Should You Invest with Less the $5,000?


should you investThere’s a line of thinking that you should begin investing as early in your life as possible, that way you can take full advantage of the compounding of investment income. But should you do that if you only have a few thousand dollars?

You’ll get different answers from different people, but I think the answer is a resounding maybe!

When we invest, we don’t do it in a vacuum. It’s actually part of our larger financial situations, and that’s what has to be closely examined before investing with relatively little money.

Creating a financial safety net before investing

Before tying up money in investments, you first need to have an emergency fund. That will not only provide ready cash in the event of a crisis, but it will also keep you from liquidating your investments to deal with the emergency. And it’s a not so funny thing with emergency investment liquidationsâ”they always seem to come up when your investments are down in price, forcing you to sell at a loss.

How much should you have in an emergency fund? Some say $1,000, some say an amount equal to six months living expensesâ”it really varies depending on your own needs and temperament. My personal thought is that you should have an amount equal to 30 days living expenses, that way you’ll at least have enough money to cover the first month of a job loss. That will generally also be enough to cover an unexpected major car repair, or the deductible on a health insurance claim.

Once you have your emergency fund in place, you can begin looking at investing what you have left over.

What else is going on in your life?

Investing isn’t all about how much money you have to play the market. You also should look closely at what else you have happening in your life that may either enhance or restrict your investing activity. Here are some things to consider:

Job stability. If you’re in a stable job situation, investing is much easier. If however your job is uncertain, you might be better off keeping your cash handy rather than tying it up in investments that will require years to fully payoff.

Income level. Investing is a less risky affair if you have a high income. High incomes mean fresh money is available to cover losses and diversify into more investments. At the opposite end of the spectrum, if your income barely covers your living expenses, investing may be playing with money you can’t afford to lose.

Debt. If you have more credit card debt than you have money to invest, you don’t need to be investing. Credit card debt carries interest rates that are not only high, but also subject to change. Interest on credit cards offsets investment returns, much like a very high margin loan account. Get rid of your credit card debt before investing.

Self-employment opportunities. Think of this as an opportunity costâ”what else could you invest your money in that might provide a higher return than the stock market? For many, that’s having your own business. If you plan to head in that direction, you might be better off keeping your money in savings so that you can start the business any time you’re ready. There’s no better investment than investing in yourself.

Diversification options

If you have less then $5,000 to invest, you probably should stay out of individual stocks. $5,000 just can’t achieve any reasonable level of diversification, and the transaction costs would eat up your capital if you tried.

Better to go with a mutual fund, and use either an index fund or some other fund that invests in the broad market. Though mutual funds work well for small investment amounts, you probably will want to avoid sector funds at least until you have a large enough portfolio that you can hold them along with broader market funds too. Sector funds may provide higher returns, but they can just as easily create larger losses.

Playing risk factors to your advantage

The conventional wisdom is that younger investors can afford to take on more risk because they have a longer time horizon to recover from losses. That may be true if you have a large amount of money to invest, but not if you only have a few thousand dollars.

Yes, you may have a need to grow your money as quickly as possible, but at the same time taking large losses to a small amount of money may leave you with insufficient capital to recover with.

It may be better to seek steady returns on lower risk stocks (through mutual funds) than to take chances on high return/high risk investments. Slow and steady wins the race, and when you’re young you have plenty of time to get that working in your favor.

Compounding of investment returns works so much better when you don’t take big losses early in the game.
As I said at the beginning, investing isn’t something we do in a vacuum. We have to consider what our resources are, what else we have going on in life, and maybe even what it is we want to do in life.

Have you been thinking about investing in the market, but only have a few thousand dollars to do it with?

photo by  44313045@N08

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Written by Kevin

With backgrounds in both accounting and the mortgage industry, Kevin Mercadante is professional personal finance blogger, and the owner of OutOfYourRut.com, a website about careers, business ideas, money and more. A committed Christian, he lives in Atlanta with his wife and two teenage kids.

Kevin

With backgrounds in both accounting and the mortgage industry, Kevin Mercadante is professional personal finance blogger, and the owner of OutOfYourRut.com, a website about careers, business ideas, money and more. A committed Christian, he lives in Atlanta with his wife and two teenage kids.

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