It must be admitted that small means different things to different people, and might be $100 for some and $100,000 for others. But for purposes of this post, I’m going to set out the following rules (my blog, my rules, right?)

1. It should be money you don’t need immediately. This is not your emergency fund, next month’s mortgage payment, etc. You should be able to hold it for a few years.
2. Similarly, it’s for investing, which means you hope to make money from its growth, but not gambling, where you’re in it for the thrill of it.
3. You will only choose an investment after assessing how much risk you can tolerate.
4. Do you have enough to meet the investment’s minimums?

While you can open a savings account with very small amounts of money, you don’t have much upside potential in them either—they’re parking lots. On the other hand, many mutual funds require $3,000 or $10,000 minimums. You can get in the game by choosing ones with lower minimums (usually Target Date or others designed for retirement or college savings) or purchasing ETFs, but if you’re very new to investing, ETFs may seem to complicated. Purchasing a few shares of individual stocks is usually hardly worth the double whammy of sales commissions and risk concentration.

On the other hand, if chump change is $100,000 for you, you’re probably an accredited investor and someone is pitching you a special-only-for-the-elite investment, which generally means you are about to be taken on a risky, money losing ride. This also includes anything with a can’t-lose return, super-special private deal annuities, non-traded REITS, hedge funds, and master limited partnerships. Be sure to check your back to see if a sign saying Easy Mark is pinned somewhere.

But what should you look for in a decent small investment?

1. Return. You ought to get some. In this low-rate market, that’s probably somewhere between 1% and 8%, with, as always, more return means more risk.
2. Safety within the range you can tolerate. A Federally insured account is the safest, but with no danger of losing principal, but of course that also means the smallest return. A big mutual fund company (like Vanguard, Fidelity, TIAA-CREF, or T. Rowe Price) offers you no guarantees on investing, and theoretically could lose all your money in its mutual funds. Most brokerages offer SIPC insurance but this only protects against the company going belly up and taking your money with it. It offers no protection whatsoever that whatever you’ve invested in couldn’t go kaput and take your money with it. On the other hand, it is highly unlikely that you would lose your principal in a money market fund, because they are invested in short term, highly predictable instruments like ultra-short term bonds. And, guess what, you won’t get much return (like, nothing) on them at the moment. By now, I’m hoping you’re seeing the pattern common to all investing: to make money you have to take some risk. How to minimize that risk while earning a little more than a bitcoin or two.
3. Diversification. This is really the key principle, and the hardest to achieve with small amounts of money. To get return you have to take risks, but to minimize risk you have to spread out an investment so that your bet isn’t riding on one number on the roulette wheel. Buying a single stock is putting all your money on one number, and in most cases I don’t recommend it. But what most people don’t realize is that buying a mutual fund focusing on a specific asset class (say, health care or mining or the S&P 500) is a pretty limited bet also. While it’s more diversified than a single stock, these guys tend to hang together. Even worse, some people think they’re diversified because they hold stock funds in several different mutual fund companies. If you’re holding “growth” stocks at Fidelity, Vanguard, and T. Rowe Price, you probably own about the same portfolio at each—i.e. little diversity.

But, what a surprise, the mutual fund companies have cooked up something designed to pander to your needs, er, address your specific investing challenge. These relatively new types of mutual funds are known as Target Date, Life Strategy, Lifepath, etc. They were developed to offer something within employer 401k plans, college savings 529 plans, etc. for large pools of investors who might be inclined to put away only very small amounts of money at a time. Indeed, a Target Date fund may be the best default choice in your retirement plan, especially if the other choices consist of a lot of high-fee or proprietary funds.

Investors with a small amount to put away might consider these funds for purposes other than retirement (as well as retirement), by remembering that the closer to goal, the more conservative the Target Date fund. Let’s take the example of investing some money that you can leave alone for 5 years. If you need to be relatively certain that you’ll have that money, you might want it conservatively invested in something such as a Target Date 2020 fund, which is going to be primarily in bonds and cash. But let’s say you hope to make a little more than that, and don’t HAVE TO with draw the money in 5 years—say, if it is up you’ll withdraw, but if it’s down somewhat you could wait another 3 years. Then, you might want to consider a Target Date 2030, or 2040, or 2060—all of which will be invested in a higher proportion of stocks, internationals, and perhaps alternatives.

Target Date funds will give you far more diversification across many types of investments and many companies than you could achieve on your own with individual investments. But they will change their investment path over time—moving to more conservative investments as they march to their Target Date. Is there any other type of fund you might consider?

Before Target Date funds came along, 60/40 mutual funds were pretty much the go-to for investors who wanted a set-it-and-forget-it investment. These funds are designed to maintain a balance of 60% stocks and 40% bonds, a mix that is generally considered prudent but with some potential of return. Also, the funds impose an automatic discipline of re-balancing whenever one side or the other gets out of whack, thereby (at least theoretically) buying low and selling high—what we’re all supposed to do, but usually do the opposite.

You may see these funds called balanced funds or moderate allocation or equity/income but drill down a little bit to take a look at management fees (should be low), make sure they’re no-load, see exactly what balance they promise, and determine whether they are made up of index funds or the choices of some manager (prefer index funds). Also, take a look at the longevity of these funds—some of them have been around since the Depression (1929, not our current ongoing situation).

The third choice you might consider is a fund of funds—a mutual fund company collects a basket of their index and actively managed funds and distributes your tiny coins among them. Not a bad choice for diversity, but I’m not a huge fan of actively managed funds. Keep an eye on fees and commissions (nope, nope, nope).

Finally, a disclaimer—none of these may fit your personal situation, and you should not take this as specific investment advice. And then, there’s always your mattress.

Really, I’m not always angry. I’m pretty calm when I’m petting my dog. But reviewing peoples’ finances does tend to show you a million ways someone has figured out how to cheat people out of their money. Recently, I’ve started to wonder whether corporate 401(k) sponsors are better at it than Bernie Madoff. Or Fabrice Torre. Or whoever is the crook of the day.

One of the ways financial crooks operate is that they count on no one paying attention, or people not understanding investments well enough to question anything. So take a moment—do you know what you invested in in that 401(k)? (I could also ask, do you have any old ones laying around from previous jobs that you’ve forgotten about, or, are you even contributing, but those are subjects for another post.) Typically, people pick investments that are labeled “growth”—who doesn’t want growth?—and to those I say, remember the adage, “Give a dog a good name”. Or maybe it’s a Target Date Fund—often I see several different target dates, because who knows when you’ll actually retire. Ugh.

But even setting aside our own individual dumbness, if you work with any number of companies (even the Fortune 100, who should know better), you’re still stuck, even if you know what you’d like to invest in. The choices are limited, the funds offered are often load, actively managed, and with high management fees. Even if the plan has negotiated a lower rate, it’s still the same lousy fund. Yes, you’re supposed to be given more information nowadays on what those fees actually are, but there’s no requirement to offer you a wider selection of funds.

So, pull out that plan document or go to your employee benefits website. Look for the following:

1. Are there index funds available in large (S&P 500), mid-cap, and small-cap funds; corporate, government, and international bonds; international developed and emerging markets; and some alternatives (such as real estate, commodities, or, if you must, gold)? It’s pretty hard to build diversification if you don’t have many choices. And if all the choices are stocks, it’s going to be impossible for you to make truly tax-savvy choices as your account builds.
2. Is it sponsored by an entity with “private banking” in the name? You’re probably being screwed. Law firms and medical practices are particularly vulnerable to pitches that sound elite. The only thing elite about this is the much higher fees and much poorer investment choices—elite for the “private bankers”.
3. Does Morningstar list the funds? If the funds aren’t publicly traded, good luck trying to get a prospectus or even any statement about what investments are actually in the fund. And forget any ability to actually get an independent opinion, rating, or comparison of them. Oh wait, maybe that’s what they wanted. Some of the descriptions I’ve seen of these private investments can only be described as wishful thinking, er, pipe dreams, er, misrepresentation, er…
4. Do you recognize any of the funds? Vanguard, Fidelity, American Century, TIAA-CREF—not all have my favorite investments, but at least you’re working with well-observed entitites. You probably haven’t heard of the “Maximize Growth Special-situations Fund”–guess why?

Here’s an issue where well-paid executives are just about as vulnerable as the average receptionist–perhaps more so because their account balances are likely to be larger investments in crummy funds. And even if you’re smart about investments, you still may be trapped without choices.

So, what to do? If you get an employer match, it’s still usually worth contributing. But contributing up to the full legal limit to get the tax benefits? Well, it depends—and for that one, you do need a financial advisor to take a personal look. And, radical thought though it is, you could actually save money outside of your 401(k), where you control the investment choices.

For a really excellent article on what you can do about a lousy 401(k), run out to the newsstand (or subscribe online) to the latest issue of Consumer Reports. They sound pretty angry, too.