What's the biggest problem that people with lower incomes have with investing? The old saying that it takes money to make money is true, and 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 IRAs and the stock market might be so far down your priority list, that you find all of these financial experts a bit out of touch.
However, the fact remains that if you don't put money away for later years, you will face a 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. We've put together a few ideas for those people who don't see any available funds for investing.
Some of these strategies may require the help of a financial advisor or the use of a brokerage account, but most people, if they're willing to give up a few small luxuries, can find small amounts of money to invest into their retirement. Investopedia has put together a list of the best discount brokers for those interested in getting the investment process started.
You Need Money
First, we have to solve this 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. How often do you go to Starbucks for your morning coffee? How often do you go to the nearest fast food restaurant for lunch, and how many times have you hit the bar to blow off a little steam after a hard day at work?
What if you cut out even half of those expenses each month, netting you an extra $50 per month? At the end of a year, you would have $600 to invest. Over 20 years that $600 could become more than $22,000 if you saved that same $600 each year. That may not seem like much to get started, but anything is better than nothing, and there are places to put that $600 to that will make a big difference.
DRIPS, or dividend reinvestment plans, allow you to invest small amounts of money into 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.
ETFs, or exchange-traded funds, 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
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 of $1,000, but they may serve as great products for investors who don't want to manage their portfolio on their own. Use caution when picking a target date fund because of the high fees that some funds charge.
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 always fund 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, but for some people, one of the biggest obstacles is debt. If you have a sizable amount of debt to deal with – be it a mortgage, line of credit, student loan or credit card – you can still learn how to balance your debt with saving and investing.
Generally speaking, 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. In other words, if you have a debt on your line of credit at seven percent interest, the money you are investing will have to make more than seven percent — after factoring in taxes and fees — to make it more profitable than simply 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 Debt: This is your credit card. High interest is relative, but anything above 10% is a good candidate for this category. Carrying any kind of balance on your credit card or similar high-interest vehicle makes paying it down a priority before starting to invest.
Low-Interest Debt: 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 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 percent than one that has to return 25 percent.
Tax-Deductible Debt: If there is such a thing as good debt, this is it. Tax-deductible debts include mortgages, student loans, business loans, investing 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 will focus on here are long-term low-interest and tax-deductible debt (such as personal loans or 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.
Using Compounding to Grow Your Money
Debt elimination, particularly of something such as 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) what 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 the lessening of your debt load and interest payments rather than the two to eight percent 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—as much of finance is. 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.