Outside of a 401(k) or other employer-sponsored retirement plan, do you invest? If you answered no, you are not alone. Investing is often seen as the domain of the wealthy, not for people who only have a small amount of money left over at the end of month. True, brokers may not be rushing to roll out the red carpet for you if you can only invest $300 a year, but there are many investment choices for those of us without a lot of cash to spare.

Why is investing a wise financial move? Because of inflation (the rise in the cost of goods and services over time), if you keep all of your savings in a safe vehicle that provide a low return, such as savings account, certificate of deposit, or shoebox buried in the back yard (just kidding about the last one!), the real value of your money will decline over time. While you should keep your emergency and short-term savings in an easily accessible account that you know won’t lose value, it is a good idea to put long-term savings in vehicles that have the potential for a higher return. (One caveat, if you have credit card or other high-interest debt, it is a good idea to pay that off before investing – chances are that the interest you are being charged is greater than what you will earn on your investments.) Historically, in the long run stocks have provided the highest return, followed by bonds, with cash equivalents (i.e. the safe vehicles mentioned above) providing the lowest return.

Dividend Reinvestment Plans and Direct Stock Purchase Plans
Direct stock purchase plans (DSPs) and dividend reinvestment plans (DRIPs) can be a great option for the small-time investor. Under a DSP, you purchase stocks directly from the company offering them, allowing you to skip using a broker (and the commission charges that go along with that – although be aware, some companies charge a fee for their DSP.) You can make a single purchase (usually the minimum is set fairly low) or set up an automatic regular purchase plan. In order to participate in a DRIP, you must already have at least one share in the company. Instead of receiving cash dividend payments (a distribution of a portion of the company’s profits to stockholders), you receive an equivalent in additional shares of stock. So if the stock is selling at $10 a share and the dividend payment is $20, you would get 2 shares. Many DRIPs also allow you to purchase additional shares after you enroll. To get started, go on-line – there are many websites that list what companies offer a DSP and/or DRIP.

Mutual Funds
One of the most fundamental rules of smart investing is that you should have diversity. Think about it – if your whole investment portfolio consists of shares in Company X and Company X goes out of business, you are sunk, But if you are also invested in Company A, B, and C and have some bonds as well, it will have less of an impact. Purchasing shares in a mutual fund is an easy way to get diversity. In a mutual fund, money from several investors is pooled to buy different stocks, bonds, and/or cash equivalents.

One potential downside to investing in mutual funds is that they can come with sizeable fees that eat away at your profits. When selecting a fund, you should pay attention to its expense ratio – the percentage of the funds assets that are used to pay for expenses. Index funds, which track a particular index, such as the S&P 500, often have a very low expense ratio because there is no advisor actively picking funds. Also look at the load – the sales commission that is charged by the broker and/or financial advisor. There are many no-load funds available as well as on-line/discount brokers that charge low commission fees.

Another challenge for the small-time investor is that the minimum amount required to invest is commonly a thousand dollars or more, so you may have to do some research to see what mutual funds allow you to buy in with a lower amount. Often the minimum amount is lower if you are investing through an Individual Retirement Account (IRA). But because it is a tax-advantaged account for retirement, there are rules about withdrawing money. (See the IRS’s website, www.irs.gov, for more information.) Roth IRAs offer a bit more flexibility than Traditional IRAs – you can withdraw your contributions at any time without paying a penalty.

Invest your pennies today, and you can have dollars tomorrow.

1. Remember, the stock market is cyclical. Resist the urge to sell simply because the value of your stocks drops.

2. You may see websites or other sources presenting “hot” investment opportunities. Always do research before investing in them. More often than not, they turn out to be a dud.

3. If you are using a broker, make sure he or she is licensed. Also check if he or she has a history of complaints. You can get a report on FINRA-registered brokers at http://brokercheck.finra.org.

4. Don’t trade too frequently. In general, the more you trade, the more fees/commissions you have to pay.

5. Opt for paperless statements. Not only is it better for the environment, but you may get a small discount.

6. Don’t borrow to invest. The interest charged on debt is usually higher than the return you earn from investing.

7. Be on the lookout for scams. Common signs include excessive pressure (You must buy today or lose this opportunity forever!), promise of returns well above average, and unwillingness to provide information.

8. Consider your timeframe when choosing investments. The closer you are to your goal (retiring, buying a house, paying for college, etc.), the more conservative you want to be.

9. If you make a bad investment, don’t beat yourself up. No one can predict what the stock market will do with certainty.

10. Don’t invest money you cannot afford to lose. While investing can be a great way to make your money grow, there are no guarantees. You always want to have enough money to pay your rent or mortgage and other basic living expenses.

The Elements of Investing
By Burton Malkiel and Charles Ellis (Wiley 2010)

The Elements of Investing is not one of those investing books geared toward those looking to make a million in a year and already know the ins and outs of the stock market. Instead, this book provides a simple introduction to the fundamentals of investing in a compact size. (A fact that most readers will be grateful for because, let’s face it, a book on investing is not exactly a pleasure read.) Topics discussed include the importance of and how to build savings, why you should consider index funds, how to diversify, blunders you should avoid (such as overconfidence and trying to time the market), and a keep-it-simple strategy for success. After reading it, you will feel ready to jump into the world of investing with confidence.

Copyright © 2010 BALANCE
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