THERE I WAS, two years out of college, earning a whopping $37,500 a year at my job and bringing in a few extra grand a year in small writing jobs and babysitting. Despite living in one of the most expensive cities in the United States, I officially had my financial oxygen mask on. A fully funded emergency savings and no debt made me feel empowered to start investing outside the 401(k) I had at work. Except I had no clue what to do, and in retrospect, I wouldn’t have done what I did next.
I made the entirely un-Millennial move of calling up my bank.
Now, I will say that I loved, and still love, this particular bank. It has great customer service, which was what inspired my phone call. I didn’t know what I was doing, so speaking to a real person helped reduce my anxiety about screwing up. I hadn’t done any research about fees or set goals or determined my time horizon or risk tolerance.
Carol answered my call and assured me she could help me set up my first investment. To do this, she asked some basic questions to determine how I should be investing.
She asked me when I thought I’d want the money. “Uh, I don’t know. Maybe for a house in ten years?”
She asked how much money I had to invest. “I’ve saved up $2,000 to invest.”
She inquired about my risk tolerance. “Hmm, I don’t mind taking some risk, I guess.”
As you can sense, my responses were not particularly well thought out. But thirty minutes or so later, I had my first taxable account set up: a mutual fund that, unbeknownst to me at the time, came with rather high fees.
I basked in the self-important glow of being twenty-four years old with a 401(k) and a mutual fund.
Silly, Erin. You still sort of screwed up.
While I guess it’s good that I took a step toward investing, albeit an uninformed one, and while I felt a smidgen of dignity in trying to be a grown-up and not calling my dad this time for advice (even though I probably should’ve), this is not the method you should use.
“I want to invest, but how do I start?” is probably the most common investing question I receive. It’s completely justified because it isn’t a straightforward process. We aren’t taught how to do it in school, googling the question yields an overwhelming amount of options that rarely actually show you how to open an account, and your parents may have never invested, either. Our go-to resources have failed!
This chapter will give you an overview of how to open a brokerage account and some of the options available to you. This will be focused more on investing in mutual, index, or exchange-traded funds. There is some overlap with what you need if you plan to do individual stock picking, too, but that topic is addressed in chapter 7.
Because this book is in print, which means I can’t update it like I could a blog post, there will be certain points at which I’m a bit vague. I don’t want to put a detail or direction in print that will be irrelevant in a few years or maybe even by the time this book is in your hands! In these moments of vagueness, I’ll do my best to direct you to places where you can find up-to-date information.
Before you even walk into a brokerage firm or, more realistically, go to its website, here are the pieces of information you’ll need for a smooth process:
Personal information: You’ll be asked for your name, address, email address, telephone number, date of birth, employment status, and occupation. The brokerage will also want to know if you’re employed by a brokerage firm.1
Social Security number or other tax identification number: The money you earn investing is subject to taxation, so the brokerage firm has to be able to report that income to the IRS. This number is also used to verify your identity.
Government-issued identification: Your driver’s license, passport, or similar identification cards will be required. The brokerage firm needs this to comply with the USA PATRIOT Act of 2001 and to further verify your identity.2
Financial information: You will be asked about your annual income, net worth, and investment objectives. Brokerages and advisors need this information in order to comply with state and US laws as well as rules from regulatory bodies like the Securities and Exchange Commission (SEC) and the Financial Industry Regulatory Authority (FINRA). Your broker may also use this information to determine suitable investment recommendations.
Bank information: You need the routing and account number for the checking account you’ll use to fund your new brokerage account.
You’ve collected all your personal information and now you’re ready to set up your brokerage account. But first you need to know a couple of things:
Are you investing for retirement, education (e.g., your child’s college education), or for other financial goals? The type of account you open will depend on the reason you’re investing in the first place. In this case, let’s assume you are investing for a medium- to long-term goal.
Don’t be like me and just randomly pick something with little to no forethought. But the one right move I made was talking to someone when I felt I needed help. I advise that you give your investment strategy more thought than I did, but picking up the phone and talking to an advisor at your potential brokerage firm is smart.
You could write a check (if you even have a checkbook!) or make a transfer from your bank account. Have your routing and account numbers ready.
You should also have decided how much you want or need to invest. Some funds have a minimum initial investment.
If your investing is retirement related, you might be doing a rollover from a former employer’s 401(k). Or you could transfer a brokerage account you already have at another financial institution to fund your new endeavor.
Here are three other questions you may need to answer when setting up your account:
As a rookie, it’s best to go with a cash account. A cash account means you’ll be paying for the investments you purchase in full. A margin loan means the broker can lend you funds to make the purchase, so you’re buying “on margin.” Money already in your account works as collateral for the loan. It’s simpler not to complicate the process, so choose a cash account.
You will be asked, at some point, what you want to do with the dividends your investment earns (assuming it earns dividends). You could take them in cash each year or you could just reinvest them, using a dividend reinvestment plan, or DRIP).
This isn’t a black-and-white situation in which one is completely superior. It comes back to your goals. Why are you investing this money? Are you trying to get some passive income right now or do you want to maximize as much growth as possible for the future, when you plan to sell the stock? Reinvesting is going to be beneficial for long-term growth.
The beneficiary is the person who will receive the money in your account upon your death. Please take the few minutes it requires to set up a beneficiary. You usually need the person’s full legal name, birth date, address, and Social Security number. Designating a beneficiary helps reduce confusion and tension for your loved ones after your death. Plus, it could help your loved ones avoid probate, in which a court supervises the distribution of your estate.
Okay, you’ve pulled all the information together that you need to open the account. Now the big question: where should you take your business?
You have many options when it comes to picking a brokerage firm. This may be a disappointment, but I’m not going to tell you which one to pick. I can’t! I don’t know what best suits your needs. Instead, I’m going to provide you with a way to vet brokerage firms to find one that’s the right fit.
“Vet them like a dating partner,” says Kelly Lannan at Fidelity Investments. “Is this someone who has my best interest at heart? This is someone whom I might spend the rest of my life working with. As a result, those are pretty high standards.”
Do you plan to do lots of trading, or will you be a buy-and-hold investor? Do you want to be more hands-on and DIY in your approach, or would you feel more confident if you connected with a human or had an algorithm maximizing your portfolio? These are the factors you need to take into consideration when determining whether a brokerage firm is right for you.
Many, but not all, brokerage firms will have minimum initial investments in order to open an account at all or to invest in certain funds. These minimums vary, and therefore can have a huge impact on which institution you pick. Let’s say you have $1,500 to get started on your investing journey and you’ve picked an index fund in which you want to invest. Well, that’s going to rule out any brokerage with a minimum investment greater than $1,500 for that fund.
If you’re dead set on a certain brokerage firm, but its minimum is too high, then you have a few options:
Search and see if another comparable fund at the same brokerage has a lower initial investment requirement.
Start investing at a different brokerage and transfer your funds after you’ve met the investment minimum at the brokerage you want.
Keep saving up until you hit the minimum.
See if the exchange-traded fund (ETF) version is cheaper than the mutual fund version. Sometimes it is!
Honestly, my favorite strategy here is word of mouth. Do any of your friends, cousins, parents, aunts, uncles, or parents of friends invest? If so, ask them which brokerage firm they use, why, and how they like it. Try to crowdsource from more than just one or two people.
Then, take to the internet.
Type in the name of the brokerage firm and “reviews” to get a sense of what people outside your immediate circle think. Be sure to also read about the negative experiences customers shared.
You can also see what Morningstar has to say about specific funds in which you want to invest. This investment research company ranks funds out of five stars, so it’s easy to see how your potential investment stacks up.
You don’t have to be a current client to take the firm’s customer service out for a test drive. Give the brokerage a call. Use the opportunity to see how long you’re kept on hold and how you’re treated by the customer service representative. You should also check whether email and live chat are options for connecting with customer service. You want to be doing business with an institution that treats you and other customers well.
I’ll be honest: a few of the websites out there are not the streamlined experience most Millennials are used to. Hopefully that changes soon, but if a particular kind of user experience on a website or app is important to you, then you should test-drive both before picking a brokerage.
Always determine what your potential brokerage firm will charge you to be a customer. Does the brokerage charge you a fee for “assets under management” (AUM)? For example, a 2 percent fee on your portfolio of $10,000 means you’ll be paying $200 annually, which could be in addition to other trading fees. Are you receiving $200 worth of guidance and value? Later on in this chapter, we’ll overview various fees you may experience and how to decode the almighty expense ratio we defined in chapter 2.
Perhaps you’ve decided to pay for investing advice. That’s perfectly okay, but you should know what type of advice you’re receiving. Is your advisor being held to the suitability standard (i.e., the recommendations are suitable for you) or the fiduciary standard (i.e., the recommendations are in your best interest)? You should also know if and how your broker receives any commissions on products he or she puts in your portfolio.
I know you’re still wondering, “BUT WHERE DO I GO?” I hear you, so I’ll overview different kinds of brokerages and list some actual options. Please be aware that I’m in no way endorsing these particular options, but simply acknowledging their existence in the space.
With a full-service firm, you’ll have an advisor helping you build and manage your portfolio, but you’ll pay higher fees. This might sound like the better option for a novice investor because an expert is helping you out. The issue: a full-service brokerage may not want to work with you. You often need to be bringing some serious money to the table to have an actively managed portfolio of this nature. This isn’t always the case, but there’s a reason the stereotype of needing double commas (aka $1 million or more) in order to be taken seriously exists.
Still, with some competition in the marketplace, plenty of firms have much lower asset minimums than $1 million, but the level of guidance and advice you get may vary based on your account balance. You’ll need to do your research if you plan to go with a full-service brokerage firm.
Examples of a full-service brokerage firm include: Morgan Stanley, UBS, Edward Jones, and Merrill Lynch. There are also investment banks like J.P. Morgan Private Bank and Wells Fargo that offer investment advice and financial planning services.
With the discount brokerage firm, you’ll be taking the DIY approach and therefore will save more in fees. Plenty of both rookie and seasoned investors utilize the DIY approach to investing, including yours truly. There is a lower barrier to entry than with a full-service brokerage, because you only need a little money to get started. Some, but certainly not all, funds at a discount brokerage may have minimum initial investments, often $1,000 to $3,000.
Similar to the full-service brokerages, some discount brokerage firms also offer access to financial advisors, but you usually need to have a certain amount of money invested with the firm in order to unlock that feature. For example, if you have $50,000 in investments, then you gain access to investment professionals for general guidance. If you have $500,000 in investments, then you get to consult with a certified financial planner (CFP) for no additional fee if you have a specific question. Just because you go with a discount brokerage firm doesn’t mean you’ll be without personalized guidance.
If you don’t have the amount of money invested that’s required to unlock the personalized advisor features, then you can always call customer service for general help.
Examples of discount brokerages include Vanguard, Fidelity, Charles Schwab, TD Ameritrade, T. Rowe Price, and Ally Invest.
Robo-advisor is the term often used to refer to digital platforms for investing. Robo-advisors are typically perceived as having little to no human interaction and relying on an algorithm, but that’s not entirely correct.
“Robo-advising, the term is too narrow,” says Alex Benke, CFP®, Betterment’s VP for financial advice and planning. “People think of Betterment as a robo-advisor, but we have an offering that involves people, too. We [Betterment] think online financial advisor is more accurate. It implies use of technology, but it doesn’t pigeonhole in terms of how you’re getting that advice.”
Robo-advisors or online financial advisors are marketed to Millennials as a digital solution for the often intimidating process of investing. You’re asked some questions online and given recommendations on about how to best build your portfolio. They can be quite helpful to a novice investor who wants either a little more hand-holding or to take advantage of other offerings, like frequent rebalancing and tax-loss harvesting. There will be more information about robo-advisors in chapter 9.
One potential downside to the online financial advisor route is paying a higher fee for access to funds you could purchase directly through the discount brokerage firms like Vanguard, Fidelity, and Schwab. However, that fee could be worth the value you’re receiving. It’s up to you to decide. It should also be noted that some brokerage firms have tried competing with the online financial advisor by adding on a robo option. You should critically evaluate whether those add-ons provide the same value. Some do and some don’t.
Examples of online financial advisors include: Betterment, Swell, Personal Capital, Wealthfront, Wealthsimple, and Ellevest.
Yes, there is most certainly an app for that. Robinhood, Acorns, and Stash are all examples of apps with which you can invest via the touch of a button on your phone. Chapter 8 will overview using apps for investing.
Yet again I’ll have to disappoint you a bit. I can’t give you a definitive answer because I don’t know anything about your goals, risk tolerance, or time horizon. But I can tell you this:
First, you’ll need to decide if you want to go the actively managed mutual fund route or the passively managed index fund or ETF route. Both are valid, but don’t forget that “actively managed” means you’ll pay more in fees.
Second, you’ll need to reflect on the goal for this money and the kind of risk you want to take. (Refer back to chapter 4 for setting actionable goals.)
Third, you’ll need to diversify as you build your portfolio. You don’t want to just pick one stock in one sector. Investing in mutual, index, or exchange-traded funds gives you exposure to a variety of sectors and companies, and is a good first step. Examples of funds that do that would be the S&P 500, Total Stock Market, and Total International Stock Market, but notably those are all on the high-risk end of the spectrum. Total Bond Market would be more conservative, while a Balanced Fund offers an approximately 60/40 split on stocks and bonds and is medium on the risk spectrum.
Now it’s time to add one more important factor when choosing your brokerage firm and investments: fees. I mentioned earlier that fees need to be a critical part of the decision-making process, so let’s do a deep dive into the fees you may encounter and how to decode them.
You’re going to pay fees on your investments. The brokerages aren’t nonprofit institutions, and at the bare minimum, they need to cover the administrative costs of running a fund. Even if your app or trading platform says “no fee,” that usually means it doesn’t take a commission on your trade, but the stock you buy or the ETF or mutual fund does have an expense ratio. In 2016, the average expense ratio across funds was 0.57 percent, according to a Morningstar study of US funds.3 This cost is generally deducted from the fund’s average net assets.
That being said, fees range significantly from modest to hefty. As Colleen Jaconetti, CFP®, a senior investment analyst for Vanguard Investment Strategy Group, mentioned in chapter 4, the more you pay in fees, the more those fees eat away at your growth potential as well as the amount of money you’ll have in the future.
Expense ratios are (or should be) prominently displayed under the details or facts about the fund. You could download the fund’s prospectus and look for it there. Or just go to the brokerage’s website, search for the fund, and then hit Control-F and search for “expenses” or “exp ratio” or “expense ratio” to hunt it down.
If you can’t easily find this on a brokerage’s website, go to Morning star.com and search for the name of the fund. Morningstar analyzes and provides data about the stock market.
If, right next to an index fund, it says “0.14 percent expense ratio,” what does that mean?
“They’re going to charge you $4 for every $1,000 you have invested,” says Jaconetti.
“I would say at least somewhere below 50 basis points would be reasonable,” explains Jaconetti. “It’s still a little on the high end relative to what you could be getting, but obviously anything above 50 basis points, I would say is on the higher end.”
Pretty much just a fancy way of expressing the expense ratio. A fund charging you 50 basis points charges you 0.50 percent. One basis point = 0.01 percent.
The way your fund is managed will impact the expense ratio. Passively managed funds are going to be cheaper than actively managed funds.
Investing in international funds is another reason you may encounter a higher expense ratio. Global diversification (investing in funds outside the US stock market) is part of a balanced portfolio because it spreads out your risk, but it does often result in a higher expense ratio than investing in the US market. For example, you might get 0.26 percent on an international fund compared to 0.14 percent on a US market fund.
“People shrug their shoulders at 1 percent, but we know how that adds up,” says Alex Benke, CFP®, Betterment’s VP of financial advice and planning. “But at some point, you get down to it and think, ‘Yeah, even a quarter of a percent is costing me a bunch of money over time,’ so the struggle there is to evaluate the payment for the value that you’re getting.”
Benke points to the various online financial advisors (aka robo-advisors) and suggests being highly critical about whether the one you plan to use is balancing cost and value. Evaluate if you are receiving value for the cost, or if it’s just setting up a portfolio for you without any added benefit. For example: is there tax-loss harvesting, rebalancing, or a streamlined user experience?
“When considering the value you’re getting out of something, you want to look at the dollars-and-cents value,” says Benke. “Is it squeezing out as much from your money as it can in terms of funds you get put in and taxes it can save you? But also, is it actually making your life easier in terms of the time that you’re investing?”
Similarly, Jaconetti recommends thinking about your “why”: are the fees for advice or just for the fund or product? “Some people are willing to pay a fee because they think the manager will have outstanding performance going forward,” she explains, but she warns you to keep in mind that past performance is not indicative of future performance. Assuming your fund manager does outperform the market, you should still do the math to see if you received a higher return after fees.
Paying for advice is a personal decision, but this could justify a higher expense ratio, especially if it helps you create a tax-advantaged strategy for your investments.
Investing more is an easy way to reduce an expense ratio. Well, it’s “easy” in the sense of being simple, not that you can magically come up with more money to invest.
Slow-and-Steady in Action
When I first started investing, I was woefully ignorant that investing more could lower my expense ratio. I picked a fund with a minimum investment requirement of $3,000 and diligently contributed monthly. The expense ratio was 0.15 percent. A few years later, I made my monthly contribution and received a prompt that I could convert to a new fund and reduce my expense ratio to 0.04 percent. What?! Turns out, once my investment hit $10,000, the brokerage offered a reduced expense ratio for the same investment. I converted to the new fund and saved myself 11 basis points, which also meant keeping more in my pocket for future growth.
Not all brokerage firms charge these fees, and fees also vary by fund. You can find more details about fees by downloading its prospectus. A prospectus is a document that overviews the investment to potential and current investors. It’s a legal document and required by and filed with the SEC. A prospectus generally includes information about what the company does, its strategy, its financial details, the risk involved, and fees. It should be readily available on any webpage detailing information about the fund. Here are some of the fees you may see on a prospectus. Notably, the expense ratio may be referred to as “management fees” and/or “total annual fund operating expenses” on a prospectus.
ASSETS UNDER MANAGEMENT (AUM): A flat-rate fee is paid to your advisor based on the size of your portfolio (i.e., your assets under management). For example, a 2 percent AUM on your $100,000 portfolio means you’re paying $2,000 to your advisor for his or her services.
COMMISSION: Your advisor or broker receives a commission for opening an account on your behalf or selling you particular products. Your advisor isn’t necessarily acting in a nefarious manner if he or she receives a commission, but you should be aware if that’s the case and ensure the product matches the fiduciary standard and not the suitability standard, because fiduciary ensures it’s in your best interest, not just suitable. You don’t want a subpar product in your investment portfolio just because your advisor gets a commission off the sale.
TRADING OR TRANSACTION FEE: A commission or trading fee is usually charged when you buy or sell shares of stocks through an ETF or buy individual stocks through your brokerage. A transaction fee may also be charged when you buy a mutual fund. The cost of the fee can vary by the type of transaction, how many transactions you make, how much you have in assets under management, and even how you make it (i.e., online or via phone). Plenty of commission-free ETFs exist.
ACCOUNT SERVICE FEE: This is similar to the monthly service fee a bank charges on a checking or savings account. It’s often an annual fee and may get waived if you hit a certain threshold for assets under management or if you waive paper statements and elect for electronic-only communication.
FRONT-END LOAD OR BACK-END LOAD: You pay a fee for the purchase (front-end load) or sale (back-end load) of your mutual fund investment. The fees for load funds usually pay the broker or advisor who researched the fund, advised you to purchase it, and placed the buy order for you. Back-end loads may be reduced or phased out depending on how long you hold the fund. DIY investors typically avoid investing in a load fund.
REDEMPTION FEE: This is separate from the back-end load fee, but also gets charged when you sell your shares in a fund. This fee is charged to offset the cost the brokerage may incur when selling your shares.
PURCHASE FEE: A fee you’re charged when you buy shares in a fund. This is separate from the front-end load fee because, like a redemption fee, it is used to cover the cost of the transaction.
NO-LOAD FUNDS: There is no fee to buy into or sell your investment in a mutual fund. The expense ratios on no-load funds are typically lower than that of their load-fund counterparts. The fewer and lower the fees, the more you pocket.
12B-1 FEE: Another fee your brokerage may charge to offset the operational costs of running a mutual fund. It is baked into the expense ratio, so you may not notice it at first, but it will push the overall cost of the expense ratio up. The 12b-1 fee is capped at 1 percent by FINRA (the Financial Industry Regulatory Authority). One percent may not sound like much, but that can really eat away at your returns, so check to see if a fund comes with a 12b-1 fee before making the purchase.
Well, that’s a bit of a tricky question, with an answer of both yes and no.
“Definitely safe, as long as the firm is SEC and FINRA registered and has SIPC* [Securities Investor Protection Corporation] insurance, which all the firms basically are required to have,” says Alex Benke. “The common worry is that the firm is newer and will fold, and then what happens to my money? It’s different than a bank folding because you’ll get the shares back and will then just have to put them in a less fancy account.”
This process of moving your shares is known as an “in-kind transfer.” Let’s say you’ve bought three shares of Netflix through Trusty Investing (a fictional robo-advisor). Trusty Investing folds after a year and you switch over to using a different brokerage firm: Reliable. You haven’t lost your claim to those three shares of Netflix because you, not Trusty, are the owner of those shares. You’ll just need to transfer the shares to your new brokerage account at Reliable.
SIPC insurance is similar to the FDIC insurance you get from a bank. As of 2018, it protects consumers with coverage of up to $500,000 for all accounts you have at the same institution, with a maximum of $250,000 for cash. This protection is for if the financial institution you use to invest fails. This is not to be confused with what happens if your investments lose value. Which takes us to the no part of this answer.
The stock market goes up and down. There will be days when your investments lose money, so no, your money isn’t entirely protected. You may one day take a risk that doesn’t pay off in the short term or maybe at all. That’s why diversifying, rebalancing, and considering your time horizon are critical. You need to mitigate the fallout you’ll experience from the inevitable downturns, market corrections, and recessions.
☐ Set your goal:
☐ Determine your risk tolerance:
☐ Decide on your time horizon:
☐ Collect all your personal information:
☐ Decide what kind of account you’d like to open:
☐ Compare fees:
☐ Pick a brokerage firm.
☐ Pick a type of investment.