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The old saying that it takes money to make money is true. There often isn’t enough money to invest for those living paycheck to paycheck. When you need the money now, consider 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 take one of the necessary first steps to build a retirement nest egg.
KEY TAKEAWAYS
- Setting aside small amounts of money can help you save even if 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 invest initially and may have substantial fees.
- A 401(k) with matching funds is essentially free money and should take priority over outside investments.
- Investors in debt need to understand what kind of debt they are in and may need to prioritize paying off the debt over investing for some 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 who don’t see any available funds for investing.
Note
As with anything else, consult a financial professional about your investment options. This is especially important if you’re juggling saving while paying off your debts.
Dividend Reinvestment Plans (DRIPS)
Dividend reinvestment plans (DRIPS) allow you to invest small amounts of money in dividend-paying stock by purchasing it directly from the company.
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Companies like GE, Coca-Cola, Verizon, Home Depot, and Johnson & Johnson are just a few of those 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 investment market sector. 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 dividends, so purchasing a fund like the Vanguard Total Stock Market ETF (VTI) will expose you to an instantly diversified portfolio that pays dividends.
Target-Date Funds
As the name implies, target-date funds target your retirement date by changing the percentage of stocks and bonds in your portfolio to ensure 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 independently. However, be cautious when picking a target-date fund because of the high fees that some of these vehicles charge.
The 401(k)
The 401(k) is an employer-sponsored retirement savings plan that lets you put 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 gives you free investment money, 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. Many factors can prevent this. Debt is one of the biggest obstacles for some people. If you have a sizable amount of debt, whether 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. Sometimes, 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. Some investments 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
High interest is relative, but anything above 10% qualifies for this category. You can count your credit card as a high-interest debt. Carrying any balance on your credit card or similar high-interest vehicle makes paying it down a priority before investing.
Low-Interest Debt
This type of low-interest debt may often be a car loan, a line of credit, or a bank personal loan.
Interest rates are usually described as a prime plus or minus a certain percentage, so there is still some performance pressure from investing in this type of debt. However, making a portfolio that returns 12% is much less daunting 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 obtaining a low-interest loan may be small.
Tax-Deductible Debt
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, you can easily build a portfolio while paying it down.
We focus on long-term, low-interest, and tax-deductible debt, such as mortgage payments. If you have high-interest debt, you’ll likely want to pay it off before investing.
Important: Not all interest-bearing loans are tax-deductible. Check with your lender or a financial professional to see if you can deduct the interest on your loan.
Compounding to Grow Money
Debt elimination, particularly of 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 than the money you pay (in terms of the money and interest you are paying to your lender).
You want to give your money as much time as possible to compound. This is one reason to start a portfolio despite carrying debt, but it’s 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 adjusted according to your tolerance and age, the idea is to make your loan payments instead of low-risk and fixed-income investments.
This means you will see 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, most of your investment money will still go toward loan payments, but a percentage will go into the market to produce returns.
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.
FAQs
1. How Do You Invest With Little Money?
Ans: It is wise to have your finances in as much order as possible before investing. The first step would be to save up cash in an emergency fund, usually three to six months of your salary. The next would be to start paying down high-interest debt, such as credit card debt. Once that is resolved, it is wise to start putting money in a retirement plan, such as a 401(k) at work or an IRA. This should be a monthly contribution and is investing. From there, you can start investing outside of retirement plans, even if it is a small amount. A simple way to start investing is to choose an ETF, such as one that tracks the S&P 500, which will give you exposure to the broad market.
2. How Much Do You Need to Start Investing?
Ans: You do not need a lot of money to start investing. You can start investing in a retirement plan with any amount of money. If you have a 401(k) at work or your own IRA, putting any money into the accounts will count as investing. If you want to invest in the stock market, having enough money to buy one share of a company’s stock that you like will also be enough to get you started.
3. How Should a Beginner Invest?
Ans: A beginner should start investing with contributions to a retirement plan. They should then choose index funds or exchange-traded funds (ETFs). A good way to start is also by choosing a robo-advisor that will make investment decisions for you based on the criteria you decide.
The Bottom Line
You can invest despite debt. The important question is whether or not you should. The answer to this question is personalized to your financial situation and risk tolerance. While there are benefits to getting your money into the market as soon as possible, 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 long-term debts can be tedious and disheartening if you do not put your shoulder into a task and keep pushing until it is done. Many people servicing debt seem to struggle to get to where their regular financial life—saving and investing—can begin.
Debt becomes like a limbo state where things are happening in slow motion. By having even a modest portfolio to track, you can keep your enthusiasm about the growth of your finances from ebbing. Building a portfolio while in debt provides a much-needed ray of light for some people.
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