Up until a few short years ago, investors didn’t have a lot of options for investing small amounts of money. Investors were limited to buying whole shares of stocks or ETFs or meeting mutual fund investment minimums.
That made it a challenge to even get started with investing, let alone build a diversified portfolio.
The easiest “fix” was to prioritize investing in ETFs. That way you could at least have a diversified investment in a portfolio of stocks, even with a one-time investment of $500 or $1,000.
But that accessibility had its limits. Since new buys were capped at whole share amounts, it remained awfully difficult to make regular, smaller contributions (say $50 or even $100 each week or month).
And even if you found yourself with enough money saved to buy another share of a stock or fund, you then had to contend with commissions.
A $9 commission may not seem like much if you’re buying $1,000 worth of stock, but it really adds up if you’re trying to add to a position $100 at a time. (That’s 9% of your total investment right off the bat.)
Fortunately, two relatively recent changes have made investing small amounts of money much easier for retail investors.
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2 Recent Changes That Have Made It Easier to Invest Small Amounts of Money
The first is the widespread availability of $0 commissions.
If you’re a younger investor you may not be aware of this, but brokerage firms used to offer blocks of free trades to incentivize customers to bring their business over; you could get 200 free trades if you started using a new active trading platform, for instance.
But the writing was on the wall for trading commissions even as recently as 15 years ago as discount brokerages dropped the fees for online trades in a race to the bottom.
$9 became $7.95, which became $6.95, and so on.
These days, commission-free trading is the norm, and you’ll find it with just about every broker.
The second change, which was pioneered by Robinhood (HOOD), is the availability of fractional share trading.
Previously, the only way to acquire fractional shares was through dividend reinvestment, and brokerage firms wouldn’t even transfer fractional shares if you moved to a different broker, you’d have to sell them (and get the commission waived).
But now, you can invest as little as $1 into a stock or ETF with many online brokers. (This article from Investopedia gives a good rundown if you’re interested.)
In other words, you could start with as little as $10 and build a relatively well-diversified portfolio of 10 different individual stocks.
But should you?
The Pros and Cons of Investing a Small Amount of Money
In a word, yes.
Investing is a lifelong pursuit, and we all have to get started somewhere. For many of us, it begins with making sure we’re investing in our company’s 401(k) (or other retirement-saving vehicle).
As a good rule of thumb, you should invest at least as much as your company matches. That part is essentially free money for you.
Beyond that, it depends on your budget, tax considerations, and many other factors that are beyond the scope of this article.
Today, let’s focus more on the pros and cons of investing beyond your retirement contributions in a self-directed account.
The Pros
· Gain familiarity with the nuts and bolts of investing: how trades work, how to track investments, etc.
· Practice your investing strategy: You may not generate life-altering returns if you’re starting with only a few dollars, but you can refine your investing strategy.
· Learn how to research companies: When you’re investing through a broker, you’ll have access to additional resources that may change how you research companies (analyst reports, more advanced charting tools, etc.).
· Build strong financial habits: Regular saving and investing is the best way to build savings over time; if you can get in the habit when you’ve only got a few dollars to invest, it’ll pay dividends when you have hundreds or thousands that you can set aside.
· Learn the value of compounding: Even if you’re investing small amounts of money, that can really add up over time. A $100 initial investment with $10 monthly investments in something that returns 8% a year (a bit less than the S&P 500 averages) will be worth $2,000 after 10 years.
The Cons
· Low-cost trading can encourage bad habits: Frequently buying and selling stocks (also known as “churning”) can lower your returns over time and is best avoided.
· Low real-dollar returns can be a bad comparison: If you buy $10 worth of stock and it rises 20% (a good return for an investment) that’s only $2, so make sure you’re focusing on your return percentage, not the dollar amount.
· Over-diversifying can be more effort than it’s worth: Is it worth your time and effort to manage a portfolio of 10 stocks if each has only a few dollars invested in it? That depends. If you’re using it as an educational tool it certainly is, but if it doesn’t reflect your investing style, you may be better off focusing the effort on a few high-quality ETFs.
It’s never been easier to get started investing, but the biggest takeaway should be that improved access to trading tools and lower costs can encourage both good and bad habits. So the most important thing you can do is approach it with intentionality.
Don’t trade simply because you can; your investing decisions should be in service to your greater goals and should reflect the kind of investor you’d like to be when your portfolio is bigger.
And one final suggestion. If you’re looking for advice on the best stocks to buy, consider our entry-level investment advisory, Cabot Stock of the Week, or one of our other advisories. After all, the best way to learn how to start investing is to do just that—start investing.
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