When I graduated from college and got my first job, I was excited.  For the first time ever, I would have real money.  In my new job I had deductions for insurance and benefits, but no 401(k) or IRA options out of the box for a new manager.  I took my cash and bought lots of fun things like snazzy suits and cool drinks.  I did not, however, buy into my future.

I am in the camp of finance bloggers like Ramit Sethi: I don’t think we should be super cheap and cut our spending to fit our income.  I think we should make more to live the life we want.  One of the easiest ways to do that without stressing is to start with an automatic investment.  I had the first part in place – direct deposit – but did not take the next steps.

Websites like ING Direct make automatic investing really easy.  ING, and other online banking sites, let you schedule automatic transfers ahead of time.  You can transfer funds to a savings account, another bank, or a brokerage firm account.  If you make it automatic, you can do it in a small dose and start your investments.  You don’t need $1000 to start; you only need to make a commitment to invest at a regular interval.  Many people call this “paying yourself first.”

At ShareBuilder, owned by ING, you pay $4 per trade.  If you decide to invest $40 per month, that is only two weeks of coffee or one dinner with the girlfriend/boyfriend, you can build up a portfolio of nearly $500 in your first year.  I am sure you can live without an extra $40 per month.  When I started automatically investing, I started at over $200 per month.  You can also make similar investments with Charles Schwab (where I do my stock trading), Scottrade, E*TRADE, or any other full service or online firm.

The next part is deciding on what to buy.  Stocks, bonds, mutual funds, ETFs, index funds, the list goes on.  As a young person you can take risk, but you don’t want all of your eggs in one basket.  Avoid individual stocks and bonds as they do not offer any diversity.  I suggest avoiding most mutual funds too, as they do not always perform well and often have high fees.  I would look into ETFs and index funds.  Pick one that reflects the market you would rather invest in.  You can buy into a Dow Jones Industrial Fund, NASDAQ index fund, S&P 500, Russell 3000, and so on.  In the long run, the markets always go up.

Now you have your formula and your plan.  As a guy, I like instant replays and recaps.  Here is the recap of a 20-something starter investment plan:

1. Get paid with direct deposit
2. Start making automatic investments every payday
3. Invest in a low fee ETF or Index Fund
4. Don’t touch it.  Build a portfolio

After a few months or a year, you might decide to invest in a different fund.  That way you are double diversified.  If you are investing purely for retirement, Vanguard is another company that makes investing easy.  Just do not be tempted to give up after a bad day, week, or year.  I don’t even check in on my stocks every day.  If I did, I would be too tempted to make bad trade.  Investments are for the long run.  Short term trades are more like gambling.  After a little while, you will no longer be Poorer than You, you will be richer than most.

If you have any questions, feel free to contact me through my contact form or just leave a comment below.

[Photo Credit]

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How can a poor college student, that doesn’t have $1000 on hand, start investing?

- A PTY reader

Your boat is my boat, my friend! It’s hard to scrape together enough money to put gas in my car – how can I save up enough to start investing and take advantage of sweet, sweet compound interest?

Should I Invest?

First things first, you’ve got to figure out if investing is a good idea for you right now. When we say “investing,” we mean “buying stocks and holding onto them over a long period of time.” With this in mind, ask yourself three questions before you start looking for ways to invest:

What’s my goal?
Since investing is so long term, you should really save it for goals that are 10+ years off. If your goal is shorter-term than that (say, a new car in five years or a down payment on a house), you should look into more conservative investments, such as bonds, CDs, and money market funds. If your goal is something like “retiring in something better than a shack,” then stock investments are your friends.

Could my money be put to better use?
It seems like investing is the best thing you could do with your money, right? But that’s not always true. If you have any debts with interest rates over 10%, you’re better off funneling your money into paying off your debt. Compound interest works both ways, so high interest rates on debts will only work against you.

Do I have enough savings?
Along the same lines as above, your money might be put to better use preventing debt. This means having an emergency fund and a “getting established fund” to take care of expenses you’ll incur when you start off on your own. You know, like security deposit and furniture for your fabulous new apartment. Don’t go overboard, but make sure you’ve got a nice cushion of savings before you dive into investing.

Investing What You’ve Got

So, you made it through the three questions, and you’ve decided it’s time to start investing. But, that just brings us back to the original question: HOW? The way I see it, there’s two ways to go about this:

No-Minimum Online Brokerages

Check out sites like ShareBuilder and Zecco – you can buy stocks and pay less than $10 in commission each time. Since there is a charge, what you’ll want to do is save up your investment money in a savings account, and then buy larger amounts every few months.

What, exactly, are you buying? Well, if you want to try your hand at individual stock picking, that’s your deal. But what I would do is buy index fund ETFs. These are little funds that act like stocks, but what’s really inside them is a tiny share of every stock in the market that it’s tracking. So if you buy an ETF that tracks the S&P 500, you’re getting a tiny share of each of 500 companies! Instant diversification.

Or… Save Up for Vanguard

Ok, so, why buy index fund ETFs instead of just buying index funds? Well, this again brings us back to the original question: how to do this with less than $1,000. Index funds have a really big buy-in. Vanguard’s index funds require a $3,000 minimum investment! Who’s got that lying around?

But the advantage to buying an index fund directly is you go from paying commissions to paying “expense ratios” – or a percent of the value of the fund. The reason I bring up Vanguard is that they’re known for having one of the lowest expense ratios around. Mmm… tasty low-cost index funds… that’s what I want!

So here’s what I’m doing: I’m putting money away each month in a savings account, building up to that $3,000 minimum investment. Once I get that, I can buy my coveted Vanguard index fund! And once I’ve made the initial investment, I can buy individual shares of that fund at my leisure. (I’ll do this within a Roth IRA, since the goal here is retirement!)

Saving up $3,000 can seem really, really frustrating. In fact, it was so frustrating to me, that I just gave up the first time I found out about Vanguard’s $3,000 minimum. I was 18 at the time, and I just pushed it out of my head – I’d never save up that much!

But… if I’d put aside $100 a month instead of giving up, I would have reached $3,000 six months ago. That’s food for thought.

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“My guess? People don’t realize just how amazingly wonderful compound interest really is. And they think they’ve got all the time in the world. Also, it’s not like this stuff is taught to us in high school – you either are lucky enough to learn it from a parent, or you sort of fumble your way through it, or you get some initiative and seek out the information yourself.”

“Alright, so, let’s say you were more awesome than you are. You’re what, 20 years old? Let’s say you had a tasty job with a nice 401(k) package. And let’s say that nothing else about your life changed – you still lived with your parents, so your expenses were minimal. What would happen?”

“Well, in that scenario, I’d be able to completely max out my 401(k) – assuming I made more than $15,500 a year at this imaginary job. That’s the 2007 contribution limit for a 401(k), by the way.

So anyway, I’ve got very little expenses and I’m making, let’s say… $25,000 at Imaginary Job. So I decide, yeah, I can max out that 401(k), put the full $15,500 in and use the remaining $10,000ish for my minimal expenses.”

“That sounds pretty nice… but how much does that translate to? In retirement.”

*calculator fun* “Well, assuming an 8% annual return on that, which is probably what we can expect… that’d be $494,766.97 when I’m 65.”

“What? Seriously? Maxing out your 401(k) now would mean half a million in retirement?”

“It only gets better. You said ‘nice 401(k),’ so we can assume there’s a company match to that money. So let’s say that company match is 50% up to 6% of my salary. That means if I contribute 6% of my salary (which I am clearly going above and beyond), the company will kick in 50% of that 6%. So that’s an extra $750 that they kick in. Doesn’t sound like much, but it’s free money, and let’s see how it affects the final number….”

*more calculator fun* “That’s $518,707.30 when I’m 65. That’s an extra $24,000 just because of the $750 that the company kicked in. And we can play with it a bit further – say we do just a teeny-tiny bit better with our return, and got 9%.”

*again with the calculator* “$785,318.40.”

“Are you kidding me? One percent point puts on like… another quarter million dollars?”

“That’s right. Want to take a guess at what a 10% return would get me?”

“… it’s gotta be more than a million.”

“Smart cookie. One last thing. Say instead of just doing the 401(k) for one year, let’s say I maxed it out again the next year. We’ll drop the rate back down to 8%, though – keep it as realistic as possible. So ok, I max it out two years in a row, with company match. How much do I have at 65?”

“Let me guess – a nice cool million?”

*calculator strikes again* “$998,991.84. And at 10%… it would be $2,261,261.60.”

“I’ve gotta get me a 401(k)!”

“You and me both, buddy. You and me both.”

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A friend of mine asked me what a Roth IRA is, and whether I should get one. I sent him J.D.’s link, but I also said I didn’t think he should get one. Yet. For the same reason that I don’t have one. Yet.

We’re both carrying around some nasty, high interest credit card debt. Sure, we could start putting money into Roths, and if the Investment Gods shined down upon us, we could earn around 10% on our money each year, and the power of compounding would give us a tasty retirement. But if we’re still carrying around our credit card debt (at 17% or higher!), then we’d just be back-pedaling. We’d be paying more to the credit card companies than we’d earn.

This is where the difference between investing in a 401(k) and an IRA can really be seen. If your employer offers matching funds in your 401(k), then it makes sense to contribute, even if you’re carrying around credit card debt. But there’s probably no one matching your IRA contributions (unless you have a generous relative – in which case, go for it).

So, my friend and I, we’ve got some credit card debt to tackle. Once we’re clear of that… well, I know I’ll be beginning my sordid affair with the Roth!

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