You Don’t Need a lot of Money to Invest in the Stock Market
There is an old saying that it takes money to make money. The assumption is you can’t build wealth investing small amounts of money. You can build wealth when you invest with small amounts of money, you just need a disciplined approach. The key to building wealth is to start young, take advantage of tax sheltered diversified investments, and increase your investment contribution rate over time. When you don’t have a lot of money to invest you need to get a little creative, here’s how.
Employer Sponsored Retirement Plans
As opposed to personal pension schemes like SIPPS, employer sponsored retirement plans like 401ks, IRAs or 403bs for government employees are a great place to start investing, especially if your employer offers a matching contribution. These types of plans allow employees to invest for as little as $25 a paycheck and as a result of recent legislation, many employers are now enrolling new hires automatically. Employer sponsored retirement plans are designed to make it easy for employees to invest in the stock market. All you have to do is decide on your asset allocation and contribution percentage. Some other benefits are:
- Contributions to 401k, 403, 457b, SEPs, and Simple IRAs are pretax dollars which reduces your taxable income.
- Employer matching contributions leverage your initial investment and is free money.
- Your 401k or 403b plan may allow you to contribute after-tax to a Roth IRA. There is no up-front tax benefit however, qualified distributions are tax free.
- Contributions automatically increase as your salary increases.
- You may be able to borrow from your vested balance at reasonable interest rates.
- You may be able to access your retirement account penalty free if you leave your job after age 55. (Does not apply to IRAs)
Dividend Reinvestment Plans
Dividend Reinvestment Plan (DRP) and their cousin the Direct Stock Purchase Plan (DSP) – Dividend Reinvestment Plans allow individual investors to purchase shares of stock directly from a company usually through a transfer agent. Investors can invest in small amounts, as little as $25 on a monthly basis, and have dividends reinvested for little or no fees. There are limits on how much you can invest in these stock purchase plans, typically in the thousands of dollars per quarter, which make these plans perfect for the small investor. In most DRP plans you will pay a “first-time” purchase fee, usually $250 and then pay a small fee for each purchase thereafter.
There are over 1000 companies that have DRPs that allow individuals to purchase shares of stock at a discount to the current market price. Typical discounts range from 1% to 10% which gives you an immediate return on your investment.
Scottrade offers $7.95 trades with a $500 initial deposit while discount brokers TradeKing and Zecco has $4.95 trades with no minimum initial deposit required. In addition, many online brokers will waive the minimum initial investment if you setup automatic monthly transfers from a bank account. Since trading fees can easily wipe out investment gains, one option is to invest in zero commission ETFs such as those offered by Schwab or Vanguard.
Wealth Building Basics
Before you run out and open a brokerage account lets review some personal finance fundamentals:
- You should have a 3-6 month emergency fund.
- Invest the maximum in your employer’s 401k plan or at least enough to take advantage of any company match.
- Pay off any high-interest debt.
Once you have your financial house in order then you will be in a position to take advantage of other investment opportunities such as a Roth IRA, real estate or other investment.
What advice would you have for building wealth with small amounts of money?