How To Start Investing With $1
So you want to start investing but are unsure where to begin? That’s totally understandable, investing initially seems like a daunting task but if broken down into manageable well thought-out steps, your chance of success can grow substantially.
You might be thinking to yourself, that a manageable well though-out step by step guide sounds a lot like a plan. And you would be right, that is exactly what it is! This may come as a surprise, but to be successful in many aspects of your life, you will not get very far without a plan. The same goes for investing; you need to understand your key objectives and goals in order to be successful in the market. Without a plan, when you go to make a simple decision like purchasing a stock or ETF, how will you know if you are heading in the right direction?
So having a plan, or a strategy for success, is crucial for becoming successful in the market, even before you invest your first dollar. You may now be wondering how one can create the right plan to succeed. Excellent question! And the answer to that question is all dependent on you.
Now, some folks reading this may be upset that I am not telling them a one size fits all strategy for success in the market – I can appreciate that, some folks that invest in the market make investing seem so simple, why isn’t investing that way for everyone? And my rebuttal to that would be that those folks make investing seem simple because they have created an investing strategy that works for them that has been polished over many years. Notice a few key words in that previous sentence, an investing strategy, polished, and many years. Investing is a skill that is crafted over many years with many pathways one can take, so keep those key words in mind when creating a suitable investing strategy for you.
The first piece of information you need to understand to shape how you will now achieve your objective is your time horizon. Depending on if you need the money in 30 days or 30 years will drastically change how you would invest a sum of money. For example, if you need the money to be there in 30 days, is it truly worth putting it in a volatile market that may lose 5%? Maybe keeping it in a high yield savings account is more suitable (affiliate link for HYSA) because you can guarantee it will be there in 30 days, plus maybe a small amount of interest. Now if your horizon is 30 years from now, you may be willing to risk small market dips in the short term for an opportunity to grow in the future. Who would not want to put their money in a vehicle that has historically grown by 7-8% per year after inflation like the S&P 500!? A simple guiding point like investment time horizon can direct you into putting your money in 30 days CDs vs. growth stocks like Apple or Microsoft.
The second piece of information that will guide your investing strategy is risk tolerance. A question that may help guide you in answering what your risk tolerance is the following: if your investment were to drop 10% over the course of 30 days would you sell? Hold or buy more? There’s no right or wrong answer to this question, so answer it honestly.
Understanding your risk tolerance is another foundation point in your strategy. I am sure most of you have heard the saying, “higher risk, higher rewards.” Now, high risk does not always mean higher rewards, but some individual investors can look beyond a 10% loss within a 30 day time period because they understand that the investments they have made may take 10 years or more to pay out. These investors may weather the storm having confidence in the investments they have made. Other investors may need the money in a year, so utilizing a less volatile investment vehicle may ensure that they do not lose money, yet still earn a return. This is just two examples of how answering the risk tolerance question can begin to form your investing strategy.
Now that you have an idea on what your time horizon and risk tolerance is for your investment strategy, the third criteria to consider is how active you want to be in your investments. Some investors like to be hands on, or active with their investments. With investments like real estate, flipping homes or putting “sweat equity” into the houses may allow an investor to have a buffer between what they bought the real estate for and what it could sell for on the market. The “sweat equity” part is hinting at the facts that not only are you putting capital into the investments, but also mental and physical active work in order to gain appreciation in your investments.
Other investors enjoy utilizing the passive approach to investing, using investment vehicles like exchange traded funds or mutual funds that are managed by brokerages for a group of investors. These funds are generally tagged to an index like the S&P500, NASDAQ or even a sector specific index like the Dow Jones U.S. Real Estate index. This allows investors to steadily invest their money into a blanket of companies or investments, diversifying across multiple assets. This allows their capital to follow macro-economic trends rather than deciding on a specific company or having to paint walls and install new kitchen countertops (in the case where you may want to do real estate investing).
This article is not trying to sway you into either stocks or real estate. Real estate can also be set up as more passive investment vehicles, just as stocks can be extremely active with day trading. This is our way of providing examples for you to try to understand what level of activity sounds suitable for your investing strategy – so think, how active do you want to be with your investments?
Now that you have some of the guiding principles under your belt about time horizon, risk tolerance and amount of mental or physical effort you want to put into your investing strategy, the next key component to understand how you want to shape your investing strategy is the frequency of adding capital to the portfolio.
Consistent capital contributions to the portfolio are vital for investing success. Period. Depending on how you answer this question, you may need to rethink your time horizon, risk tolerance and amount of effort you are putting into your investments. Now just think, if you add $1,000 to the portfolio, and you think you want to retire in 30 years with $500 thousand dollar net worth, you’ll need to multiply your money 500 times to achieve your goal – seems rather unreasonable. You definitely wouldn’t be able to accomplish that with CDs in 30 years, so you may now be thinking that you have to go back to the drawing board on time horizon, or adjust how risky you can be... Take a step back – what other ways can you get closer to your $500,000 goal? Oh yeah, you can add another $1,000 to the portfolio over the course of a year (for example). That’s only $83/month. And let’s just say for simplicity sake, your portfolio did not grow over the past year, but now you have $2,000 – now you only need to 250x your money in next 29 years. Half your battle is already over and all it required was a small $83/month contribution. Now not only do you have consistent capital contributions chipping away at your goal, but also compounding interest and dividend growth, may also contribute to your success.
Now this portion of the strategy requires discipline, but if you use a simple approach like paying yourself first, like many financial gurus preach, you will be ahead of the game. Focus on how much money you can save on a monthly basis and see how this fits into your investing strategy. Maybe you can direct deposit a portion of your paycheck into a Roth IRA or brokerage account so that way you don’t even see the funds in your checking account. This prevents you from spending the money so easily. I personally do this for two accounts – a personal savings account in case of emergencies, and my brokerage account. That way I know every 15th of the month, I can go on a $1500 stock shopping spree.
Now that you have 4 of the keys to a great investing strategy, it is time to define the reason why you are investing in the first place. Maybe you want a new house, a vacation fund, early retirement – all suitable reasons for investing. But let’s make sure your goal can be quantified financially. For example, in ten years’ time, I want to have enough money to take a $2,000 trip every year for the rest of my life. Awesome, now that you know what you’re aiming for, let’s see how we can equate this to an objective. $2,000 a year can be achieved by saving $50,000 and investing the money at a 4% dividend yield. Or you may say $100,000 at 2%.
Now let’s put it all together with a string of examples.
Taking the retiring early scenario where someone has $36,000 in expenses and wants to retire in 20 years. Now there are infinite amounts of ways we can find a solution to getting this individual $36,000 in income for early retirement – through dividends, capital appreciation, and principle usage.
In the case of dividends, one may look at a 3% yielding portfolio and weight the risks vs a 5% yielding portfolio in order to generate $36,000 a year in dividend income. For simplicity sake, not account for taxes, you can calculate that for $36,000 a year in income at 3% requires $1.2 million dollars in income, while the 5% yielding portfolio only requires $720,000. Let us assume the risks of a 5% portfolio would be substantially more than a portfolio yielding 3%. Now based on how much you can save over 20 years, assumed portfolio appreciation, are you comfortable choosing 5% yield over 3%?
Now for capital appreciation or principle usage, we can use something called the 4% rule. In short, with past performance, studies have shown that if you only utilize 4% of a portfolio’s value, then there is a high likelihood (over 80%) that the principle being used for funding your retirement will not deplete over time. (future link to 4% rule post) Now, looking at the $36,000 problem, that means we would need approximately $900,000 in portfolio value to meet our income goals. Now you might be thinking, well 4% is 33% more than 3%, and I want a 30% buffer for risk reasons, so you choose to use 3% instead. Now you’re back to using $1.2m so that you have a margin of safety for increasing medical costs, taxes, anything to meet your risk and time horizon criteria.
Now that you understand how to find your objective that will assist in molding your investing strategy, and you now know the 4 key parts to creating your investing strategy, I wish you the best on your endeavor to getting started in the investing world. Recognize that you may go down the road of one investing strategy and realize that you made a mistake. That’s okay; just remember what we talked about early on, “folks make investing seem simple because they have created an investing strategy that works for them that has been polished over many years.” Investing is a skill that you build over many years and with much refinement with much to learn as markets, technology and businesses change. Be cautious, always try to keep learning and continue to polish your strategy, and you’ll do just fine.