How to Invest – Hui Ying Wen

How to open an investment account and invest in a stock index fund (for USA residents only). If you haven’t already, read “What Is Investing?” Updated March 31, 2024.

Before you start investing

Here are things to think about before you open your first investment account:

Have money to invest: The money you use for investing should be money that you won’t need for many, many years (see the “lost from wallet” test in “What Is Investing?”). It can be as little $100 or so, or thousands of dollars. Also, it is best if you can keep investing more money over time, whether it’s every month, once a year, or whenever you happen to have spare cash.

Pay off debts: I see debt as the “negative” of investing: investing gives you dividends every year, while the interest rate on your debt increases the amount you owe every year. Instead of investing, it’s better to sink every free dollar you have into getting rid of, say, credit card bills (these have obscenely high interest rates). However, some debts – like a mortgage or a large student loan – can take many years to pay off, and you might not want to wait years to start investing. Although my general advice is to get rid of debt before you start investing, the choice is up to you.

Survey existing investments: Did your workplace open a retirement account for you? Did a parent or relative set something up for you when you were young? Before starting a new investment, it’s good to learn about what you may already have. You may even want to change the investments in existing accounts, based on what you learned here.

Specific advice for workplace retirement accounts (click to show more)

If your employer will match your investment contribution up to a certain amount, invest as much as you can up to that limit. Otherwise, you’re throwing away free money.
By default, your money is probably invested in a “target retirement” fund. The names of these funds contain a year, estimated to be close to when you’ll retire. Such funds often charge a higher fee (I’ll explain this later) than a stock index fund. The only thing special about these funds is that, as you get close to retirement, it automatically moves a bit more of your money into something called “bonds” every year, which are less risky than stocks. This simple feature is not worth the higher fee. I strongly suggest moving your money into a stock index fund with a low fee. Then, if you want, manually move a bit more money into a bond fund (also with a low fee) once a year when you get close to retirement.

Type of investment account: You can open two main kinds of investment accounts: “IRA” (Individual Retirement Account) and a regular, non-retirement account.

IRA – If you do not already have a retirement account, you will need to open one. (Even though my workplace has opened a retirement account for me, I still opened an IRA of my own.) When you open a retirement account, you will choose between a “Roth” IRA and a “traditional” IRA. Here are the differences between the two. (If you don’t want to think about it, choose a Roth IRA.)

Regular investment account – For a regular investment account, you have to pay taxes every year on money you make (I’ll cover this later), but you won’t have to for a retirement account. Nevertheless, here is why you might also want a regular investment account, in addition to a retirement account:

You can’t use the money in a retirement account until you’re a certain age, or you may have to pay penalties. A workplace retirement account will also have a rule like this. However, you can take money out of a regular investment account anytime.
There’s a limit, which can differ based on your age and income, on how much you’re allowed to invest each year in IRAs. A workplace retirement account also has its own limits. If you want to invest more money than these limits, you will need a regular investment account.

There are other types of investment accounts for very specific purposes, like saving for a child’s college tuition. I won’t cover them here, but I encourage you to do your own research.

Open your investment account(s)

Go to Vanguard and open a new account. As of this writing, they are the investment company that charges the lowest fees I know (I’ll explain this later), and their website is incredibly easy to use.

This step is really easy, similar to opening a bank account. Here are some notes:

Vanguard will ask you how you will fund your new account. The easiest way is bank transfer. You’ll need your bank account number and your bank’s 9-digit ABA routing number (easily found via Google, somewhere on your bank’s website, or on the bottom of your checks).
Each type of account (Roth IRA, traditional IRA, regular investing) will have to be opened separately. After you open your first account, open other ones with the same user name, so you’ll see all of them in one place when you log into Vanguard.
Vanguard will open a fund for you called a “settlement fund.” This is just a place to park your money when you’re not investing it. For example, you can transfer money from your bank into this settlement fund, then use the money in the settlement fund to buy shares of the stock index fund you want to invest in.
Sign up for “e-delivery,” in which they send you documents via email instead of postal mail. If you don’t, you may get charged a $20 account service fee every year.

If any of these instructions are outdated, or if there’s something important or confusing that I should cover, send me a message at the bottom of this page. When in doubt, just pick the most default-looking choice; you can usually change things later. Even if you open the wrong account type, you can simply not use it and open another one.

Start investing

Once you have opened your investment account(s), go in there and buy shares of the “Vanguard Total Stock Market Index Fund.” This is a stock index fund that contains thousands of US companies, including tiny ones you’ve never heard of and big ones like Apple, Microsoft, etc.

The most important thing you need to know about this fund is its fee, or “expense ratio,” shown on the fund’s profile page. The expense ratio is the percentage of your invested money that Vanguard takes from you. You won’t actually see this money deducted from your account: it gets subtracted from the fund’s profits. For example, if the fund made profits of 4% one year, but its expense ratio is 1%, you’ll see your investment increase by only 3% (4% minus 1%). An expense ratio of 1% is way too high – it should be as close to zero as possible. Personally, I never invest in funds that charge more than 0.1% or 0.2%.

Why buy this fund? Can I invest in another fund? (click to show more)

Here are some notes on buying shares of this fund:

ETF vs. mutual fund: You can buy this fund in two forms, “ETF” (exchange-traded fund) and “mutual fund,” depending on how much money you have to invest:

ETF – You can only buy “whole” numbers of ETF shares. For example, if 1 share of the stock index fund you want to buy costs $120, you can buy 1 share for $120 or 2 shares for $240, but you can’t invest exactly $200. The minimum amount you can invest is the price of 1 share, which is shown as the “market price” for the current day on the fund’s profile page: “Vanguard Total Stock Market ETF” (ticker symbol: VTI).

Mutual fund – Unlike with an ETF, you can purchase any dollar amount each time in a mutual fund, even as little as $1. However, the minimum investment – your first purchase – needs to be at least a certain amount. For example, the “Vanguard Total Stock Market Index Fund” (ticker symbol: VTSAX) requires an initial minimum investment of $3,000.

Reinvesting: When you buy a new fund, make sure it is set to “reinvest” your dividends (use the dividends to buy more shares of this fund).

What to do from now on

Do not sell your shares: You might be alarmed to see the value of your investment dropping over its first few days. It might even keep dropping over the next year. Do not get frightened and sell your shares to try to stop “losing money.” Your money is now part of the US economy, which drops and rises in value each day, generating small profits in some years and large profits in other years. Seeing this can be scary, but this is a better place for your money to be than in a bank account where it gradually loses value with each passing year. I suggest logging into Vanguard only to invest money, and forget that it exists otherwise.

Needless to say, do not try “clever” tricks like selling your shares when they’ve gone up in value, hoping for the price of the shares to drop, then buying them again at a lower price.

Keep investing: In fact, when the stock market is doing poorly, it’s a great time to buy more shares before their price rises back up! (However, don’t try to “time” your investing by waiting for the price of shares to drop. Invest money as soon as you have some.)

Taxes: You have to pay taxes on dividends earned in a regular investment account. Vanguard will send you the required tax forms every year to file with your taxes (I enter the forms into TurboTax each year – no need for calculations myself.) Also, the amount you invest in a traditional IRA is tax-deductible (again, tax preparation aid like TurboTax easily take care of this).

That’s it. You’re investing.

Resources

“A Random Walk Down Wall Street” by Burton G. Malkiel is a more modern-day version of the classic book “The Intelligent Investor” recommended in “What Is Investing?” Since it was written closer to our present day, you may find it more helpful in explaining the practical nuts-and-bolts of investing as it exists for us today.

Next: My Investments