The old saying that it takes money to make money is true. For those living paycheck to paycheck, there often isn't enough money left over to put towards investing. When you need the money now, thinking about an individual retirement account (IRA) and the stock market might be far down on your priority list. However, by reading this article and gaining knowledge, you are taking one of the necessary first steps in building a retirement nest egg.
- Setting aside small amounts of money can help you save even if the idea of investing is daunting.
- Dividend reinvestment plans allow you to buy small amounts of dividend-paying stocks straight from the company while reinvesting the dividends.
- You can buy one ETF share at a time through a broker.
- Although target-date funds divvy up your investment based on your target retirement date, they often have large minimums to initially invest and may have substantial fees.
- A 401(k) with matching funds is essentially free money and therefore should take priority over outside investments.
- Investors who are in debt need to understand what kind of debt they are in and may need to prioritize paying off the debt over investing for a period of time.
You Need Money
The fact remains that you must put money away for later years or face a possible catastrophic situation. Someday, you won't be able to work and Social Security won't be enough to live on—assuming the fund is around in 20 or 30 years. You can start investing now with less money than you think it will take.
First, we have to solve the problem of limited funds and the advice isn't new or revolutionary. Something in your life has to go, but it doesn't have to be a big life change. Simple changes that save $1 here and $5 there can add up to make a big impact.
We've put together a few ideas for those people who don't see any available funds for investing.
As with anything else, make sure you consult a financial professional about your investment options. This is especially important if you're trying to juggle saving while paying off your debts.
Dividend Reinvestment Plans (DRIPS)
Dividend reinvestment plans (DRIPS) allow you to invest small amounts of money into a dividend-paying stock, by purchasing directly from the company.
Companies like GE, Coca-Cola, Verizon, Home Depot, and Johnson & Johnson are just a few of the companies that allow you to make regular purchases of very small amounts of stock, and reinvest the dividends.
This can add up to a big investment over time and, as you gain a larger balance, you may consider diverting some of these funds into other investments.
Exchange-Traded Funds (ETFs)
Exchange-traded funds (ETFs) are financial products that track the performance of a certain sector of the investment market. You can buy as little as one share of an ETF through a broker, and some of these ETFs track the performance of the total stock market, the bond market, and many others.
Many ETFs also pay a dividend, making a purchase in a fund like the Vanguard Total Stock Market ETF (VTI) an instantly diversified portfolio that also pays a dividend.
Target-date funds, as the name implies, target your retirement date by changing the percentage of stocks and bonds to assure that your money remains safe as you approach retirement age.
Some of these funds require a minimum investment of $1,000, but they may serve as great products for investors who don't want to manage their portfolios on their own. But make sure you use caution when picking a target-date fund because of the high fees that some of these vehicles charge.
The 401(k) is an employer-sponsored retirement savings plan that allows you to put away a portion of your paycheck into an investment account. The plan comes with tax savings depending on the type of plan you have:
- If you invest in a traditional 401(k), you can set aside pre-tax dollars, which lowers your taxable income and, therefore, your tax liability.
- If you invest in a Roth 401(k), any withdrawals you make during retirement are tax-free.
If you have a 401(k) that will match your contributions, invest there first. Since your company is giving you free money to invest, you should consider funding your 401(k) before outside investments.
Investing While in Debt
If you have some money saved or invested, you want to see it grow over time. There are many factors that can prevent this from happening. Debt is one of the biggest obstacles for some people. If you have a sizable amount of debt to deal with, whether it's a mortgage, line of credit (LOC), student loan, or credit card, you can still learn how to balance your debt with saving and investing.
Having debt can make it very difficult for investors to make money. In some cases, investing while in debt is like trying to bail out a sinking ship with a coffee cup. For instance, if you owe money on a LOC with 7% interest, the money you put aside will have to make more than 7% (after taxes and fees) to make it more profitable than paying down the debt. There are investments that deliver such high returns, but you have to be able to find them, knowing you are under the burden of debt.
It is important to briefly distinguish between the different kinds of debt that may be incurred.
High interest is relative, but anything above 10% is a good candidate for this category. Having said that, you can probably count your credit card as a high-interest debt. Carrying any kind of balance on your credit card or similar high-interest vehicle makes paying it down a priority before starting to invest.
This type of low-interest debt may often be a car loan, a line of credit, or a personal loan from a bank.
The interest rates are usually described as a prime plus or minus a certain percentage, so there is still some performance pressure from investing with this type of debt. It is, however, much less daunting to make a portfolio that returns 12% than one that has to return 25%.
One thing to keep in mind, though, is that your credit score determines your interest rate. The better your score, the lower your rate. But if you have a less-than-stellar credit history, the chance of a low-interest loan
If there is such a thing as good debt, this is it. Tax-deductible debts include mortgages, student loans, business loans, investment loans, and all the other loans in which interest paid is returned to you in the form of tax deductions. Since this debt is generally low interest as well, you can easily build a portfolio while paying it down.
The types of debt we focus on here are long-term low-interest and tax-deductible debt, such as mortgage payments. If you do have high-interest debt, you'll likely want to focus on paying it off before you begin your investing adventure.
Not all interest-bearing loans are tax-deductible. Be sure to check with your lender or a financial professional whether you can deduct the interest on your loan.
Compounding to Grow Money
Debt elimination, particularly of something like a loan that will take long-term capital, robs you of time and money. In the long term, the time (in terms of the compounding time of your investment) that you lose is worth more to you than the money you actually pay (in terms of the money and interest that you are paying to your lender).
You want to give your money as much time as possible to compound. This is one of the reasons to start a portfolio in spite of carrying debt, but not the only one. Your investments may be small, but they will pay off more than investments you would make later in life because these small investments will have more time to mature.
Creating a Plan to Invest
Instead of making a traditional portfolio with high- and low-risk investments that are adjusted according to your tolerance and age, the idea is to make your loan payments in the place of low-risk and/or fixed-income investments. This means that you will be seeing returns from decreasing your debt load and interest payments rather than the 2% to 8% return on a bond or similar investment.
The rest of your portfolio should focus on higher-risk, high-return investments like stocks. If your risk tolerance is very low, the bulk of your investing money will still be going toward loan payments, but there will be a percentage that does make it into the market to produce returns for you.
Even if you have a high-risk tolerance, you may not be able to put as much as you'd like into your investment portfolio because, unlike bonds, loans require a certain amount in monthly payments. Your debt load may force you to create a conservative portfolio with most of your money being invested in your loans and only a little going into your high-risk and return investments. As the debt gets smaller, you can adjust your distributions accordingly.
The Bottom Line
You can invest in spite of debt. The important question is whether or not you should. The answer to this question is personalized to your financial situation and risk tolerance. There are certainly benefits from getting your money into the market as soon as possible, but there is also no guarantee that your portfolio will perform as expected. These things depend on your investing strategy and market timing.
The biggest benefit of investing while in debt is psychological. Paying down long-term debts can be tedious and disheartening if you are not the type of person who puts your shoulder into a task and keeps pushing until it is done. For many people who are servicing debt, it seems like they are struggling to get to the point where their regular financial life—that of saving and investing—can begin.
Debt becomes like a limbo state where things seem to be happening in slow motion. By having even a modest portfolio to track, you can keep your enthusiasm about the growth of your personal finances from ebbing. For some people, building a portfolio while in debt provides a much-needed ray of light.