Decide how much money to invest
Paying off high-interest debt trumps investing.
If you’re paying an interest rate higher than expected investment returns, say above 6%, you’ll be better off eliminating this debt before investing.
Once you’ve paid off high-interest debt, you need to build an emergency fund.
Most experts recommend 3 to 6 months living expenses and keeping this in cash, e.g. in a checking account.
The intent of this money is to cover you if you lose your job, have a health emergency, etc.
You don’t want this money invested—the same emergency that necessitates this cash can cause investments to collapse
(e.g. imagine those who lost their jobs in March 2020 while their company’s stock price crashed).
With high-interest debt eliminated and an emergency fund available, you’re no longer tethered to cash.
Holding excess cash over the long haul is almost always suboptimal.
Once you’re in this situation, you probably want to invest the remaining money.
If you're saving for retirement, most experts recommend investing about 15% of your pay.
For more information see "How much to save for retirement."
You'll need to save on top of this for other things like a house down payment.
Create an account with a low-fee brokerage
- Your brokerage will store your funds and buy/sell assets on your behalf.
- Identify your specific needs and find a brokerage that satisfies them. E.g. do you need an IRA, a low account minimum, or cheap trades?
- You have many brokerages to choose from.
NerdWallet has some good suggestions.
Many people saving for retirement have an employer-sponsored 401(k).
It typically makes sense to use that for retirement savings.
Others saving for retirement may want to use a traditional or Roth IRA.
If these retirement accounts make sense for you, ensure your brokerage offers them (most do, but check).
These accounts provide tax savings that effectively boost your returns.
Regarding fees, it may be difficult to select the optimal brokerage.
While many brokerages now offer commission-free trades, they make money other ways.
Sometimes, as in
payment for order flow (PFOF),
you end up buying a bit higher and selling a bit lower in exchange for a “free trade.”
Brokerages are competitive, so most of the big names won’t charge egregiously more than others.
NerdWallet has some suggestions if you’re trying to pick a brokerage.
Vanguard is a nonprofit that’s pretty good for most people,
particularly those buying Vanguard funds (my only complaint is that their website/UI feels awkward/outdated to me).
Determine your asset allocation
For example, you may choose to invest 50% of your money in domestic stocks, 20% in foreign stocks and 30% in bonds.
- This is the most complex step.
- Spend most of your time initially thinking about your goals and limitations, not about what assets to buy. For example, if you'll likely need to access
this money soon, then higher-risk assets like stocks may not be suitable.
- Check for existing funds already designed to meet your needs. For example, if your goal is to put away money for retirement in 2045, check out the
Vanguard 2045 retirement fund.
- Check out our articles on diversification, beating the market and
a simple view of assets.
- The sooner you may need to access your funds, the more conservative you should be. Being conservative typically means investing more in high quality bonds (less in stocks).
Like choosing a shirt to buy, your asset allocation is dependent on your specific circumstances.
You may select a shirt based on your gender, size, and where you plan to wear it.
Even the best t-shirt may not be a good choice on a winter day in Alaska.
Likewise for your investment portfolio—you need to be very clear about your scenario and personality before selecting it.
Even if your neighbor has an awesome portfolio, you may not want to copy it.
If you’re saving money to buy a house in the next few years, your approach should be quite different from a 25-year-old saving for retirement in 40 years.
If you’re afraid of losses (or think there’s any chance you’ll panic/sell after big losses), then your portfolio should be quite
different to someone who can really stomach wild fluctuations in their net worth.
(Just be sure you know who you are—many people who think they are in the latter category end up panic selling in a downturn.)
Once you know your scenario, look for existing portfolios that fit.
For example, if you’re saving for retirement in a specific year you’ll find “target date” retirement funds that are set up for your scenario (e.g. the
Vanguard Target Retirement 2045 fund).
If your goal is preventing short-term loss (as opposed to higher long-term gains) then something more like an
all weather portfolio may suit your needs.
You may want to deviate from these portfolios to some extent to fit your personality.
If you’re willing to accept a risk of loss in exchange for a potentially large short-term gain, you may want to buy your favorite cryptocurrency.
Unless you really know what you’re doing, you may want to limit such deviations to a small percentage of your portfolio.
Unless you want to analyze businesses for a living, take advantage of low-cost
Buying an index fund is analogous to getting a high score on a (very) difficult test without studying.
Sure, you could spend your nights and weekends studying businesses and have a chance at doing better, but it’s less likely and steals time from family, leisure, ….
If you're considering a non-standard asset, you may want to review
information from the SEC before taking action.
Transfer money to your brokerage
- Typically you will do this on their website.
- You should not incur any fees for this transaction, and most brokerages will not require a minimum investment.
- Ensure you are on the correct website before providing sensitive information.
- It may take several business days for your funds to clear, before you can start investing.
Purchase your assets
There are two main ways people do this: (1) purchase all assets you can as soon as possible, or
(2) gradually purchase assets over
time using a method like
The former can be scary: it's possibly you could invest just before a major market downturn.
It can be hard to stay invested if you suffer a big loss so early.
The second option may be better for some new investors.
More slowly investing your money, using an option like dollar-cost averaging, prevents major losses early in your investing career.
This helps some people build confidence and sleep better at night.
A market downturn can even be a good thing—you get to buy investments at a discount!
However, realize that most investments like stocks and bonds have positive returns on the average day.
Hence, you'll more often than not (not always) be penalized for days out of the market.
Shift and rebalance your portfolio
- Typically 1 or 2 times a year is plenty.
- If you invested 70% of your money in stocks and the stock market had a great year, you may end the year with 80% of your money in stocks.
Although psychologically difficult, you may want to sell stocks to get back to your intended 70% allocation.
- If you are nearing a time when you may want to access your funds, gradually shift to a more conservative portfolio.
The idea is to avoid having to sell a large amount of volatile assets during a downturn.
Wondering if you're on track for retirement? Check out our article "How much to save fore retirement."