Whenever people thinking about the stock market, they often think about the hundreds of millions of pounds that are transacted everyday. They think of the enormous profits that people make and often think that it is unattainable for them to achieve.
Of course, the easiest way to make a lot of money from the stock market is to have a lot of money in the first place. 10% of $1m is considerably more than 10% of $100.
This perspective shouldn’t deter people from investing though. In fact, almost every investor starts with very little money, unless they are from a wealthy family.
The true power of investment comes from compound interest, where small investments can grow into very large amount of money over the long term.
A classic example would be the case of Warren Buffett. Although he is now one of the richest men in the world, his first investment was worth just $114 back in 1941 (worth $2,019.34 today).
Over time, Warren grew his investment capital into significantly large amounts of money. This shows how small amounts can be invested and transformed into large amounts.
When it comes to investing small amounts of money, buying individuals stocks can be off-limits, depending upon how much you consider small to be.
If an individual wanted to invest $100, many individual stocks would be out of reach.
The reason is simple. Many stocks are priced above $100.
For example, Amazon stock is priced at $3,200, Alphabet stock (Google) is priced at $1,800 and Facebook stock is priced at around $300.
As you can see, it’s not possible to buy any of these stocks with just $100.
Of course, there are stocks that are priced under $100, many of which have low stock prices because they are less attractive.
This present a significant barrier to entry for a lot of new investors.
Another issue with buying individual stocks is the impact of transaction fees. When you invest in individuals stock, you will likely be charged a broker fee of $10 to $30 per trade.
When you are investing just $100, this could be an enormous blow to your investment from the outset.
Say if your broker fee was $10, you’d essentially be down by 10% from the very beginning, which could take several months to recover from the growth of the stock price.
Despite the clear barriers to entry in terms of buying individual stocks, many investors would still like to invest their money in big companies like Google, Apple and Amazon.
The best way to do that with small sums is to invest in an mutual fund or an exchange traded fund.
The standard advice for most investors is to invest in an index fund, which is a fund that is made up of all the stocks in a stock market index.
The reason for this is that in finance theory, it is believed that it is impossible to beat the market and so investors should be satisfied with the market return as it is the optimal return. Whether this is true or not is another story.
The most famous example is the S&P 500, which is a fund that is made up of the 500 largest companies in the United States.
Therefore, by investing in the S&P 500, you can get exposure to stocks like Amazon, Apple and Google.
The reason why mutual funds or exchange traded funds are so attractive is that they are low cost, both in terms of transaction fees and the price of the fund.
It’s fairly commonly to find funds that are priced well below $100, with transaction fees that are less than $2.
So, if I was to invest $100 and pay a $1 transaction fee, my investment would start in a negative 1% position – which is a lot better than the negative 10% or 30% when investing in individual stocks.
Starting in a negative position is to be expected, it is very rare that you would invest money and be in a positive position straightaway. The goal is to try and minimise the negative position that you start in.
The only way to do that is to invest larger sums of money, which will come over time as your investment grow.
There are a few things to be wary of when it comes to investing in mutual funds. The first is that funds can often charge large annual management fees. The second is that the fund managers can often lose you money.
For that reason, it is advantageous to invest in a ‘tracker’ fund, which is basically a fund that does not have a manager.
Research shows that, in the majority of cases, tracker funds perform much better than funds that actually have a manager.
People are often surprised when they hear this but there are a number of reasons why this is the case. In short, it’s because fund managers are human and suffer from human errors as a consequence.
These human errors have an impact upon investment returns. Perhaps the manager will sell a stock when they shouldn’t or will analyse a stock incorrectly.
The most important thing is to know what you are investing in. Make sure that you read all of the key investor information documents so that you understand what the fund is and what charges it comes with.
In summary, when you pick the right mutual fund, there’s no better way to invest small amounts of money into the stock market.
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