One of the common myths about investing is that you need to have a big fat bank account to even get started. In reality, an investor can build a solid portfolio starting with a few thousand or even a few hundred dollars.
If you're living on a tight budget to start with, your nest egg might seem microscopic, but the secret to wealth is thinking long term. You'll be surprised at how big that nest egg will grow over time.
Some of the basics of building wealth on a budget:
- Stash your cash in an index fund, CD, or other low-fee, lower-risk investment. Leave stock-picking to the pros for now.
- When your stash is big enough, branch out to investments with bigger potential.
- Maximize your retirement plan savings. There are immediate benefits to you.
- Understand the basics of taxes on investments.
- Consider an automatic savings app to get you started.
- Get out of debt.
- Minimize the fees on banking and investing.
Whether you're starting off with $500, $5,000 or something in between, and living on a tight budget, the key is to choose investments that offer the most value for every dollar.
How to Invest $500
It may seem like a small amount to work with, but $500 can go farther than you might think.
Exchange-traded funds (ETFs) are an attractive option for investors who are comfortable taking on a degree of risk but don't want to pay high fees. Unlike most mutual funds, ETFs typically feature a passive management structure, which translates to lower fees. Because they tend to have lower turnover, exchange-traded funds are also more efficient in terms of how frequently taxable events occur.
Another low-fee alternative is a dividend reinvestment plan (DRIP). You buy shares of stock, and your dividends are automatically used to purchase additional shares or even fractional shares.
This is a great choice for small investors because the shares are purchased at a discount and without paying a sales commission to a broker. Buying a single share of a company's stock will get you started.
How to Invest $1,000
With $1,000, it's possible to do a branch out a little more. Keeping fees to a minimum is still a priority, but you can move beyond ETFs and consider other options, such as index funds.
An index fund is a type of mutual fund that tracks a specific market index, such as the Standard & Poor 500 or the Dow Jones Industrials. Like exchange-traded funds, index funds are passively managed, which means a lower expense ratio.
The goal of an index fund is to at least match the performance of the index. It also gives you broad exposure to a number of asset classes.
With that $1,000, you also could consider purchasing individual stock shares, which come with higher risk but can generate higher returns. Investing in individual stocks that pay dividends is a smart strategy. You will have the option of receiving the dividends as cash payouts or reinvesting them in additional shares.
How to Invest $2,500 to $3,000
Moving up the ladder, the question of how to invest $2,500 to $3,000 depends on your goals and risk tolerance.
If you prefer to play it safe, park it in a certificate of deposit or use it to purchase short-term treasury bills. The growth potential is limited but the returns are guaranteed and the risks are virtually zero. Both bonds and mutual funds can be purchased through an online broker.
On the riskier side, peer-to-peer lending offers the potential to earn significantly higher yields. Crowdfunding platforms like Lending Club and Prosper connect investors with money to lend and entrepreneurs trying to fund new ventures. As the loans are repaid, each investor receives a share of the interest in proportion to the amount they have invested. Generally, annual returns fall in the 5% to 8% range but can climb to 30% or more for investors who are willing to take a big risk.
How to Invest $5,000
The possibilities become broader at the $5,000 level. One worth considering is investing in real estate. While $5,000 isn't enough to purchase property, it's enough to invest in real estate in either of two ways. The first option is investing in a real estate investment trust (REIT). This is a corporation that owns a group of properties or mortgages that produce a continuous stream of income. When you invest in a REIT, you're entitled to a share of the income generated by the underlying properties. REITs are required by law to pay out 90% of their income to investors as dividends annually. REITs can be traded or non-traded, with the latter carrying much higher upfront fees.
Real estate crowdfunding is the second option. Real estate crowdfunding platforms are now permitted to accept investments from both accredited and non-accredited investors. Many platforms set the minimum investment for gaining entry to private real estate deals at $5,000.
Investors can choose between debt and equity investments in commercial and residential properties, depending on the platform. Returns for debt investments range from 8% to 12% a year. Equity investments can see higher yields if the value of the property increases. Keep in mind, this type of investment can carry more risks than other more traditional investments.
Maximize Your 401(k)
If your company offers a 401(k) retirement plan, you really don't want to overlook it. And that goes double if your company matches part of your contribution to the plan.
For example, if you have an income of $50,000 and contribute $3,000, or 6% of your income, to your 401(k) plan, your employer might match that by contributing an additional $3,000. A less generous employer might contribute up to only 3%, adding $1,500 to your $3,000 contribution.
You'll always want to invest up the full amount of your employer’s match. Otherwise, you're throwing away money.
Even if your employer doesn't offer a match, the 401(k) plan is a good deal. If the money is invested in a tax-deferred account, your contribution comes straight out of your paycheck in pre-tax dollars, reducing your taxable income for now.
If you have the option, you can invest in a tax-exempt account, paying the taxes up front. In that case, you will not owe taxes on the principal or the capital gains when you withdraw the money. Granted, if you're on a tight budget, giving up money now may not be feasible.
Invest in a Target-Date Fund
If you’re saving for retirement or a major purchase, and want to make your investments as affordable and easy as possible, you might look for a low-fee target-date fund with a low minimum investment.
With this type of fund, you choose the target date. The investments in the fund are automatically adjusted over time, with the balance moving from riskier to safer as your target date nears.
Why is this important? When you’re just starting out, you have time. You can make riskier investments that might earn higher returns. But as you near your target date, especially if that's your retirement date, you want to protect yourself from sudden losses that can wreck your plans.
If you’re investing on a small budget, you don’t have the cash to spend on every fund under the sun. A carefully chosen target-date fund with a low expense ratio can be a good way to grow your savings.
Consider Mutual Funds
Picking individual winners and losers in the market is hard, and putting all your money in a single asset is risky. So how can you benefit from a rising market without the risk of blowing your whole nest egg?
Mutual funds and exchange-traded funds (ETFs) solve this problem by investing in a number of assets. Your contribution, no matter how large or small, is spread among a wide variety of assets. Your investment is diversified, which reduces your risk.
If you want exposure to a certain sector or the U.S. markets as a whole, investing in an ETF or mutual fund is a wise idea. You can invest in the technology sector, for example, without betting the house on a single technology name.
Low-fee ETFs and mutual funds are a great way to get broad exposure to the markets. In addition to stock ETFs, there are ETFs that invest in international equities, commodities, real estate, and more.
The New York Stock Exchange recently moved to list cryptocurrency ETFs, so you may even be able to invest in bitcoin ETFs soon. Of course, just because an ETF exists doesn't mean it's a good investment.
You can’t escape taxes, but you can minimize their impact.
If you open a standard brokerage account, you're investing with your after-tax money. If those investments are profitable, you are then taxed on the capital gains. Or, you can also open a tax-deferred account (TDA) or a tax-exempt account (TEA), which will mean the money in the account is only taxed once.
With a tax-deferred account, you pay taxes only when you withdraw the money. For example, if you have an annual income of $50,000 and put $3,000 in a TDA, you will be taxed as if you had made $47,000 that year. You will pay taxes on that $3,000, and on whatever profit you make, only when you withdraw those earnings in the future.
Typically, TDAs are a better choice if you think your future tax rate is likely to be lower than it is today. A traditional individual retirement account (IRA) is one example of a TDA.
If you have a tax-exempt account, you use after-tax money to make the investments. Using the same example, if you earn $50,000 and put $3,000 in a TEA, you will pay income taxes on that $50,000. However, any gains from the $3,000 in the TEA are tax-free.
If you are currently in a low tax bracket but think your future tax rates will be higher, a TEA is probably a good choice. A Roth IRA is one example of a TEA.
Because of their special tax status, TDAs and TEAs have special restrictions that standard investment accounts don’t have. For example, there is a 10% penalty if you withdraw the money for a non-qualifying reason before the age of 59½. These accounts also are subject to contribution limits that vary with your age.
Open a Low-Fee Brokerage Account
Online brokerage accounts are an affordable way to buy and sell investments. Companies like TD Ameritrade have fees as low as $6.95 per trade with no account minimum. Serious investors with an account balance of $10,000 or more can benefit from fees as low as $0.005 per trade at Interactive Brokers.
Ultimately, your choice of broker matters less than making sure you get started investing.
Automatically Save and Invest
Earning money is hard, spending it is easy. Putting aside even $1 a day is a good way to start saving. But most target-date funds require a minimum investment of $1,000, while ETFs and mutual funds can require higher minimums. If you’re having trouble building up enough money to make such an investment, consider signing up for a service that automatically saves money for you.
Here are three choices:
- Acorns is a mobile app that automatically rounds up transactions from linked credit or debit cards and puts it into one of several low-cost ETF portfolios. The service costs just $1 a month until your balance is over $5,000, at which point you only pay a 0.25% expense ratio. There are no minimum investment amounts and no trading fees. Although savvy investors can avoid Acorns' 0.25% fee by investing directly in reputable ETFs, newbies to investing might prefer the convenience of Acorns. If you're a college student, it's free.
- Qapital is an app that links to your checking account and automatically transfers money, based on rules you choose, to an FDIC-insured Wells Fargo account. Qapital will even round up all your credit card purchases and save the change to your account. Or you can create your own savings rules. There are no fees but you don't earn any interest. You might use Qapital to build up some savings and then transfer it into a low-fee investment account.
- Bank of America's Keep the Change: Bank of America customers can sign up for its Keep the Change savings program, which automatically rounds up transactions made with a debit card and saves it.
All of these programs can help you save a little money without even thinking about it. But they're not the best choices for everyone. If you can qualify for cash-back or other rewards credit card, you could use that plus an automatic savings service to save more efficiently.
Save Your Tax Refund
If you find it hard to save money throughout the year, setting aside part or all of your tax refund is one of the best ways to get started with investing. It’s one of the few moments in the year where you're likely to get a chunk of cash that you weren't already counting on.
Depending on the size of your refund, it could be a good time to invest in an ETF with a higher minimum-investment requirement or to put a larger amount of money into a retirement account than you might otherwise feel you can afford.
It's Easier Than You Think
Given today's technology and competition, there has never been an easier or cheaper time to get started investing. A robo-advisor can help you create a balanced portfolio at a low price. The vast number of ETFs and mutual funds give you access to any asset class on Earth.
The hardest part of investing is getting started. Whether you consider a 401(k), a mutual fund or a robo-adviser, starting today is a responsible choice that will pay off in the years to come.
Get Out of Debt
Even if you're earning a healthy income, student loans and credit card debt can weigh down your finances. Sometimes getting rid of debt is the best investment you can make.
The average annual real return of the U.S. stock market is about 7%. High-interest credit cards can carry rates of 20% or more, and some student loans have interest rates over 10%. If you’re carrying a lot of high-interest debt, it makes more sense to pay off some of your most expensive debt quickly instead of investing that money. You can’t predict the exact return on most of your investments, but you can be certain that retiring debt with a 20% interest rate one year early is as good as earning a 20% return on your money.
Invest in Yourself
Not all debt is bad. Debt accrued to increase your earning potential can be a great investment. A 2017 U.S. News & World Report survey found that graduates of the 14 top MBA schools command salaries of more than $100,000 in their first year after graduation. The Financial Times found that 2017 salaries for top 100 business school graduates average $142,000 just three years after graduation.
When evaluating your likely return on an investment in graduate school tuition, compare the average student loan debt with the average starting salaries of graduates in your field of study. It will help you decide whether the degree is worth it.
Ultimately, investing is about using money wisely today to have more of it tomorrow. If that means investing in education or opening a business instead of putting more money in a mutual fund, then that’s what you should do.
Get a Low-Fee Checking Account
Saving money and minimizing fees starts with a low-fee checking account.
Some online checking accounts offered by companies like Ally Bank and Charles Schwab offer no-fee checking accounts with free checks. Many online banks offer rebates on ATM fees, and some offer overdraft protection.
Traditional banks such as Chase or Bank of America not only charge for checks but often don’t pay interest on checking accounts and charge monthly fees of $10 or more on accounts below a certain balance, usually $1,500.
Policies vary by bank, but these fees may be waived with qualifying direct deposits or a large enough minimum balance.
A credit union may offer you a no-fee checking account, free checks, and reduced fees on other services.
In any case, it pays to shop around for a bank and read the fine print to compare costs.
Minimize Investing Fees
No matter your net worth, it’s important to minimize your investment fees, whether it’s on a checking account, a mutual fund, or any other financial product.
That is especially important when you’re investing on a budget because fixed fees will take a bigger chunk of your savings. A $100 annual fee on a $1 million account is trivial, but a $100 fee on a $5,000 account is a financial hit.
It’s been said that being poor is expensive, but the principle holds true even if you aren't poor. High-fee investing accounts can sap your savings and reduce your returns. If you’re investing on a budget, carefully choose where you put your money.
The Bottom Line
Investing can get complicated, but the basics are simple. Minimize taxes and fees and maximize employer contributions and the amount you save. Make smart choices with your limited resources. Start by using your tax refund or automatic savings programs to fire up your savings engine.