One of the most important aspects of investing is simply getting started. Even if you're only able to start off small, you're better off starting than waiting until you have more money to squirrel away. The longer you invest, the more you're able to take advantage of the compounding effect of your money.
Why you should invest with little money
Financial pundit Dave Ramsay uses the example of Ben and Joey. Ben starts investing $2,400 every year from the age of 21 and stops when he's 30. Joey only starts investing $2,400 annually when he's 30 and contributes for 37 years.
If the investment grew at an annual rate of 11% and they both decided to access their investments at age 67, Ben would have $2.1 million, and Joey would have $1.2 million. While Joey invested more, Ben enjoyed the effect of compounding interest for longer.
Now that you know the "why," let's look at the "how."
How to invest with limited funds
Choosing an investment path should closely align with your personal needs and goals. Even when you start off small, you can set clear goals and directions for your funds.
Assess your needs and set your goals
While "get rich" and "get out of debt" might be common financial goals, it helps to whittle it down into smaller, clearer components. Break down your financial goals into different categories. This allows you to easily match up an investment strategy to align with those goals.
The simplest way to do this is to categorize them into short-, medium-, and long-term financial goals.
- Short-term financial goals — These goals are typically under five years and could include a downpayment for a house or car, travel, home renovation, starting a small business, or saving up for an emergency fund.
- Medium-term financial goals — These investments are typically for the longer term and fall within 5-15 years. They could include the same investment needs as the short-term category, depending on where you are in your financial journey. Other financial goals that could fall into this category include buying an investment property or paying off your mortgage.
- Long-term financial goals — You have more than 15 years to save towards these goals, which could include saving for college for your kids or retirement. This category is also ideal for those who want to maximize the effect of compound interest.
Once you have your financial goals in place, you can assess how much you'll have to set aside each month to reach these goals.
It's important to note that you might not have the financial means to meet your financial goals exactly according to your timeline. For instance, if you want to save up for a downpayment of $20,000 on a property within the next four years, saving $100 a month won't get you there.
However, that said, it's still important to invest even if $100 is all you can afford. It will get you closer to your goal and help you rely less on debt when you're faced with large financial purchases.
Set your budget
When you set your budget, you can create more opportunities to invest a higher amount. You can increase the contributions incrementally over time. Common budget rules include:
- 70/20/10 — This rule recommends that 70% of your income goes to needs, 20% to wants, and 10% to savings. This might be one to start with, especially if your expenses are quite high.
- 50/30/20 — When you start paying off high-debt items such as student and auto loans, your needs become a little less. With this split, half of your money addresses needs, 30% goes to wants, and 20% to savings.
- 60/20/20 — This is midway between the 70/20/10 and 50/30/20 and is ideal for those who are just about to pay off big-ticket items but have a little more wiggle room for savings.
Understand your risk appetite
High-risk investments are known for their potential to generate higher returns. But because they're high risk, you also have the chance to lose everything.
Selecting investment vehicles and funds depends on your willingness to take on risk.
- Low-risk investments — These investment types are suitable for those who don't have long to invest or simply don't like any risk. While the returns might not always be the best, some of these investment types might offer capital guarantees. Some examples here include certificates of deposit, fixed annuities, money market funds, high-yield savings accounts, and index funds.
- Moderate-risk investments — The returns here might be slightly higher, but so are the possible fluctuations in response to market volatility. Examples of moderate-risk investments include property, dividend stocks, corporate bonds, and peer-to-peer lending.
- High-risk investments — High-risk investments have a better chance of providing high returns, but there's also a greater risk that you'll lose some, if not all, of your funds. Some examples of high-risk investments include crypto assets, contracts for difference (CFDs), real estate investment trusts (REITs), and venture capital.
Know your investment options
There are a number of ways you can invest small amounts, including:
- Retirement — There are several different ways to contribute towards retirement, and some options include 401(k), individual retirement accounts (IRAs), and annuities. Some of these have no minimum, and the minimums are instead set by brokers. Shop around to find a broker that allows small investments to be more aligned with what you can afford.
- Stocks, bonds, and cash — Stocks cover a large variety of investments, including common stock, preferred stock, growth stock, and foreign stock. Popular bond investment types include corporate and government bonds, and money market accounts (MMAs) and certificates of deposits (CDs) are common cash investment types.
- Real estate — You don't need to buy a property to be able to invest in the real estate market. If you have at least $5,000 to invest, real estate crowdfunding might be an option.
- Robo advisor — Robo advisors go according to your investment preferences, such as time to invest, risk appetite, and age, to invest your funds automatically across a range of portfolios. Robo advisors can also readjust your asset allocation. It's important to compare fees here, as robo-investing can be costly once you start investing higher numbers.
- Mutual funds — This investment type pools funds from across securities and is a popular option for those who need diversification. Various funds can make up a mutual fund, including stock, index, balanced, money market, and income funds.
Diversify your portfolio
Once you understand your needs and appetite for risk, it's important to choose your asset allocation wisely. A rule of thumb is to diversify your portfolio, which means you don't invest all your funds into one product. A healthy mix should include stocks, bonds, and cash.
You can further diversify your portfolio by investing in index funds. You can also use investment tracker tools to recommend different funds as you get closer to your investment end date, for instance, retirement investments. This means that your assets are placed into less risky portfolios closer to your retirement date, so you're less likely to be affected by market volatility.
Revisit your asset allocation
Over time, your assets need to be rebalanced. For instance, funds that were deemed low-risk or moderate may no longer enjoy that status. That means if you had a moderately aggressive portfolio, this might shift to aggressive if you don't rebalance your funds in line with your strategy as the markets change over time.
Simplify investing through investment apps
Some of the top financial institutions offer investment apps that simplify investing, even if you only have a small amount to invest. Apps worth checking out include:
- Ally Invest
- E*Trade
- Merrill
- Charles Schwab
- J.P. Morgan
- Webull
- Acorns
- TD Ameritrade
- Fidelity
- Vanguard
Build wealth a dollar at a time
It doesn't take much to get your investment journey going. Some brokers allow you to open your investment account at no cost and no minimum contribution. Simply shop around for the best option that aligns with your investment goals, needs, and personal risk appetite.
