Many individuals who want to start investing in the stock market wonder how much is needed. As the old phrase goes, it takes money to make money. Obviously someone with $1,000,000 to invest can make a lot more money than someone with $1000. Still, there are investment choices for those of even modest starting amounts.
The following are the amounts required to begin investing in various investment options:
Mutual Funds: $1000-$5000 – moderate risk, $20,000-$50,000 – low risk
Exchange Traded Funds: $2000 – $10,000 – moderate to low risk, $30,000 – $60,000 – low risk
Individual stocks: $2000-$5000 – high risk, $20,000-$50,000 – moderate risk, $100,000 and above – low risk
Note that for each of the investment options the amount of risk varies with the amount invested. The reason is that larger amounts allow for greater diversification.
Investing involves taking on additional risk in order to get additional reward – income. While a savings account carries little risk of the account balance declining, the amount of income received is actually not enough to keep up with inflation. Over a period of years your account balance will actually be declining. Real estate will basically keep up with inflation, although investing in the right markets at the right time can generate returns above inflation. Renting properties, especially if the house is entirely paid for so that the amount lost to inflation is balanced by the rise in the value of the house and the rents received, minus upkeep and taxes, is a good way to receive income above inflation.
Stocks provide a unique niche in that the growth rate for stocks is above that of inflation, and yet the risk involved is not so substantial. While there is a possibility that the whole amount invested may be lost, the likelihood is fairly low. Also, the likelihood of a total loss declines to approximately zero if several stocks are bought rather than just one or two. This process, called diversification, also causes the amount of volatility in account balances to decline since stocks that go down are balanced by stocks that go up. Because the economy in general is normally growing, the balance on the account will normally grow with time (10-20 years) and at a rate higher than inflation, typically by 5-10%.
The difficulty in investing with small amounts is that there is not enough money to buy positions in several companies directly. To gain substantial diversification in individual stocks would require $50,000-$100,000. For this reason, many people who have small amounts to invest buy mutual funds – which are arrangements in which groups of investors pool their moneys together to buy a group of stocks. Most mutual fund companies have minimum initial investments in the $1000 to $5000. Some will also allow investors to invest less provided that they sign up for automated purchase such that a fixed amount is invested each month.
Another consideration, however, when starting out in investing is that while one does not have a lot of money to invest, the amount that could be lost is also fairly modest. If an individual only has $2000 to invest, while the entire amount could be lost if invested in a single stock, the $2000 loss could be easily regained through work. It therefore may be worth the risk for the possible gains. (Note that a typical position in a stock is 100 shares, so $2,000 would be needed to buy 100 shares at about $20 per share. Stocks trading at less than about $10 are fairly risky and usually should be avoided.) If the individual could not afford the $2000 loss, mutual funds should be purchased or the individual should wait to invest when on firmer financial footing.
Whether investing in mutual funds (or exchange traded funds, which function in a similar manner but are purchased on an exchange like a stock) or in individual stocks, an investor should plan to put money away regularly. One should be putting away at least a few hundred dollars from each paycheck in a savings account. Each time that an individual raises a couple of thousand dollars, that money could be used to buy more shares of stock. If investing in mutual funds, those funds could be added directly to buy more shares of the mutual fund with each paycheck since mutual funds typically accept smaller amounts after the account minimum is met.
Even if starting with a modest amount, by regularly investing and minimizing trading to reduce transaction costs and taxes, one can build a substantial portfolio.
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Disclaimer: This blog is not meant to give financial planning advice, it gives information on a specific investment strategy and picking stocks. It is not a solicitation to buy or sell stocks or any security. Financial planning advice should be sought from a certified financial planner, which the author is not. All investments involve risk and the reader as urged to consider risks carefully and seek the advice of experts if needed before investing.