The old saying that you need money to make money is true. Those who live paycheck to paycheck often don't have enough money to invest. When you need money now, thoughts about an individual retirement account (IRA) and the stock market may be far down your list of priorities. However, by reading this article and gaining knowledge, you will have taken one of the necessary first steps in creating a retirement nest egg.
Key Findings
- Saving small amounts of money can help you save, even if the idea of investing is scary.
- Dividend reinvestment plans allow you to buy small amounts of dividend shares directly from the company while reinvesting the dividends.
- You can buy one ETF share at a time through a broker.
- Although target date funds divide your investment based on your target retirement date, they often have large minimum initial investment amounts and can charge significant fees.
- A 401(k) with matching funds is essentially free money and should therefore take precedence over outside investments.
- Investors in debt need to understand the type of debt they are in and may need to prioritize paying off debt over investing over a period of time.
you need money
The fact remains that you will have to save money for later years or face a possible catastrophic situation. Someday you won't be able to work and Social Security won't be enough to live on—assuming the fund comes around in about 20 or 30 years. You can start investing now with less money than you think.
First, we need to address the problem of limited funds, and this advice is not something new or revolutionary. Something in your life needs to go away, but it doesn't have to be a big life change. Simple changes that save $1 here and $5 there can add up to a big impact.
We have collected several ideas for those who do not see free funds for investment.
As with everything else, be sure to consult a financial professional about your investment options. This is especially important if you're trying to balance saving and paying off debt.
Dividend Reinvestment Plans (DRIPS)
Dividend reinvestment plans (DRIPS) allow you to invest small amounts of money in dividend-paying stocks by purchasing directly from the company.
Companies like GE, Coca-Cola, Verizon, Home Depot, and Johnson & Johnson are just a few of the companies that allow you to buy very small amounts of stock on a regular basis and reinvest the dividends.
Over time, this can lead to larger investments, and when you have a larger balance, you may want to consider redirecting some of those funds to other investments.
Exchange Traded Funds (ETFs)
Exchange-traded funds (ETFs) are financial products that track the performance of a specific sector of the investment market. You can buy just one share of an ETF through a broker, and some of these ETFs track the performance of the entire stock market, bond market, and many others.
Many ETFs also pay dividends by purchasing a fund like Vanguard Total Stock Market ETF (VTI), an instantly diversified portfolio that also pays dividends.
Target date funds
Target date funds, as the name suggests, target your retirement date by varying the percentage of stocks and bonds to ensure your money remains safe as you approach retirement age.
Some of these funds require a minimum investment of $1,000, but they can serve as excellent products for investors who don't want to manage their portfolios themselves. But be careful when choosing a target date fund because of the high fees some of these companies charge.
401(k)
A 401(k) is an employer-sponsored retirement savings plan that allows you to put a portion of your salary into an investment account. The plan provides tax savings depending on your plan type:
- If you invest in a traditional 401(k), you can put away pre-tax dollars, which reduces your taxable income and therefore your tax liability.
- If you invest in a Roth 401(k), any withdrawals you make during retirement are tax-free.
If you have a 401(k) plan that matches your contributions, invest there first. Since your company provides you with free money to invest, you should consider funding your 401(k) before making outside investments.
Investing in debt
If you have savings or investments, you want them to grow over time. There are many factors that can interfere with this. Debt is one of the biggest obstacles for some people. If you have a significant amount of debt, whether it's a mortgage, line of credit (LOC), student loan or credit card, you can still learn to balance your debt through savings and investments.
Having debt can make it very difficult for investors to make money. In some cases, investing in debt is like trying to save a sinking ship with a cup of coffee. For example, if you owe money on a letter of credit with an interest rate of 7%, the money you put aside will need to earn more than 7% (after taxes and fees) to make it more profitable than paying off the debt. There are investments that provide such high returns, but you must be able to find them knowing that you are under the burden of debt.
It is important to briefly differentiate between the different types of debt that may arise.
High interest debt
A high interest rate is relative, but anything above 10% is a good candidate for this category. Having said that, you can probably think of your credit card as high-interest debt. Having any balance on your credit card or similar with a high interest rate makes paying it off a priority before you start investing.
Low interest debt
This type of low-interest debt can often be an auto loan, a line of credit, or a personal loan from a bank.
Interest rates are usually described as simple plus or minus a certain percentage, so investing in this type of debt still puts some pressure on performance. However, it is much less difficult to create a portfolio that generates a 12% return than one that needs to generate a 25% return.
One thing to remember, however, is that your credit score determines your interest rate. The better your score, the lower your rating. But if you don't have a great credit history, you're likely to get a low-interest loan
Tax-free debt
If there is such a thing as good debt, this is it. Tax-deductible debts include mortgages, student loans, business loans, investment loans, and all other loans where the interest paid comes back to you as a tax deduction. Since this debt also typically has a low interest rate, you can easily build a portfolio while paying it off at the same time.
The types of debt we focus on here are long-term low-interest debt and tax-exempt debt such as mortgage payments. If you have high-interest debt, you'll probably want to focus on paying it off before you begin your investing adventure.
Not all interest-bearing loans are taxable. Be sure to check with your lender or financial professional to see if you can deduct the interest on your loan.
Compounding to make more money
Eliminating debt, especially debt like debt that requires long-term capital, costs you time and money. In the long run, the time (in terms of growing your investment) you lose is worth more to you than the money you actually pay (in terms of the money and interest you pay to your lender).
You want to give your money as much time as possible to grow. This is one reason to create a portfolio despite having debt, but not the only one. Your investment may be small, but it will pay off more than investments you make later in life because those smaller investments will have more time to mature.
Creating an Investment Plan
Instead of building a traditional portfolio with high- and low-risk investments that are adjusted according to your tolerance and age, the idea is to make loan payments instead of low-risk and/or fixed income investments. This means you'll benefit from lower debt loads and interest payments, rather than the 2% to 8% returns from bonds or similar investments.
The rest of your portfolio should be focused on higher risk, higher return investments such as stocks. If your risk tolerance is very low, most of your investment will still go toward loan payments, but there will be a percentage that will make it into the market and make you a profit.
Even if you have a high risk tolerance, you may not be able to put as much into your investment portfolio as you would like because, unlike bonds, loans require a certain amount of monthly payments. Your debt load may force you to create a conservative portfolio in which most of your money is invested in your loans and only a small portion goes towards your high-risk, high-return investments. As the debt gets smaller, you can adjust your distributions accordingly.
Bottom line
You can invest despite being in debt. The important question is whether you should do it. The answer to this question depends on your financial situation and risk tolerance. Of course, there are advantages to getting your money into the market as soon as possible, but there is also no guarantee that your portfolio will perform as expected. These things depend on your investment strategy and timing of the market.
The biggest benefit of investing in debt is psychological. Paying off long-term debt can be tedious and frustrating if you're not the type of person who throws their shoulders to the task and keeps pushing until it's done. Many people who are servicing debt feel like they are struggling to get to the point where their regular financial life of saving and investing can begin.
Debt becomes like a state of limbo where everything seems to happen in slow motion. Having even a modest portfolio to track can help keep your enthusiasm for growing your personal finances from fading. For some people, building a portfolio in debt provides a much-needed ray of light.
