Investing Is Easy: Just Set It and (Mostly) Forget It
When a lot people think of investing, they imagine painstakingly picking individual stocks, tracking their daily performance and constantly buying and selling. This might make for good movies and TV shows, and sure, you could hire a financial adviser to do this for you, but the fact of the matter is that most financial advisers fail to beat the market. So, why pay a financial adviser a bunch of money for something you could do on your own? (If you’re dealing with an abnormally large sum of money, though, and are a bit over your head, a good financial adviser can be a worthwhile endeavor.)Instead, most smart investors try to match the market, which, over a long period of time, tends to improve. Past performance isn’t an indicator of future performance, but it’s all we have—and over the long term, the stock market averages about a 7% annual return. That’s pretty solid!
So, all you need to do is pick a couple funds that attempt to mimic the total market’s behavior, and—for the most part—leave them alone for 20 or 30 years. It’s very simple, and it’s something everyone can and should do. In fact, it’s one of the best ways to effortlessly build wealth in the long term.
Many refer to this as “buy and hold” or “set it and forget it” investing—because it requires little effort and you don’t have to constantly track your portfolio. You will have to check in once a year or so, but it takes minimal work, and you can mostly leave it alone. Which is perfect for us average joes.
Step Zero: Open an Investment Account
If you don’t have an employer-sponsored 401(k), you’ll need to open an investment account in order to actually start investing. If this is your first investment account, you’ll probably want to open an Individual Retirement Account, or IRA. We’ve outlined the process here, but here are the basics:- Decide whether you want a Traditional or a Roth IRA. If you’re self-employed, you might want a SEP-IRA. Learn about the differences here.
- Pick an investment firm that offers an IRA, like Vanguard or Fidelity. Many banks offer them, too. Wells Fargo, for example, has a few to choose from.
- Open an account. If you have assets in an old 401(k) to add to the account, make sure to roll over properly.
- Connect your checking or savings to the account and start buying index funds.
Step One: Figure Out Your “Asset Allocation”
How much of each depends on your age, risk tolerance, and investment goals. A common rule of thumb is:
110 - your age = the percentage of your portfolio that should be stocksSo, if you’re 30, you’d put 80% of your portfolio in stocks (110 - 30 = 80) and the remaining 20% in lower-risk bonds. If you’re more conservative, however, you may want to put 30% in bonds instead. It’s up to you, but this is a good starting point.
Then, as you grow older, you should adjust your asset allocation accordingly. So if you’re following the 110 rule above, you’ll want to buy more bonds when you’re 40, so that you have 20% in bonds instead of 10—the idea being that, the closer you get to retirement, the less volatile your portfolio becomes.
Personal Capital’s asset allocation tool actually lets you personalize your portfolio a little more. The basic formula mentioned above is a good starting point, but it uses only your age as a guideline. With Personal Capital’s tool, you fill out a portfolio and answer questions about when you plan to retire and how much risk you’re comfortable with. Based on your answers, they give you a more customized allocation.
This is a great primer on asset allocation if you’d like to learn more. (These aren’t the only types of assets you can hold, either—you can also invest in real estate, TIPS, and other things—but for simplicity’s sake, we’re going to start with stocks and bonds.)
Step Two: Choose Some Index Funds
The best way to get started investing is to choose a couple of index funds. An index fund is a collection of stocks or bonds that aims to mirror a specific portion of the market. They’re great because they have particularly low fees (or expense ratios). That, coupled with the fact that they attempt to match the market, mean higher returns for you over the long term. You can read more about index funds (and how they differ from other funds) in this article, if you’re interested.Of course, there are a lot of index funds out there, so let’s talk about how to pick which ones are right for you.
The Ideal Scenario: Pick a “Lazy Portfolio”
You can create a complex portfolio of many funds, but you only really need two or three to get started. You don’t need to start from scratch and pick funds at random, either—one of the best ways to get started is with a “lazy portfolio”. Think of it as a “starter pack” for index funds: a couple of basic funds that will get you a simple, balanced portfolio that matches the market in a few different classes. You can check out a few example lazy portfolios over at the Bogleheads Wiki, but let’s walk through some easy ones.In an IRA or regular investment account, you’ll be able to choose whatever index funds you want, so let’s talk about this ideal scenario. If you’re investing in a 401(k) with limited choices, we’ll get to that in a bit—just stick with us.
So, let’s say you want an asset allocation of 90% stocks and 10% bonds, the easiest portfolio would be Rick Ferri’s two-fund portfolio, which uses two very popular funds from Vanguard:
The total world stock index fund contains around 50% US stocks and 50% international stocks. If you prefer to change that weighting—some might like to put less than 50% into international stocks, for example—you could use a three-fund portfolio like this one:
Also, keep in mind: some index funds have minimum buy-ins. This means you might have to buy at least $3,000 worth of the fund to buy any at all. We name a few funds with cheaper buy-ins here. Note that as you put more into your account, you may qualify for funds with lower net expense ratios, like Vanguard’s Admiral Shares or Fidelity’s Advantage Class.
That’s all you need to get started. Invest in two or three funds, make sure they have low expense ratios (ideally under 0.25% or so, but the lower the better), and make sure they match your ideal asset allocation. Again, there are a lot of other things you can invest in too—real estate, TIPS, and so on—but you don’t need a perfect portfolio right out of the gate. The goal is to get started, and this is a great starting point.
The Less-Than-Ideal Scenario: If You Have a Limiting 401k
The above option is perfect for a basic investment account or an IRA, where you have lots of choices. However, if you have a 401(k) through your employer—or a similar retirement plan like a 403(b)—you may have a more limited selection of funds. Some are decent, some are horrible—but either way, your 401(k) is worth taking advantage of for the tax benefits.Let’s say you have a 401(k) with some decent funds, but nothing as simple as the total stock and bond market funds listed above. For example, maybe you have the total bond fund, but you’re missing the total stock market fund. You can approximate the total stock market with some other available funds, as described here. For example, you could combine:
- An S&P 500 fund (which includes 500 of the largest companies in the US)
- A mid-cap index fund (which includes medium-sized companies, making up for the medium-sized companies missing from the S&P 500)
- A small-cap index fund (which includes smaller companies, making up for the small companies missing from the S&P 500)
The Crappy Scenario: If Your 401k Has a Bad Selection of Expensive Funds
Okay, let’s say your 401(k) is missing some of the funds you’d need to “round out” your asset allocation. Or, maybe your 401(k) just plain sucks and has nothing but expensive funds (with expense ratios above 1%). What do you do then?As we’ve talked about before, there are a lot of advantages to having both a 401k and an IRA, and this strategy is especially useful if your 401(k) doesn’t offer a lot of flexibility. If you decide to have both, this is ideally how you’d invest in them:
- Contribute only enough in 401k to take advantage of employer match.
- Contribute any additional savings to an IRA, which has more flexibility.
- If you still have money after maxing out your IRA (you can see the limits here), then go ahead and put it in your 401k.
- If you max out both your 401k and your IRA (wow, good for you), you can open a regular taxable investment account. These accounts are also good for more medium-term goals, since retirement accounts don’t let you withdraw until later in life.
Step Three: Contribute Regularly and Rebalance Annually
So you’ve bought your funds, and you’re all proud of the asset allocation you put together. Good job! Now, your best bet is to set up a recurring deposit—say, whenever you get your monthly paycheck—so you’re always saving a bit of money in your investment account. If you have a 401(k), this is especially important, since that money is tax-deferred! This will help your investments grow over time. Treat your savings and investments like a bill, and you’ll never be tempted to overspend.Then, once you’re done, forget about it.
Seriously, walk away. Don’t check it every couple days, don’t obsess over whether the market’s going up or down, don’t do anything—remember, you’re in this for the long haul, and market dips and peaks don’t matter as much as the general trend over years and years.
You will, however, want to check your portfolio every year or so and “re-balance”. What does that mean? Let’s say you’re invested in 20% bonds, 50% US stocks, and 30% international stocks, like so:
A Much Simpler Alternative to All of The Above: Target-Date Funds
If all that sounds a little too complicated, there is a simpler solution: invest all your money into a target-date fund.Target-date funds (also sometimes called lifecycle funds) aim to do the work for you by splitting up your money into a balanced mix of stocks, bonds, and other holdings. It then adjusts them over time, rebalancing regularly and adjusting its asset allocation as you grow older (so as you grow older, it’ll automatically put more into bonds for you). Nice, huh?
It’s insanely convenient: you just pick the one with the year you plan to retire, put all of your money into it, and just let it grow. So, if you plan to retire in 2055, you’d choose the 2055 target date fund from Vanguard, Fidelity, or whomever you’re investing with. If you plan to retire in 2050, you’d choose that one instead. You can also choose a different one depending on your risk tolerance. If you prefer to be more conservative, for example, you can choose one with an earlier retirement date, that might give you more bonds at an earlier age. Or vice-versa. Just be sure to check your target date fund’s prospectus to see how it changes its asset allocation over time. Some may be more conservative or risky than you expect.
Similarly, if you’re opening an IRA or taxable investment account, you can try a robo-advisor, which will pick your investments for you based on your goals.
So why go through all the trouble of picking your own index funds when automatic solutions like target-date funds are so convenient? Well, target-date funds—while great—tend to have slightly higher fees. Some will be higher than others, so use an expense ratio calculator like this one to see how much it would matter in the long term.
To give an example: Say you’ve put together your own portfolio with Vanguard funds averaging an expense ratio of 0.05%, compared to Vanguard’s target-date fund, which clocks in at 0.18%—still low, by many standards, but still .13% higher than the do-it-yourself method.
If you max out your 401k every year for 30 years, that .13% savings can add up to $50,000 more in your account, just for taking the minimal effort of the DIY approach. That’s a decent amount of money for a little work. And Vanguard’s target-date funds are considered quite cheap compared to their brethren, so this is a best-case comparison. If you have a less-than-ideal 401(k), the difference could be much more than $50,000.
I don’t mean to poo-poo target-date funds. They’re fantastic for people who don’t want to do a bunch of work, and would otherwise not invest at all—and if that’s you, by all means, dump all your money in a target-date fund and let it grow! But creating your own portfolio gives you more control and lower fees, which can add up to a lot...as long as you do your homework.
That may seem complicated, but once you get over the initial hump, you’ll have a simple, set-and-forget portfolio ready to start making you money. These aren’t the only investing strategies in the world, mind you, but this is some of the most popular advice, and it’s perfect for a beginner portfolio—and when it comes to investing, the most important thing is that you get started now.
If you want some more resources on these strategies, here are a few good places to start:
- If you’re interested in a more detailed introduction to investing, try a book like The Four Pillars of Investing, the Bogleheads’ Guide to Retirement Planning, or I Will Teach You To Be Rich (which is slightly more about personal finance, but has a good beginner investing section)
- The Bogleheads Wiki, which we’ve linked to a few times in this article, has some great information, including lots of other “lazy portfolios” and examples.
- The /r/personalfinance wiki at Reddit has a lot of basic information on all things personal finance, including investing. Their step-by-step guide to fund selection is fantastically laid out.
- Mr. Money Mustache’s blog and forum are both good places for personal finance and investing info along these same lines.
