In these difficult economic times, the idea of putting extra money aside for investments might seem like a daunting task. But planning for the future is essential to financial security. You don't have to earn a degree in economics or get a second job to come up with the extra cash to start an investment portfolio. Here are some of the best practices for getting into the market.
- Create an Investment Policy Statement (IPS) that lays out the purpose of your investment.
- Review your IPS annually to make sure it is still aligned with your financial goals.
- Find ways to cut back on some budget items so that you can allocate small amounts to investing.
- Put the funds in a separate interest-bearing account
- Consider setting up an automatic transfer that devotes an amount from your pay check to savings.
- Find budget-friendly investment vehicles, such as exchange traded funds (ETFs), and brokerages that offer low or no commissions on trades and no minimum balance.
- Thoroughly research any financial professional before using them as an advisor.
Develop a Plan
Before you invest a dime, it is imperative that you come up with a plan for your money. A written investment plan, known as an Investment Policy Statement (IPS), can be helpful in getting organized. An IPS should address the purpose of your investment, such as paying for a child's college education or funding your retirement. This information will determine the amount of return you want on your investment and how soon you'll need it. The IPS will also address your risk tolerance. Investors that need their money in the short term should shy away from volatile investments that tend to fluctuate up and down. If your goals are more long term, you can enjoy the rewards of riskier investments while having time to recover from the inevitable downturns in the market. There are several types of investment products available, and each has its own set of benefits, risks, and fees.
Why You Should Develop an Investment Policy Statement (IPS)
The U.S. Securities and Exchange Commission operates the website "Investor.gov," which provides an easy-to-read guide on everything from stocks and bonds to money market funds and commodities. Another benefit of creating a personal IPS is the opportunity to prepare for bad financial times before they happen. A strong IPS will alleviate the hasty decision-making that can become common during economic upheaval.
It is likely that your financial goals will change over time. Review your IPS annually or as big life changes occur, such as getting married or divorced, having a child, or purchasing a home, to ensure that your plan still matches your needs. You can even practice investing without using any real money. Pretend that you have a specified amount of money (say $15,000) and use it to track how different investments would do over the course of a year or more. This will allow you to learn how different investment vehicles work and which ones best fit your needs.
Determine Your Initial Investment
Investing will be less intimidating if you don't have to bet the farm to get in the game. It is possible to start a thriving portfolio with an initial investment of just $1,000, followed by monthly contributions of as little as $100. There are many ways to obtain an initial sum you plan to put toward investments. First, look at your personal budget and see if there are any areas where you can cut back, such as entertainment, shopping, or dining out.
Take the money you would have used on these non-essential expenditures and put the funds into a separate interest-bearing savings account. Another idea is to live by the rule of paying yourself first. Determine an amount that you will take from each paycheck and devote it to savings before doing anything else. You can set up automatic transfers from your checking account to your savings account so that you aren't tempted to skip on saving. Finally, don't underestimate the power of simply saving your spare change.
Many credit unions and banks, such as Bank of America, offer programs that round up debit card purchases to the nearest dollar amount and transfer the difference from your checking account to your savings account. To get the most out of one of these programs, find a financial institution that will match some or all of your savings.
Find Budget-Friendly Investment Products
There are a few different ways you can invest once you have at least $1,000. One such method is exchange traded funds (ETFs), which only require a minimum purchase of one share. You'll get a greater return with brokerages that offer low or no commissions on trades and no minimum balance. Another option is to find an all-in-one or pre-mixed fund that will let you in for $1,000 or eliminate the minimum investment requirement in exchange for monthly automatic contributions (usually at least $50 a month). The benefit of this type of fund is that it gives you an instant diversified portfolio of cash, bonds, and stocks.
While having experts manage your portfolio might sound appealing, many believe that the higher annual fees tied to actively managed funds are not justified compared to the returns from passively managed funds with lower fees.
According to a Morningstar report, in 2021 actively managed funds continued to underperform when compared to passively managed funds. The report found that only 45% of actively managed funds were able to outperform their passively managed peers.
Protect Your Money
Once you finally have the money to start investing, the last thing you want to do is lose it all to a fraudulent deal. Although a professional financial advisor can be invaluable when it comes to navigating your investment portfolio, beware of scam artists who are only pretending to have their investors' best interests in mind.
There are several different types of fraud that can target both new and seasoned investors. Investors should never give their money to anyone without doing the proper research to verify an advisor or broker's credibility. The U.S. Securities and Exchange Commission's Electronic Data Gathering, Analysis and Retrieval (EDGAR) filing system is an online resource for checking a company's financial statements and activities. You can also use the SEC's database to research the disciplinary histories of securities salespersons, who should be licensed to sell securities in your state.
Avoid working with companies and individuals who pressure you to invest quickly or promise "guaranteed returns." At best, a highly optimistic annual return is 10%. A promise of anything more than that is likely too good to be true. If you have any questions or concerns regarding investment fraud, contact the SEC, the Financial Industry Regulatory Authority (FINRA) or the North American Securities Administrators Association (NASAA).
The Bottom Line
Even on a small budget, it is well within the realm of possibility to save up extra cash to put toward an investment portfolio. All it takes is some planning to figure out your investment goals, finding investment products that don't require large inital commitments, and the proper research to ensure your funds are properly protected.