If you’ve followed along so far, we’ve gone through getting your life in financial order so that you can start investing, found money in your budget and set it aside, and decided whether you will invest in individual securities or just stick to mutual funds. You’re now ready to set up an investing account and get started for real. (If you haven’t been following, just choose “How to invest” from the categories to the right to find all of the posts in this series. The first post in the series is here
If you have chosen to invest only in mutual funds, there is really no reason to invest through a broker. You can simply start an account at one of the mutual fund companies by filling out some paperwork and sending in a check or transferring cash electronically, and then choose from among the funds that they offer. Choosing a mutual fund company that has a good selection of funds, meaning they have funds that invest in different areas and they have low costs, is important. The fund company you choose should have dozens of different funds and they should have several index funds will fees less than 0.50% of fund value per year. One excellent fund company, which was one of the creators of index funds, is Vanguard. (I know someone who reads this blog regularly probably thinks that I have an arrangement with Vanguard to promote their funds, but I really don’t. They are just a great fund company because of their low fees and diverse offerings.)
If you wish to go through a broker you can still invest through funds, but most of the mutual funds the broker will offer will have high fees and what is called a “load” – a big commission paid when you buy into the fund. A better way to invest in a whole segment of the market easily through a broker is to buy Exchange Traded Funds, or ETFs. These are like mutual funds, but you buy them in the open market like a stock.
ETFs can actually have lower fees than index funds, and there are ETFs that track many index funds. In fact, Vanguard now sells ETFs for all of their popular index funds. The difference in using an ETF versus a standard mutual fund is that with an ETF you will pay a commission to a broker when you buy or sell shares of the fund. If you trade shares very often, you might be better off with a traditional mutual fund despite the higher yearly fees. If you are willing to buy in and leave things alone for many years, which is the right way to invest anyway, ETFs would be a lower cost choice much of the time. Of course, mutual funds can be better if you’re investing small amounts regularly will let you send any amount of cash in to buy more shares, where you would pay a minimum commission each time you purchased shares in an ETF.
One advantage of setting up a standard brokerage account is that you can then buy shares directly in companies. You can pick specific stocks that you think will do well over long periods of time. Once you buy the stocks, until you sell you will pay neither fees each year nor taxes. Probably the lowest cost way to invest would be to buy shares of several long-term investments and then leave them alone unless things change with the company. The fees on mutual funds aren’t really that important when you have a small amount invested, but if you have several hundred thousand invested you could be paying $50,000 in fees each year or more even if you stay fully invested in the funds and don’t move your investments around. With a mutual fund you could also end up paying capital gains taxes on your investments because the fund manager sell shares at a gain even if you don’t sell and shares of the mutual fund.
Setting up a brokerage account is simply a matter of filling out some forms and sending in some cash to the account. In the past you would go into a brokerage firm and filled out paper forms (or give the information to them verbally). but today this can be done online. In fact, there are many online brokers who have no physical location, the most famous of which is E-trade, that do everything online.
Typically brokerage firms charge a fixed account fee each year, on the order of $100. Otherwise, they generate income from you each time you buy or sell by charging a commission. Commissions can be flat fees, like $50 per trade, or a percentage of the value of the trade, with some minimum commission. Full service brokers, like Merrill Lynch, charge more for trades but offer a lot more advice and services than discount brokers. If you don’t trade very often, as is the advice of this blog, it really won’t matter much if you use full service or a discount broker. Commissions can certainly add up, however, if you do trade more frequently than a few times per year.
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Disclaimer: This blog is not meant to give financial planning or tax advice. It gives general information on investment strategy, picking stocks, and generally managing money to build wealth. It is not a solicitation to buy or sell stocks or any security. Financial planning advice should be sought from a certified financial planner, which the author is not. Tax advice should be sought from a CPA. All investments involve risk and the reader as urged to consider risks carefully and seek the advice of experts if needed before investing.