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Where to Send Your First Investment Check

Jason Stipp

Jason Stipp: I'm Jason Stipp for Morningstar.

Many would-be investors know they need to get going on their portfolios, but they might not know where to start. Here with me to offer some insights on where to send that first investment check is Morningstar's Christine Benz, director of personal finance.

Thanks for joining me, Christine.

Christine Benz: Jason, great to be here.

Stipp: So, I think a lot of investors are familiar, or a lot of would-be investors are familiar with investing through their 401(k) plans at work. This is where they usually start investing. We're going to be talking a little bit about investing beyond that, but before we even get to that, how do I know if I even need to invest beyond that 401(k) plan?

Benz: Well, I think you want to do some basic homework on your plan, how good it is, how good the investment options are, and if it's not measuring up from that standpoint, you certainly would want to think about going outside the plan once you've invested enough to earn any matching dollars that you're getting.

But another thing to think about when investing outside of a 401(k) plan is that diversification of tax treatment that you can get by going with some sort of Roth vehicle. Now, your 401(k) plan may offer a Roth feature as well, so it will allow you to take tax-free withdrawals in retirement, but your money gets taxed on the way in, but it may not. A lot of 401(k) plans don't offer that Roth feature. So, that might be one very good reason to consider going outside of a 401(k), to be able to take advantage of Roth IRA contributions.

Stipp: Also, 401(k)s have contribution limits as well. So, if you're bumping up against those, you would likely to be looking outside [the 401(k)] for additional funds, but what about for time horizon? So, 401(k)s are for retirement, but we all know that we're saving for lots of things before retirement.

Benz: Right. So, I think that's an essential first step to think about when deciding to invest outside of a 401(k). Think about, what am I doing with this money. So, if it's money that you expect to tap within the next couple of years or next five years or so, you need to keep that money relatively safe. Certainly, if it's money that you expect to deploy within the next couple of years, you probably want to just keep it in cash or a money market vehicle,. Yields are terrible right now, but I think you have to settle for that steady return versus one that is higher but potentially a lot more volatile.

Stipp: And it's also liquid and accessible if it's outside the 401(k). You might not be earning a lot on it, but the value won't fluctuate, and you won't be paying any penalties when you draw that money.

Benz: Or taxes, right.

Stipp: Okay. So, what about the types of investments? So, we know that there are lots of different options among mutual funds and ETFs. You should be thinking about that as well before you decide where to send the check, obviously.

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Benz: Well, I think so, and I think that that is a trap that investors might fall into where they look at different platforms and say, well, this one offers 1,200 funds and 200 ETFs, whereas this one only has 500 and 200. But if the one that has fewer actually has the ones that you want, that's the one that you should go with.

So, spending some time thinking about, well, what is my optimal portfolio, what are the holdings I really want, what are the best-of-breed things, and then going out and finding the platform where they are available at the lowest possible cost. Do your homework at the outset before shopping for the right platform.

Stipp: So, we've certainly seen a lot of bells and whistles, advertisements for the discount brokerages that may be alluring but make sure that it can do what you want before you send the check there.

So, Christine, I want to talk about the types of accounts, because this is a yet another wrinkle. As we mentioned before, there are Roth accounts that have a certain kind of tax treatment. You need to decide what sort of shelter you want to put this money in as well before you send that check in someplace.

Benz: Right. So, you need to decide if you want it in some sort of an IRA. You may be looking at a more specialized vehicle. Particularly, if you're self-employed, there's a whole array of different vehicles that you can choose from. Here's a place where an advisor can maybe help you select the right vehicle. But once you've done that, say, you've determined that you need, say, a solo 401(k) or you need a Coverdell Education Savings Account, then that's minimum requirement that you would have of any brokerage firm that you would look to for your trading. So, you want to first figure out what sort of wrapper you'll put your investments inside, and that will maybe help shape your platform choice.

Stipp: So, certainly a lot of legwork needs to go into it before you send that first check and partner with a brokerage, for example.

So, assuming that I know exactly what I want and the kind of account that I want, as I'm going out as a do-it-yourself investor who's going to be putting money to work, what are my options? Where might I'd be sending that money? I know that there are fund companies and brokerages and lots of options there, how do I start to compare them?

Benz: Well, as you've said, Jason, you can go directly to a fund company and send them a check directly or you can go to a brokerage firm. So, there are a couple of key things you want to look at: breadth of choices, you want to look at the commissions that you're paying to buy and sell, and think about what type of investor you are or plan to be and how often you'll be trading. You also want to look at any account maintenance fees. They may seem small in dollar terms but can actually add up, especially if you are a smaller investor, and same goes with commissions.

You also want to check on the user-friendliness of the interface. So is this something that's easy to click around, get the information that you need, get the data you need on the securities that you are trading. Do some basic due diligence before you partner with a firm to do your trades.

Stipp: So I know that there are different fund shops that specialize in different areas. Some are really good with fixed income; some are known as growth shops. If I want to mix and match investment types, does that mean I need to go with an independent brokerage or could I still somehow invest through a fund company?

Benz: You definitely can invest through a fund company. So I wouldn't rule out some of the big fund companies because they offer you a wide range of choices, not just their name brand mutual funds, but also stocks, ETFs and mutual funds that aren't under their own proprietary umbrella. So the big shops, Vanguard, Fidelity certainly have made it very easy for investors to go outside of their own branded fund. So I wouldn't rule those out. In fact, some of those firms have very good, powerful platforms.

Stipp: And in those cases, how would you compare the fees for maybe using Vanguard but investing in another fund? You still need to compare those fees potentially with an E*Trade, for example, right?

Benz: You do, and one thing to think about is usually you'll get a break if you are investing in the proprietary lineup of funds. So you usually will not have to pay a commission to buy and sell those. You may have to pay commissions to sell things that aren't within that proprietary lineup. So be careful if you want, say, a couple of Vanguard funds and then maybe a couple of these other funds, you may find that you will have to deal directly with Vanguard on its own funds, but go outside for the non-Vanguard funds. So just do your homework on what it will cost you to mix and match. You may not be able to get everything you want under one platform's umbrella.

Stipp: Christine, you mentioned commissions and paying attention to that. If I am just investing a little bit each month, say I am just getting going, do I need to be especially careful about who I am going with and how much I am paying?

Benz: Well, you do, and the reason is that they can really neck your returns over a long period of time if you are just investing small sums but you are having that commission taken out each time. So that's one reason why if you are starting small, it may make sense for you to aggregate you money for a few months before you get started rather than getting started with a very small sum on which you will owe commission.

Stipp: Okay. We've been speaking mostly about do-it-yourself investors, so those self-starters who are going out and picking their own investments, but what if I want a little bit of help with my investments or with my portfolio? How does that factor into the mix of what option I might choose here?

Benz: It definitely does, and really we could have a whole video segment about how to choose an advisor because there are so many different tiers of advice. Increasingly brokerage firms are offering clients, particularly larger clients but also smaller ones, some level of advice if they need it, but you may pay for it. So do your homework on what type of advice you'll be getting, whether the person giving you advice is a fiduciary and is making arms-length decisions or maybe is in some way wedded to using that platform's lineup of choices. There are a whole host of considerations, but one of the key questions to ask is, how do you get paid and how much will I pay you for you to give me advice?

Stipp: Of course, another option just outside of the brokerage would be to use a completely independent, perhaps fee-only advisor who can look at the whole picture, right?

Benz: Exactly. That's a terrific way to think about paying for advice, especially if you are a small investor. A lot of advisors work on an hourly basis. So for someone who is just starting out, I think that that model can make a lot of sense, where you actually write a check at the end of the engagement rather than having a commission embedded in your purchase. I think that that can often be the most cost effective way for people who just need that roadmap to help them get started.

Stipp: All right. Christine, some great tips for those would-be investors and hope that they can get started on their investing plans soon. Thanks so much for joining me.

Benz: Thank you, Jason.

Stipp: For Morningstar, I'm Jason Stipp. Thanks for watching.