Investing a Small Amount

Jonathan Clements is my favorite columnist. He writes a column Getting Going on Wall Street Journal every Wednesday and Sunday. I always seek out his column online every week and see what he has to say. A week ago he wrote about investing a small amount. Here’s the link:

Start Small, Think Big: How to Launch Your Financial Life With Just a Few Bucks

Although I usually like with what Jonathan writes, I disagree with his suggestions in that column. Here’s what he suggested for investing a small amount (less than $3,000).

1. Buy ETFs through one of the low-cost Internet stock-purchasing services, like ShareBuilder or FOLIOfn.

To get a diversified portfolio, Jonathan suggested buying three ETFs, VTI, EFA and AGG. ETFs are the wrong products for investing a small sum. For each ETF purchase, the investor must pay a commission. Although $4 per trade sounds low, it adds up quickly. When a small portfolio grows larger and meets the minimum for a mutual fund, and if you want to move into a mutual fund, you will have to sell the ETFs and pay another set of commissions.

If you only have a small amount to invest, that probably means you haven’t maxed out your 401k/403b or Roth IRA yet. You are much better off contributing to those accounts. Setting up an IRA with ShareBuilder or FOLIOfn will cost more money than having an IRA at a mutual fund company.

2. Buy stocks through a company’s dividend-reinvestment plan, or DRIP.

Again, individual stocks are the wrong products for investing a small amount. It’s very difficult to build a diversified portfolio in individual stocks with a small amount of money. Small fees here and there will eat up a good portion of the small investment. It’s almost impossible to use DRIPs for an IRA.

3. Buy life cycle funds at T. Rowe Price or AARP.

This last suggestion from Jonathan Clements is better than the previous two. AARP Funds allow you to open an account with $100 and add to your account with $25. IRA fee is a reasonable $10 per year. 0.5% expense ratio on its funds is not the lowest but low enough. If a few hundred dollars is all you have to invest, AARP Aggressive Fund is a fine choice. But if you have at least $1,000, you are better off investing in Vanguard STAR Fund, because AARP Funds become more expensive than Vanguard Funds as your account grows larger and because AARP Funds’ low expense ratio is subsidized by a fee waiver which may go away after November 2007. Vanguard STAR Fund is a winner of the TFB Award for Best Mutual Fund for Investing Less Than $3,000. If you have less than $1,000, you will have to decide whether it’s worth it starting with AARP Funds and moving to Vanguard after you accumulate more in your account.

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  1. TJP says

    I disagree with your claim on lesson #2.

    I’ll admit this guy is way off when it comes to ETF trading, but his commentary on investing small amounts of money in stocks is right on target.

    It’s a great way to build a substantial portfolio over time.

    Your 401(k) is your investment portfolio for the long-term, a time horizon of over 30 years for some people. Everyone should have money in stocks to invest for shorter time frames like 10+ years as well.

    If you limit selling, the commission fees on even a $500 account can be kept at bay.

    I believe in buying stocks that you can hold for some time. You’ll gain the return on investment, and with ShareBuilder, you won’t be charged inactivity fees or annual account fees.

    Simply buy the shares and let them sit and collect dividends and value.

  2. TFB says

    My argument against buying individual stocks is the lack of diversification. It makes no sense to buy individual stocks when you can buy inexpensive mutual funds which hold hundreds or thousands of stocks in one place. I refer you to this great article on The Money Tortoise:

    Diversifying Risk vs. Stock Picking

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