After you've been at it for long enough, investing ends up a bit like golf -- you play the ball as it lies. You have money invested in certain ways in certain account types. When it comes to moving money across account types or between investments within brokerage accounts, there's only so much you can efficiently do.
With that in mind, it makes sense to get a good start so that you have fewer money regrets later. If I were just starting out investing today, I know exactly how I'd start from scratch and invest my first $5,000. I'd get the money inside a Roth IRA, buy the Invesco S&P 500 Equal Weight ETF (NYSEMKT:RSP), and set the dividends to reinvest. It's a simple strategy, but one with a lot of power behind it.
Why a Roth IRA?
In many respects, Roth IRAs truly are the gold medal winners of retirement accounts. Key benefits of that account type that make it so powerful include:
- Money in your Roth IRA can grow completely tax free for your retirement
- You never have to withdraw money from your own Roth IRA within your lifetime
- In a pinch, you can access your direct contributions with no penalties or taxes
- With a decent annual contribution limit, your Roth IRA can make you a millionaire over time
Indeed, those factors make Roth IRAs so incredibly powerful that they deserve consideration to be high priority investment vehicles for virtually any new investor. About the only key reasons to invest elsewhere first would be:
- Taking advantage of a 401(k) match if you get one.
- If you don't have earned income (since Roth IRAs need to be funded by earned income).
- If you earn too much to directly contribute -- in which case, a backdoor may be available.
Since most people with jobs have a $6,000 (or $7,000 if they're age 50 or older) Roth IRA contribution limit, a $5,000 investment fits nicely in such an account for many people.
Why reinvest dividends?
Although each year's dividends may seem like only a small amount of money, over time, they play a huge role in providing investors with strong compounded total returns. Especially if you're investing in a broad index-oriented fund like the Invesco S&P 500 Equal Weight ETF inside of a Roth IRA, those automatic dividend investments can really add compounding power over time. Even better, since they're automatic, you get the long-term benefits of staying invested with almost no new work involved.
Note that If you're investing outside of a retirement account or picking individual stocks, it may make sense to collect your dividends as cash. In ordinary accounts, the basis tracking needed for tax purposes adds a lot of transactions to keep track of. If you're investing in individual stocks, you might want finer control over where you invest your dividends in order to add oomph to your favorite picks.
Why the Invesco S&P 500 Equal Weight ETF?
Over time, index-based investing has consistently trounced the performance of most actively managed funds. There are structural reasons behind that -- most notably, the costs and fees associated with managing an active fund make it hard for those types of funds to win.
The current challenge with a typical S&P 500 fund, however, is that most such funds are market-capitalization weighted. As a result, the largest companies in the index have a huge share of that index. In the S&P 500, the top 10 companies represent over a quarter of the total index, and those companies are largely technology companies.
There's nothing wrong with owning technology companies, but if a goal of index investing is to get exposure to a broad swath of the economy, the Invesco S&P 500 Equal Weight ETF does that better. Both a market capitalization weighted S&P 500 fund and an equally weighted S&P 500 fund invest in the same stocks, but the more balanced nature of the equally weighted fund give it a diversification edge.
With a mere 0.2% annual fee and almost no turnover, the Invesco S&P 500 Equal Weight ETF has a good combination of low fees and low churn that give index funds their edge. All in all, there are lots of reasons to believe that ETF has what it takes to be worth owning as a reasonable first investment in any investor's long-term portfolio.
Why all at once?
While $5,000 is a great start on investing, a single $5,000 investment will not likely be enough to get you to and through a comfortable retirement all by itself. As a jump-start, first investment it's a fabulous foundation, but building your more financially secure future will be more of a marathon than a sprint.
As a result, regardless of whether the market moves up or down in the short term, your plan should be to add money on top of that initial $5,000 as you can. In all probability, sometimes, you'll buy in at a higher valuation, and sometimes you'll buy in at a lower one. Over time, though, treating that $5,000 as a first step on a long journey will be a better idea than worrying about getting in at the perfect price point today.
Get started now
Indeed, time is the most valuable tool you have when it comes to building wealth. The sooner you get yourself on a trajectory where you're regularly investing, the better off you'll likely be. So if you've got $5,000 to put to work for you, use it to set up your financial foundation and inspire you to stay on course for your longer term future. When you look back at how far you've come after keeping at it over the course of your career, you'll be really glad you did.