One of the best things you can do to build wealth is to start investing as early as you can. This is easy in theory, but it is more difficult in practice. Someone new to investing wouldn’t know where to begin. I sure didn’t when I was young. I started investing by going to the “free financial advisor” at my old bank. The so call advisor sold me some loaded funds that performed worse than cheap index funds. Loaded fund means you pay a fee upfront and the financial advisor makes a commission from the sale. That was a mistake I don’t want any new investor to repeat. It should be easier to invest your first $500 and that’s why I’m writing this post. Also, I need to help our son make his first investment in the stock market.
Start investing early
There are 2 big advantages to investing early. First, your investment will have more time to compound. The power of compound interest becomes exponential only after many years. The earlier you start investing, the more time your investment has to grow. Second, you learn many valuable lessons and make many mistakes when you invest. It’s better to get these mistakes out of the way when you’re young and don’t have much money. I didn’t lose much money when I made the mistake of investing with a bad financial advisor because I didn’t have much at that point. If I waited until I was 40 to make the same mistake, it would have been a much more expensive lesson.
That’s why I’m starting our son off early. Earlier this year, I hired our son to be a model and photographer for Retire by 40. All of his pay goes straight into a Roth IRA for minor. After 6 months, his account has about $500 and we can start investing in earnest.
Before investing your first $500
Investing is actually easier for RB40Jr because his situation is very simple. He lives at home and doesn’t have any expense. He’s just a kid. Life is easy and he can invest his $500 without any worries. Most adults have more complicated lives. Before investing that first $500, you need to make sure to do these first.
- Employer sponsored 401k. Many employers have a 401k plan and most will match a certain percentage of your contributions. This is 100% guaranteed return. It is pretty much impossible to get this kind of return by investing. You’ll also get some tax deduction as a bonus. That’s why I love my 401k. Employer matching is a great bonus and everyone should take advantage of it.
- Pay off high interest debt. If you have high interest debt, pay those off first. I’m thinking about credit cards in particular. At the time I’m writing thi, the typical credit card interest rate is 14-22%. This is very high and it’s a huge drag. Most investors can’t generate this kind of return. It’s better to pay off those high interest loans first, then invest.
- Invest in yourself. The best thing you can invest in when you’re young is yourself. If you can improve your earning potential, then don’t hesitate to invest in yourself. Of course, the easiest way to improve yourself is to read a lot of books and blogs. Those aren’t too expensive.
- Emergency fund. Lastly, everyone needs to set some aside some cash to deal with emergencies. You don’t want to invest $500 only to find out that you need it next week. I think you need at least $1,000 in your saving account as a cushion before starting to invest.
Investing your first $500
Once you’re ready to invest your first $500, there are some choices to make.
What kind of account?
Basically, there are 2 choices here – a Roth IRA or a taxable brokerage account. I choose the Roth IRA for our son. If you’re young, the Roth IRA is a great choice. RB40Jr make so little income that he won’t have to pay any income tax. He can invest this income in a Roth IRA and avoid tax on the earnings too. This is awesome because tax can take a big bite out of investment gains.
For younger folks, I think Roth IRA is the way to go because they’re typically in the lower tax brackets. Also, the investment will have a lot more time to compound. When you go with the Roth IRA, you don’t have to pay any tax on the gains. That’s perfect for young folks. If you’re older or need to be able to access the money, then it’s a toss up.
Where to open a Roth IRA?
For RB40Jr, I choose Fidelity because they offer a Roth IRA for minors. This account can be open and manage by an adult relative on behalf of a minor earning income. I already have an account at Fidelity so that was an easy choice to make. Many brokerages offer a custodial IRA so give them a call and check.
For adults, I highly recommend Firstrade. They are a discount brokerage with very good service and low transaction fees.
Beware transaction fees
With $500 to invest, you need to pay attention to the transaction fees. Discount brokerages are much more affordable than when I started investing, but I still don’t want to pay the transaction fee with this amount of money. RB40Jr makes about $100 per month. If he has to pay $10 in transaction fee, that’s a 10% drag on his returns. That transaction fee will offset the gains from the investment.
That’s another reason why I recommend Fidelity and Firstrade. Fidelity offers many commission-free ETFs from iShare. Firstrade has more than 700 commission-free ETFs. This is perfect for new investors who want to avoid commission fees.
*I just found out that Vanguard is getting rid of commission fees for most of their ETFs in August. That’s great news. However, I believe they have some annual maintenance fees when your account is small.
What to invest in?
I’m a big believer in learning to walk before you run. New investors should invest in core asset classes before getting into more complicated investments. You really can’t go wrong by investing in a solid passive index fund. Just keep adding to that investment every year and you can’t lose.
For RB40Jr, I choose IJR – iShare core S&P small-cap index fund.
This fund gives him the exposure to US small cap stocks with no commission fees. I choose small cap instead of a broad-based US stock index fund because it has more growth potential. Small cap index fund is more volatile in the short term, but it should work out well in the long term as long as he keeps adding to the investment every month.
Fidelity also has these iShare funds available.
- IVV – iShare Core S&P 500 ETF
- IJH – iShare Core S&P Mid-Cap ETF
- IEFA – iShare Foreign Equity Large-Cap ETF
We’ll probably add these to balance out RB40Jr’s account later. For now, we’ll just focus on adding to IJR. I don’t think you can go wrong with any of these if you’re young.
How would you invest your first $500? What would you recommend for your kid?