It is often assumed that stock market investment is something that is only possible for people who are lucky enough to have large sums to invest. However, the good news is that it is possible to make investment work for you even if you only have fairly modest sums to invest. This article looks at how you can maximise your returns through regular investment of small sums of money.
Before we go on to look at investment strategies for small investors, though, it’s worth pointing out something in relation to this article’s title. It is not possible to invest if you have no money as investment is defined as To commit (money or capital) in order to gain a financial return’. I will focus therefore upon instances where individual have some money available to invest, with the assumption being that they will be able to add a little money each month.
The principles that come into play for the small investor are largely the same as those that even the likes of Warren Buffet need to observe. However there are some aspects that will have particular importance for the investor who has less money to play with.
The steps that you should go through are as follows:
1. Determine whether you can afford to invest?
All of us need to maintain a safeguard pot of instant access savings. You can call this a rainy day fund and it is the money that you may need to fall back on if an unforeseen cost or problem emerges.
For the investor with less cash, maintaining this rainy day fund may be more challenging. It may be tempting to do without it and instead put all your money into buying shares. This however is an extremely risky strategy and certainly not one that any financial planner would advise you to take.
2. Choose how you are going to purchase shares?
Assuming that you have enough money, over and above your rainy day savings fund, your next decision is how you are going to buy shares? Very rich investors may prefer to have a stock broker who will place their orders for them. Smaller investors may prefer to opt for Internet purchases as the costs tend to be lower.
It is, however, still important to do some research before deciding which Internet broker to choose, as there can be big differences in the costs quoted. Typically, there is a fixed cost for each trade. For example, Internet broker A may charge you $20 per trade and Internet broker B may charge you $30 per trade. It’s easy to see how this will especially affect smaller investors. $20 may be a small consideration on a $10,000 trade but not so small if your strategy is to invest $200 per month.
3. Individual shares or mutual funds?
Assuming that you’re happy that you’ve got money to invest and have chosen who to place the trade with, the next question is what shares are you going to buy? It can be incredibly difficult to predict which companies are going to do well and which are going to do badly. There are so many unpredictable variables that even the professional investors often get it wrong. One of the variables that affects performance is if the economy goes into a recession. The recent example of well known banks getting into trouble highlights the particular perils during recessionary periods.
One way of limiting your risk is to shun the purchase of individual shares and instead buy into a mutual fund. The basic principle of a mutual (or index) fund is that you’re buying into a bundle of shares. That bundle may include some banks, some Telecoms companies, some mining shares, etc, etc. If one company, or even one industry goes through a turbulent time, the hope is that the other shares within the fund will perform well and the overall value of the fund will keep rising.
Mutual funds, therefore, are generally considered less risky than buying into one individual company and most financial advisers tend to suggest that private individuals include mutual funds amongst their stock portfolio.
The downside to mutual funds is that the return you get will just mirror the average of that particular index. Let’s say that the average increase in the FTSE100 index is 7% over a period of time. That’s quite a good return but within it, there may be a select few companies whose value has gone up by much more than 7%. The temptation, therefore, is to try to pick the next big thing and make a whooping return on your small investment.
Which approach you take will depend on your attitude to risk and reward. However, an often quoted piece of advice in relation to investing is to avoid putting all your eggs in one basket. For this reason, my preference would be to start with a mutual fund (giving you that diversification) and then possibly consider expanding your portfolio to include some preferred companies.
4. Select your purchases:
This step is pretty much the same whether you’ve got $1,000 or $100,000 to invest. You need to do your research and determine which mutual funds or companies to invest in. For beginner investors, there are lots of books and websites that you can use to build up your knowledge of investment strategies and approaches. Helium, of course, is a great source of investor information but I’d also recommend a website called www.fool.co.uk that presents investing information in a no nonsense easy to read way.
5. Frequency of purchases:
There are two options when buying shares. You can make ad hoc large(ish) purchases, or you can make regular small purchases, sometimes called the drip feed’ approach. For example, I might save up for three months and then buy $1,000 worth of shares, or alternatively I might arrange for $100 to be paid each month to build up my share holding.
For an investor with little money, he/she might need to wait longer to have accumulated the desired amount of cash to make a purchase. However, the second option of paying a small(ish) amount out each month might be a more attractive option. That’s something that I have done in the past via a mutual fund. I set up a monthly credit of 50 (c. $100) into a mutual fund that my bank ran. Unlike the one-off purchases, there wasn’t a charge for each of these additional contributions so that was quite attractive.
A benefit of the drip feed approach, is that if the short-term price of the stock drops, then you will pick up more shares. For example, if I’m paying $100 per month and the share price is $10 in January, I will get 10 shares. If the share price drops to $5, then I pick up 20 shares. You also don’t have to worry about trying to pick the optimal time to purchase the share so it’s popular with people who want a hassle-free approach to investing.
It is of course easier to make big returns from the stock market if you have big sums of money to invest. For starters, any per-trade charges will make up a much smaller percentage of your trades. However, it is possible for investors to make worthwhile returns from fairly modest trades. The key thing to remember is that you should be aiming to make a better return than you would if you just put the money into a savings account.
There are a couple of final things that you should consider. Firstly, when a share does well, the company often offer a dividend, which is a way of giving a regular return back to the shareholder. When purchasing shares, you should consider whether you wish to take that dividend as cash or whether you’d prefer it to be reinvested in buying more shares in the company. The reinvestment of the dividends can be a good way of building up the number of shares that you hold.
For UK shareholders, you should also remember that you can use a Shares ISA to get a tax-free return on shares. There are yearly limits on the amount that will be tax-free but since we’re talking about investors with little money those thresholds are probably irrelevant.
Participating in the stock market can be very rewarding, both in terms of the monetary return and the enjoyment of picking funds and seeing them prosper. However, always remember that the value can go down as well as up. There may be some steep learning curves along the way and, in this respect, it can be quite good to start with small sums of money.