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.
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.