More than 40 years after rule changes started lowering the cost of trading stocks, we are now living in a perfect environment for beginning investors.
No longer required to purchase stocks in 100 share bunches, investors are now able to purchase as little as one share. And most firms will allow people to open a brokerage account with a zero balance and a promise to add $50 a month, or more.
That means most people have the wherewithal to invest, if only a little. Yet many individuals I meet believe they don’t have enough money to invest outside their 401(k). They believe that putting together a $1,000 portfolio is beyond reach.
Your early investments might be small, but the rewards will be great.
Compare: Mary saves $50 per month and socks it away in a money market account at her local bank. If she’s lucky, she’ll accrue interest at a rate somewhere below 1%. If she signs up at an online bank, she may earn as much as 1.5% to 1.7%. At a rate of $50 per month at 1.7%, she would create a nest egg of $6,590 after 10 years.
Kate, on the other hand, saves $50 a month but deposits her savings into a brokerage account and buys an ETF that mirrors the Standard & Poor’s 500 stock index. Let’s assume an average historical rolling ten-year rate of return of about 8% for the S&P 500. In that case, Kate ends up with $9,114.
The best strategy, of course, is to save to invest, and here are three tips to begin that process:
- Open a brokerage account. Once it’s open, auto-transfer a comfortable amount each month to be invested. This should be money you won’t need for the next three to five years. Buy what you know, one share at a time. If you are having trouble coming up with ideas, your broker’s website is a great resource. When I taught college finance and my students didn’t know what stocks to buy, I would steer them to the largest ETFs in each sector, suggest they peruse the largest holdings for ideas and then research them. All of that data is available on the website. If you are still at a loss, buy an ETF in a particular industry or sector you like (technology, health care, finance or the overall market). Being invested is the point.
- Automatically reinvest all dividends. This is a simple check-the-box selection on your broker’s website. Historically, dividend-paying stocks have outperformed their non-dividend paying counterparts, though the most recent decade has put the lie to that long-term historical trend with growth stocks outperforming dividend-paying stocks. Still, growing dividends, when reinvested, contribute significantly to total return and add a hedge against inflation. Plus, you get paid every quarter — especially important during declining market periods. Dividends and their growth account for about two-thirds of the total return for stocks over a 200-year period ending in 2002, according to Rob Arnot, founder and chairman of Research Affiliates, a global asset manager. That’s a compelling strategy.
- Be engaged but not obsessed. I have found over my 30-plus years of investing that looking at your holdings daily can be detrimental to your total return. The great thing about automatically investing every month is that you apply dollar-cost averaging. That means you invest smaller amounts in the market at regular intervals, helping you ease the effects of price swings. You also eliminate the natural tendency to avoid buying stocks when they go down (which means you buy them at cheaper prices).
Many who have accumulated great wealth have started with a pittance. Don’t eliminate yourself because you think you are a small fish. The barriers have been removed and the 21st century will be remembered as a period when everyone had the chance to save to invest.