The personal finance community is a funny bunch. We complain endlessly about the average person not having very much money saved up, and yet most of our investing articles assume the reader has mountains of cash to invest.
Is anyone else seeing a chicken or the egg scenario here?
Quick story: When I first got hired at a bank, the bank organized the second week of the job as a marathon of credit training. Why they hired me without anything to do for a week, we’ll never know.
Anyway, week two of the job starts up and I’m thrust into a room with other new hires learning about the basics of lending for 9 hours a day. The course had a detailed and promising curriculum, and everyone was excited to get learning.
And the training was a total disaster.
The instructors for this “introductory” class had a minimum of 30+ years of banking experience. They were experts in their field, and the career bankers had simply forgotten what is was like to start a career.
Concepts that were second nature to them were completely foreign to us. They constantly talked over our head, and neither the teachers nor the students could speak to each other in the same language if our careers depended on it.
Today, I notice a similar phenomenon on the web. Millionaires retirees try to get people with only a couple thousand dollars, or less, to start investing.
As a somewhat recent college grad who vividly remembers what it’s like scraping together part-time income just to have something to invest, I’m hoping I’ll be a little more successful at showing you how to invest with little money, than the 60 year-old bankers explaining credit default swaps to fresh faced new hires.
Let’s get started:
Investing With Small Amounts of Money – Special Considerations
There are a few rules of investing which become even more important if you want to invest a smaller amount of money wisely:
1. Don’t Be Nervous
Pulling the trigger on your first investment is probably the most nerve wracking experience of your entire investment career.
What if you make a mistake? What if you lose everything?
I’ve been there. Every investor has been there, from your beginning indexer to Warren Buffett.
Here’s the good news: there’s no better time to start your investment journey than right now. Unless you want to pay literally hundreds of thousands of dollars to a financial advisor over your investing career, you’re going to want to learn this stuff eventually.
What better time to learn than when you’re just getting started? After all, it’s much better to make a mistake when you’ve dealing with a $3,000 portfolio than a $300,000 portfolio.
2. Trying to beat the market is even dumber than usual.
Typically, trying to outperform the market by trading individual stocks is a loser’s gamble. Most professionals can’t do it, and when you’re dealing with a smaller amounts of money, it makes even less sense to try.
The reason is simple: math. And percentages.
Okay, that’s a terrible explanation. Allow me to explain:
Imagine a hedge fund manager managing a client’s $10,000,000 portfolio. If he has a great year and outperforms an index fund by 3%, the portfolio earns an extra $300,000. That’s a tempting amount of money.
If you’re starting your investment career with a $3,000 portfolio, beating the index fund by 3% in a year gives you… $90. Not exactly worth your time and effort.
Of course, there’s the giant elephant in the room – tons of research indicates almost nobody can consistently beat the market. Going against this research, especially when the potential payout is so minuscule, is truly a fool’s game.
3. Trading fees can eat you alive
Yet again, that old bugger of percentages is here to discourage the small investor from getting too crazy with his trading strategy.
The typical brokerage fee to buy a stock is about $8, and then another $8 when it’s time to sell. $16 isn’t a huge deal when you’re dealing with $100,000 of stocks. When you’re dealing with $1,000, those fees are a big deal!
Incurring $16 of fees on a $1,000 purchase means your stock pick must increase 1.6% just for you ever break even. Talk about pressure!
My Own Small Money Investing Experience
If I sounded confident in writing out those last three points, then I’ve got a confession:
I know all those points because I’ve experienced them all, first hand.
When I started investing in the stock market, I didn’t even have $1,000. I can remember my first stock purchase vividly. I remember nervously staring at the “place order” screen for hours before mustering up the courage to click the button.
I also remember thinking that I’d juice up my returns by selecting individual stocks to outsmart the market. When I hit a home run, I’d walk away with an extra $50. When I was wrong? Hundreds of dollars lost.
Somewhere along the line I added up just how much I was paying in trading fees. My returns were lagging the index funds, by a lot! I was shooting myself in the foot, and I was spending tons of time and effort to do so!
The Best Way to Invest Small Amounts of Money Wisely
Eventually, I wised up, and I turned around my investing strategy. The surprising part?
The wisest way to invest small amounts of money is almost identical to the best investing strategy for large amounts of money!
Find a low fee, broadly diversified index fund.
Building up a broadly diversified portfolio of many different stocks requires far too much capital for someone with a small investing budget.
Instead, take advantage of what Warren Buffett considers the greatest advancement for the average investor – the index fund!
With the purchase of one share, you can become instantly diversified in hundreds, if not thousands of the top companies in the world.
Here are two great choices for the beginning investor:
Vanguard 500 Index Fund:
- Ticker: VFINX
- Minimum Investment: $3,000
- The Money Wizard’s Thoughts: The 500 largest companies in the United States. When you hear those talking heads on TV talk about “The Market,” these 500 companies are what they’re usually referring to. VFINX is the exact Vanguard fund Warren Buffett recommends to his trustees.
Vanguard Total Stock Market Index Fund:
- Ticker: VTSMX
- Minimum Investment: $3,000
- The Money Wizard’s Thoughts: For even more diversification, this vanguard fund tracks the entire US Stock Market – large, medium, and small sized companies and all! That’s a total of 3,578 different stocks. How’s that for diversification? VTSMX is where I now invest most of my own money.
(Both of these funds come in ETF equivalents, with lower minimum investments. How to decide between an ETF or mutual fund?)
And Keep Investing!
Although it may not seem possible at first, I promise that consistently adding to your small investment will add up.
Through steady contributions to this strategy, I’ve gone from a sub-$1,000 net worth to over $170,000 of investments by my 27th birthday.
By tailoring your investing strategy to your portfolio size and avoiding some of my mistakes, this wise approach will supercharge your wealth.
Disclaimer: I am long VTSAX. I am not an investment professional, registered investment adviser, certified financial planner, or anything of the sort. This article represents my opinions. 🙂