Any time you move money from your checking account to another account, whether it's an individual retirement account (IRA) a mutual fund or savings account, you're making an important step toward a financially secure future.
But what if you only have $25 a month to invest? Can you still secure your financial future? Or is it better to put it into a savings account until it's large enough to counteract fees? This article will explain how to evaluate fees involved in small investments.
How to Translate Fees Into a Percentage
Saving $25 a month will total $300 in a year, not including any interest. A $40 fee on an investment account equals more than 13.33% of your investment. Thus, this $25 investment would have to earn more than $40 in a year just for you to break even – that is, if an account fee was taken out at year's end, you would have to earn a 27% return on your money. Why 27% instead of 13%? Because your money grows steadily, and you earn interest on the amount you have in your account.
For example, after one month you've invested $25, after two months you've invested $50, and so on. As your account grows, the principal on which the investment earns interest grows.
Therefore whether a fee is charged for buying stocks or mutual funds, maintaining or opening an IRA, or a savings account where your savings aren't higher than the minimum balance, you have to consider whether the fee offsets the benefits of your investment. The easiest way to figure out if your fee is too high for your investment is to calculate how much money is necessary in interest or profit earned to offset fees.
For instance, if you invest $25 per month, $3 equals 1% of your yearly total of $300 invested. Divide any fee by $3 to figure out the percentage you would have to earn to overcome the cost of having the account.
If you are investing a different amount, multiply your monthly investment by 12. Then, divide the result by 100. This tells you what 1% of your investment is.
Investing Directly With Mutual Fund Companies
Cut the amount of fees you incur by setting up an investment account directly with a mutual fund company. You can contact mutual fund companies through their websites or by phone and avoid the fees charged by brokerage firms or financial advisors. This is a good choice when you don't have much money to manage.
A pitfall of investing small amounts through this investment avenue is that you are subject to losses. It is similar to investing in stock in that your principal can decrease, or even be lost, based on how the stocks or bonds in your diversified fund rise and fall. Therefore, make sure the amount you invest regularly isn't money that you will need in the next two or three years.
Paying Off Debt
An alternative to traditional investing avenues is to invest in decreasing your debt load. For instance, you could add $25 to the minimum monthly payments you currently make on your credit card, which charges you a 12.9% interest rate. By doing this, you save roughly $3.23 per year for every $25 you pay off.
When your debt is gone, you'll be able to put more money into long-term investments, and you won't have to worry about a small fee eating up all your profits because your earnings will more than make up for the fee charge.
Decreasing Your Mortgage Balance
If your home is tied to a 30-year, $150,000 mortgage loan with a fixed interest rate of 6%, sending in an extra $25 per month with your mortgage payment will cut approximately two years off your mortgage repayment term. There are two reasons for this:
- You're paying down your principal. For every $25 you pay off, that's $25 dollars less you owe on your mortgage.
- The amount of interest you pay on the amount of principal you pay off is eliminated for the rest of the term of the loan.
For example, suppose that you have a balance of $148,000 on your 30-year home loan after your first payment, and you decide to send in an extra $25 this month. You now have a mortgage balance of $147,775. The $25 you just paid off will save you $143.59 over the life of your mortgage.
As a bonus, you're essentially saving for retirement by helping to insure that you won't have to make mortgage payments after you retire if you stay in the same home.
The Bottom Line
Putting aside $25 a month to invest in a savings account, mutual fund, or individual retirement account is a worthwhile venture. However, pay extra attention to make sure profits counteract fees. Also, consider alternatives, such as reducing your credit card debt or amount owed on your mortgage, which will allow you to invest larger amounts in the future.