. And so the primary beneficiary, let's say that, I mean, I don't have a 401K because I'm an independent contractor, but let's say you have a 401k and you pass away tomorrow. Your primary beneficiaries would be in line to inherit that money. Most people who are married use their spouse for the primary beneficiary. It could be whoever you want. If you're a young, single person, who do you want to have the money? I can't really tell you. But most people use their spouse. If you have kids, most people use their kids for the secondary beneficiary or contingent beneficiaries, because that is,

if your primary beneficiary is no longer around at the time of your passing, then it would pass to your secondary beneficiaries. So personally, I have my wife listed as my primary beneficiary and my two children, or trusts for them, rather, listed as contingent beneficiaries. You could do whatever you want, but basically primary is first in line. If they're not around when you pass, pass away, it goes to your secondary beneficiaries. Very important because it keeps your 401K out of probate after you pass. Yeah, it's, it makes sure that your account will go to who you wanted to, and it will go to them quicker because it bypasses probate, and they will have more options for that account once they inherit it. So even though it may seem like just a silly little thing

when you sign up for your 401k, it's very important to fill that out and to update it regularly. All right, so we talked about the employer-sponsored account. Good place to start if you get the match. There are some downsides, though. They might have high costs, or you might have to be able to just be restricted to the selection of mutual funds within that account. So let's move on to step number three. Choose the best discount broker. It could be a discount broker for an IRA or for a taxable brokerage account, but this is an account in which you have a lot more choices in terms of what to invest in. Yeah, and just before we start on that section, it's worth noting that you can have a 401k and an IRA. A lot of people don't realize that.

As long as if your income is under a certain level, you can use both. IRAs, whether it's traditional or Roth, are generally designed to help low-to-moderate income people save for retirement. They're not meant for the ultra-high-income people. So if you have a moderate income, it changes every year according to IRS rules, you can have both. there's absolutely nothing wrong if your employer is willing to match up to 5%, contribute 5% of your paycheck to your 401k to get your match, and then contribute extra money to the IRA so you have more control over it. You're not limited to that menu of mutual funds. If you want to put some of your retirement savings in Microsoft stock, a IRA through a brokerage can let you do that, not recommending Microsoft, but it's possible. So there's a lot to choose from. Like I mentioned earlier, 20 years ago, there were not very many options when it came to online brokerage.

That was a pretty new idea. Now there are dozens, if not over 100, different ways you can invest in stocks either online through an app. And there's a lot to kind of consider. First, I would say the investment platform. If you are a beginner, you need to choose a beginner-friendly platform. Ideally, you should choose that. You should choose something with a lot of educational resources, which some of these app-based platforms, let's say Robin Hood or SoFi or one of those, they make it really easy to buy

and sell a stock. They don't make it that easy if you want to learn how to invest in stocks. That's something that the, quote, legacy brokers do a whole lot better. I wrote a piece for our sister site The Ascent recently on why. I have two brokerage accounts, one at SOFI and one was Schwab. It's because Schwab has a lot of things that SOFI doesn't, including a lot of educational resources, a lot of tools you can use to screen stocks, a lot of like charting tools, a lot of things that are really nice to have, especially when you're just getting started, especially

on the educational side. One thing I will point out is when you're shopping around most brokerage platforms, whether it's a web-based platform, an app-based platform, whatever, will let you test it out without using real money. Most have a play-money mode. I know Schwab does. I know TD Ameritrade did. I know even the app-based ones like Robin Hood usually will let you do it without committing any actual money, so you can get a feel for the platform, learn how to navigate it before you put actual money to work. And I would highly recommend trying a couple of them. On the Ascent, we have some great brokerage reviews so you can kind of narrow it down to things that, you know, fit what you want,

you'll offer the account types you want and things like that. But there's no way we can tell you which platform you're going to like the best. I can't tell you. That's a matter of personal preference. So I would recommend test driving a few of them before you made a choice. If someone is new to investing, they might feel like, I don't feel comfortable doing this alone. So do some of these discount brokers offer some sort of in-person consultation? Yes, and some offer what are called Robo-Advisor platforms that will do it for you. It's essentially, it's similar to a 401K, actually, in the Target Retirement Funds I mentioned, where they'll just kind of create an age-appropriate portfolio for you.

If you want to kind of do it yourself but need some guidance, there are platforms that have a lot of in-person guidance. Some even have branch offices. You can go talk to somebody. I know Schwab has a branch, you know, no more than three blocks from where I'm sitting right now. There are some that actually have in-person branches. There are some that will give you access to real live CFPs, even without a charge. So far is one that does that. You can actually talk to an advisor, tell them your situation.

They'll walk you through some basic investment ideas maybe or how to screen ETFs or how to choose your first mutual fund or how much you need to put into a certain mutual fund. They can help you with things like that. You don't necessarily have to navigate the platform. Some will provide in-person help, some it's over the phone, some through live chat. But in most cases, you can get some level of help. One of the most important things to consider with investing is fees. So these days, they're called discount brokers for a reason, and that is most of them don't charge fees. And most of them don't charge fees. Most of them don't charge commissions on most types of investments. So where's the differentiation there with fees?

Yeah. So you're right. Stock trading commissions are pretty much a thing of the past. That would have been very nice when I got started. At one point I added up, I did a rough calculation of how much I paid in commissions over the years just being an investor, being a long-term investor, not a day trader or anything, and it was in the thousands. So that's a big luxury that people getting started today have.

Most brokers have what's called the NTF list for mutual funds, which stands for no transaction fee. It's a collection of maybe a few hundred, maybe a few thousand, mutual funds that you can trade without any commissions or transaction fees whatsoever. If the fund you want is not on that list, for example, Vanguard mutual funds are often not on the no transaction fee list with a lot of brokers. You will have to pay a commission. Now, I've seen brokers that have mutual fund commissions of $999 for all mutual funds. where no transaction fee was just flat rate commission, or commissions of up to $49.95 and above for a mutual fund transaction if it's not on the list. With mutual funds, it's also worth mentioning you at most mutual fund companies offer direct purchases. With Vanguard, like I just mentioned,

you could open a Vanguard account to buy mutual funds if that's what you choose to do. But that's a big commission differentiator. There are transfer fees if you want to transfer your account out, some will charge you a lot of $100 or so to move your account to another broker. So if you're not sure you like a broker, you sign up for an account, you want to transfer the money out, how much is that going to cost you? Because like I said, we can talk about the platforms all we want until you actually try it. You're not going to know how much you like it. So transfer fees are one big differentiator. There are others too.

Some charge for paper statements if you want them. Some don't. But for the most part, those are the big differences. Okay, so let's say you decided, all right, I'm going to be an investor. I've decided the purpose of this money, so you've chosen an IRA or a taxable brokerage account. You went to a place like the assent. You chose your provider. You opened the account. You send in the money, but it doesn't stop there because we come to step number four, choose your investments because you don't want it just sitting in there in cash for the next few decades. Yeah, and this is where it gets tougher. The process of open. putting a brokerage account these days is surprisingly easy. You could probably do it in five minutes in a lot of cases. Choosing your investments is something else. So the biggest decision is do you want to buy mutual funds, ETFs, or other passive investment vehicles, or do you

want to buy individual stocks? There's no perfect answer to that question. What I tell people is if you have the, you have to have three things to invest in individual stocks. You have to have the time to research stocks and do your homework. You need the knowledge to invest in stocks wisely, which you can get from reading things like The Motley Fool in The Ascent. And you need the desire to do it. A lot of people just don't really care about the stock market if I'm being totally out. There's no way to lose my wife's attention quicker than for me to start talking about a stock. Some people just don't like it. It's boring to them. And that's fine. There's a reason that Warren Buffett said, the best way for most people to invest is index funds. It's because

a lot of people don't have those three characteristics that you need to be able to invest in stocks well. We absolutely believe you can beat the market with individual stocks. That's a lot of the premise of why we're here. But there's absolutely nothing wrong with indexing buying ETFs. A basic SEP 500 ETF would have returned about 10% annually over the past 50% of, over the past 50%. 50 years, that can build some serious wealth over time. A lot of people don't realize that. They think those, that index funds are boring, and they may be in the sense that you buy them and leave them alone. And, you know, there's really nothing to do after you buy them. But the returns are not boring. So if you are at all uncomfortable with buying individual stocks, or even if you want to

buy individual stocks, but you also would feel a lot more comfortable having like a backbone to your portfolio, there's absolutely nothing wrong with index funds, ETFs or mutual funds. Yeah, I definitely agree. Great place to start, and it's not either or. I personally have a large percentage of my portfolio in index funds in the S&P 500, but also international stocks, small cap stocks, value stocks to create a diversified portfolio. But then I also have individual stocks. And here at the Mali Fool would believe that you eventually should get up to a point where you're at least owning 25 companies to have a diversified portfolio of individual stocks. Ideally, you know, no more than 10% of your portfolio

in one stock, no more than 30% in one sector. And that may sound like a lot, but these days, without any commissions and the ability to buy fractional shares, which is basically you could buy a half a share of Apple or a half a share of Amazon, you can actually build a diversified portfolio with not a lot of money. So if you're just getting started, I think starting with index funds is the place to start. But then you can, sort of creep into individual stocks, just buying a share or two, and see if you like it. You may love it and decide to eventually, I'm going to invest mostly in individual companies. But most people I think, what they'll find is it's kind of interesting. I'm going to do it with 5% to 10% of

my portfolio, but put the rest in index funds, and that's perfectly fine. Yeah, I mean, I consider myself a pretty knowledgeable person when it comes to evaluating individual stocks, and I have about half of my portfolio in index funds. There's nothing wrong. There's nothing wrong with the backbone. Bro's right with fractional shares. It's much easier to diversify. And by the way, not all brokers offer the ability to buy fractional shares. Just some of the big ones don't. E-trade does not offer the ability to buy fractional shares right now. Some only offer it with certain companies, like companies that are in the S&P 500. I think it was either Fidelity or Schwab that did that. Not all brokers allow fractional shares.

When you're just getting started, that could be one of the things you want to look for when shopping for a broker. But I have about... I think six index funds right now. The S&P, I have a small cap index fund, which I think is a great opportunity right now. I have a dividend index fund, a real estate index fund. It goes on. And I also own about 35 individual stocks. Some of them are very small positions, none more than 10% of my portfolio. But even people who are very, very knowledgeable about the stock market, there's nothing wrong with indexing with a good bit of your portfolio. you. All right, Matt, let's close with some parting wisdom. What final pieces of advice do you have

for someone who wants to open their very first investment account? Don't rush. And what I mean by that is take your time when you're researching investments, take your time when you're figuring out how to put in an order. Because if you put in an order the wrong way and order 100 shares instead of 10, you really can't reverse that without selling. It's a pain. Don't invest in with margin without really knowing what you're doing. Don't invest in any individual stock without really understanding what the company does, why you're buying it, and if you're paying a good price, do the homework before you buy any individual stocks and take advantage of all of the resources your broker has. You would be surprised at how extensive the educational libraries of some of the brokers are.

There's no rush. No one's going to ask how long it took between when you opened your account to when you bought your first stock. In the grand scheme of things, it's not going to make a big difference in your returns if you take a week and spend an hour each night reading about how the order system works, how ETFs work, making a list of your favorite ETFs. So my biggest advice to someone starting is take your time and learn from the mistakes of others. I've certainly written a lot about the mistakes I've made as an early investor. You're not going to avoid them all. everyone makes mistakes, but take your time and don't get discouraged and get started. So my final piece of advice will be building on that and maybe even somewhat contradictory,

and that I agree with you that you should take your time and not rush into investment, especially individual stocks that you don't understand because that was one of the mistakes I made when I was an early investor. But you don't want to wait too long. Get money into the amount. I don't mean years. Exactly. Exactly. Weeks is fine, not years. I opened my first account, which was an IRA back in the 90s when I was a struggling elementary school teacher. And I did a pretty good job at choosing the broker because I'm still with that provider. But like you said, I just rushed into the investments that I made.

I bought an actively managed fund just because I had a great one-year return, didn't pay any attention to its long-term return or expenses. And then I just bought some individual stocks just because I like the goods of services. Didn't really look into whether they were great investments. So I should have put in more time there. But in the end, it didn't really matter that much because I just got started. That account to which I contributed maybe several thousand dollars is worth tens of thousands of dollars now because I got money into the account. I gradually learned more about investing and then I gave it enough time to grow through the years. So I agree with you. Don't rush into things you don't understand, but don't wait too long.

Survey after survey of older Americans show that their biggest financial regret is that they didn't stand. start investing sooner. So just get started. Yeah, I would agree with that. Like I said, don't wait years. But, you know, one of the big, one of the biggest mistakes that I made when I first started was I would hear about a stock on TV. I'd take five minutes to look over the, you know, the numbers and hit the buy button. That's what I mean by take your time. Like, you know, if you, if you hear a hot tip, do your homework, don't rush into it. You'll probably thank yourself later. All right, that might be a good place to end it.

Like I said, learn all you can. Check out the Ascent. It's definitely full of great information on all of the different investment account options you can hope. If you finished today's show and you were familiar with a lot of the stuff that Bro and Matt had to say, I hope you'll consider sharing it with somebody who may find value in the episode. As always, people on the program may own stocks mentioned, and The Motley Fool may have formal recommendations for or against, so don't buy or sell anything based solely on what you hear.

I'm Ricky Mulvey. Thanks for listening. We'll be back tomorrow.