Question: Hello. I've decided I want to start investing, and I'm thinking of using an online broker instead of visiting a brokerage firm. Is there anything I need to know before I start?
Karen K., Palo Alto, Calif.
Answer: I'm a big fan of online brokers. You can trade any time you want, the fees are typically lower than a brick-and-mortar broker, and your investment options are virtually limitless.
That said, remember there's no professional guiding your decisions, so without some sense of direction, investing online could seem to be like walking on a tight rope without a net.
But don't worry, I'll guide you through the process with these five tips.
1. Have a way to fund your online brokerage account.
This is simple but often overlooked. Most online brokers want you to be able to transfer funds electronically to your online brokerage account from a checking or savings account. Whatever account you choose to transfer from, be sure you have plenty of funds available in that account so you don't face overdrafts.
Many brokerages also allow you to mail in checks, cashier's checks or money orders to fund your account, but these 'snail mail' methods may come with fees and slow down your investing plans, so be aware of that.
2. Know what you're investing toward.
When you know what kind of investment account (retirement account, taxable investment account, or 529 plan) is right for you, you'll be better prepared to shop for the best online brokerage.
Retirement Plans: If you're planning to invest for retirement and not touch the money until you turn 60, you'll likely want to open an IRA or a Roth IRA account, which offer tax advantages that can save you tens of thousands of dollars in the long run (We talk more about this in The 8 Best Reasons to Invest in a Roth IRA).
Taxable Investment Accounts: If you're investing for fun or for a shorter term goal, you may opt to open a regular investment account -- then you can sell your investments without penalties (but with normal capital gains tax if you profit from your sale).
College Funds: Those looking to save for their child's future college may consider investing through a tax-advantaged 529 plan.
3. Decide between investing yourself or using a robo advisor.
If you prefer to choose your own investments and make your own portfolio mix, stick to the traditional online brokerage firms. TD Ameritrade, E-Trade, Charles Schwab, Scottrade and others typically let you buy or sell hundreds of different stocks, ETFs, mutual funds or other investment options online for less than $5 per trade while giving you full control over your portfolio.
However, if you'd rather have a less hands-on approach to investing and want to dollar cost average (i.e. invest automatically on a monthly or weekly basis), you may consider using a low-cost, robo advisor service such as Betterment or Wealthfront. These automated services take your money and invest it for you on a regular basis without you having to worry about choosing your investments, portfolio allocations, or even rebalancing.
4. Be aware of online brokerage minimums and fees.
Whether you choose your own investments or use a robo-advisor, just know that not all broker services are the same, so get to know each online broker's 'fee schedule' or 'pricing' pages. Some brokerages will charge commissions per trade, while others ask you to pay a certain percentage of your account balance as a 'management fee' (typically 0.25% to 1% of your account balance) each month or year.
Also pay attention to the account minimums, which tell you how much cash you'll need to open an account in the first place (If you're opening a retirement account, most firms typically waive this requirement).
5. Know what you want to invest in.
Just as you shouldn't go to the grocery store on an empty stomach without a shopping list, you don't want invest online without a definite plan of what you want to buy. And even if you're going the robo advisor route, it's a good idea to be familiar with what investments the automated program is putting your hard-earned money in.
If you enjoy the challenge of stock picking, you may want to read The 8 Key Facts To Know About A Company BEFORE You Invest to avoid mistakes many investors make when choosing stocks.
But if you don't have time to research individual companies for eight hours a day, you may consider investing in mutual funds or ETFs that allow you to spread your investment dollars among several companies at once for instant diversification. You can see how I did this myself by using a low-cost online brokerage to make a well-diversified investment mix and automatically investing $100 a month toward my future in The Lazy Man's Retirement Portfolio.
With cash, some knowledge and a good investment plan under your belt, you should be ready to responsibly invest online in as little as 20 minutes.