Saving and Investing With Smaller Amounts of Money

“Bart, with $10,000, we’d be millionaires.” – Homer Simpson

I was recently helping a family member set up a Roth IRA because she wanted to invest a small amount of money on a periodic basis. She eventually wants to increase that amount but we all need to start somewhere.

This is a situation that many investors find themselves in when they are just starting out. An IRA is a great way to save in a tax advantaged account, especially if you don’t have access to a workplace retirement plan like a 401(k).

But this can also be an option for those who are contributing to their 401(k) plan but would also like a broader set of investment options.

OPTIONS FOR INVESTING SMALLER AMOUNTS
Once we figured out the purpose of the Roth IRA (long-term retirement savings) we had to find the correct place to open her account to start saving. I did some research to find the best fit and I found a couple of options.

I will go through each of them and list some advantages and disadvantages depending on your preferences and then give a verdict for each option.

Vanguard Target Date Retirement Funds
Advantages: You can invest in Vanguard Target Date Retirement Funds for as little as a $1,000 minimum investment. The fees on these funds are below 0.20%, which is great since costs are such a large determinant of mutual fund performance. Any additional investments can be made for as little as $100 per contribution.

Target date funds are set by year (usually every five years) so you can pick a fund offering that is close to the year in which you will retire. The fund company will shift the asset allocation to less risky investments for you as you approach retirement.

So if you are 30 years old right now you would probably choose a 2040 or 2045 fund since that should be close you your retirement date. You can go up by five years to increase the risk a little or down by five years to reduce the risk depending on your risk tolerance.

Disadvantages: You have to invest in a single, diversified fund like a target date retirement fund unless you have more capital to invest. Most of Vanguard’s other funds come with minimum investments of at least $3,000 for the initial contribution with some being even higher than that.

This would also mean that you will have to save enough to hit the minimum investment level before you can invest (but this shouldn’t be a problem if you are dedicated to saving).

Verdict: This is a great option for someone looking to start off in a simple low-cost, diversified fund offering. Target date funds aren’t perfect because you don’t have any say in the asset allocation, but for those looking for a hands-off approach to investing this is an efficient and effective choice.

The current diversification of the Vanguard Target Retirement 2045 Fund is about 90% stocks and 10% bonds. The stocks are also diversified by U.S and international markets.

If you would like to eventually pick your own individual index funds for your portfolio you can simply invest in the target date funds for a few years until you can build up enough money for the higher minimum funds and slowly diversify your portfolio by adding more fund offerings.

Charles Schwab Commission-Free ETFs
Advantages: Charles Schwab has a program that offers commission free ETF trades. It covers over 100 ETFs from 6 different fund providers. ETFs offer slightly lower fees than index funds which means that you are keeping your costs very low since there are no fees to make the purchases and sales.

Plus there are no minimum investment thresholds that you have to meet, so you can start investing before you hit the $1,000 mark in your savings.

This gives you the option of investing in a number of different funds to build your own portfolio instead of just using one as you would have to in the Vanguard example.

Disadvantages: Mutual funds allow you to automatically set your investment amount each month or quarter and the fund company will make the trade automatically for you. Since mutual funds only make purchases and sales after the market closes, there is only one time to perform transactions.

ETFs trade all day long on the market exchanges just like stocks so you have to actually make the trades yourself. This makes it much harder to automate good behavior like dollar cost averaging and rebalancing (although you can direct them to automatically reinvest your ETF distributions).

You can automatically have your money sent to your Roth IRA account periodically (it will simply sit in cash until you invest it) but you still have to make the actual purchases yourself.

Plus the prices of the ETFs are not always nice round numbers and you cannot buy partial shares so the amount you invest for each transaction could change depending on the price. You can leave the remainder in cash but this is another factor to consider.

Verdict: This option would work for those who would like to create their own lost-cost investment portfolio. Schwab offers diversified ETFs in stocks, bonds, REITs, stock sectors and commodities. You can create an extremely diversified portfolio using only a handful of funds and do so at a ridiculously low cost.

You can also periodically rebalance the portfolio to your desired asset allocation target weights which is the point of diversification.

Going the commission free ETF route would mean you have to be a self-starter since you would have to make the actual trades on your own each month. This is one feature of ETFs that makes them difficult for those who need a little nudge to get going to start saving and investing for the future. But those who are interested in creating a simple portfolio could do a lot worse than this option.

CONCLUSION
Everyone’s financial situation is going to be unique. It really depends on how quickly you would like to get invested in the market based on these choices. The Vanguard option is the simple option and I usually recommend less complex strategies to make sure investors don’t deviate from their investment plan.

But the Charles Schwab ETF program also has a number of benefits for those who would like to be a little more hands on with their portfolio.

Whatever route you choose just make sure you start saving as soon as possible. Saving small amounts may not seem like much by it can have a huge impact in the long run. Just make sure you start saving and gradually increase that amount over time for the best results.

One of the biggest mistakes people make when they start saving is they try to take on too much all at once and end up failing because of it. It’s much easier to give up when you try to save $500 a month than it is when you start with $50 a month.

That’s why it makes sense to make incremental changes to see lasting results in your finances. It would be nice if we could make wholesale changes and implement them with no bumps along the way.

Unfortunately, that is not as easy as it sounds. Making minor changes means it won’t be as painful when you try to save more and you can continue to make periodic changes going forward.

Sources:
Vanguard
Charles Schwab

Here’s what I’ve been reading this week:

• Quantifying the Behavior Gap (Multifactor World)
• Wishing Upon a Star Manager Doesn’t Work (Rick Ferri)
• How The Spurs Use Financial Arbitrage to Win Games (Washington Post)
• Things Investors Should Read. Things Investors Should Avoid (Motley Fool)
• 10 Things Economists Won’t Tell You (MarketWatch)
• How You Frame Investment Decisions Matters (CBS Moneywatch)
• What You Don’t Know About Your Portfolio May Help You (NY Times)
• $1 Million Isn’t What it Used to Be (NY Times)
• Does We Need a Mandatory Retirement Savings Program? (Abnormal Returns)
• Charlie Munger’s 18 Biases to Fool Yourself and Make Bad Decisions (Motley Fool)
• Why Do So Many Investors Ignore the Evidence? (CBS Moneywatch)
• Sure, But That’s Not a Plan (Seth Godin)
• Investing Secrets of Wealthy Technology Entrepreneurs (Huff Post)