How to invest a small amount of money

Posted on May 12, 2014May 12, 2014 by Danielle

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?)

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.
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.
You will only choose an investment after assessing how much risk you can tolerate.
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?

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.
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.
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.

Updating the envelope system for financial planning

Posted on February 21, 2014February 21, 2014 by Danielle

(Photo credit: Sarabbit)

I love the old envelope system. In case your mom never taught you about this, you decide how much you’re going to spend for food, housing, clothes, etc. and you put that amount in each marked envelope every time you get paid. When the envelope is empty, you’re out of business. (Actually, my mom never taught me this—her approach was basically to just save everything, and not spend at all until they pried it loose from her fingers.) Unfortunately, just don’t use cash anymore.

Nevertheless, it works. If you are really in debt, I do recommend that you move your spending to cash as much as possible. Freeze those credit cards in a block of ice and don’t use them until they defrost (seriously). Give yourself, your partner, and your kids a specific amount of spending money and when it’s gone, it’s gone. Renew when you get paid.

But since we live in a modern plastic and virtual world, can we create a virtual envelope system? Well, sort of, and it would help many of us to better money management.

First, set up a budget. OK I can hear the groans already. Don’t make this too complicated—savings, required expenses and spending money might be enough. Most people find it easier to do a percentage of income rather than a fixed amount. That way, you know what to do with any “found” money, pay raises, or freelance income.

Next, put the required living expenses (rent, insurance, utilities, etc.) in your checking account. In general, it’s best not to carry your checkbook around with you—you probably pay these expenses at home at your desk and not having the checkbook removes some temptation. If possible, have your paycheck sent directly to this account.

Set up auto-pay and auto-withdrawals. You can either authorize the payees, such as credit card companies, to automatically withdraw from this account, or you can set up payments from the checking account to payees such as utilities. Don’t pay extra for this (some utilities are really dumb on this one).

Groceries are a special case. Certain unnamed hoity-toity supermarkets don’t accept checks anymore. If you do have any budgeting problems, it’s probably better to take out grocery (and restaurant) money in advance and put it in an actual envelope. Or use a cash card like Bluebird (transfer the right amount of cash into it each month). If all else fails and you have trouble monitoring this, designate one credit card for groceries and set up alerts to warn you when you’re getting near your pre-set goal (some allow this and will text you).

Now we get to savings. Again, you can set up auto-pay and auto-withdrawals from most investing institutions. I highly recommend NOT having your savings accounts in the same place as your checking. It’s just too easy to raid it when you need extra. For this reason I like internet based banks, credit unions that are different from where you have checking (so you have to make a special trip), or the big guys like Vanguard where you have minimum requirements.

I particularly love the automated options because it removes opportunities to make bad decisions. We all tend toward inertia. Making a decision every month to save is much more likely to fail than making a decision once, having the savings going forward happen automatically, and just getting used to those withdrawals happening.

Finally, make a list of annual or intermittent expenses (insurance, tuition, property taxes, etc.). Add up what it amounts to annually, then divide it by your pay periods. That’s what you need to put away if you don’t want to be surprised when they show up.

Don’t be afraid to create multiple accounts, say, savings for intermittent expenses, checking for regular household expenses, goal savings for vacation, retirement account, etc. Some internet savings (CapitalOne 360, for example) will allow you to designate “sub-accounts” and name them for specific purposes. You make the deposit and let them know which sub-account it should be designated as.

Mind-games? Sure, but sometimes these little tricks result in big improvements.

Hitting the re-start button

Posted on January 14, 2014January 14, 2014 by Danielle

Certain places are the end of the world. San Francisco was like that when I lived out there, and Key West (from which I just returned) appears to be another. These are places that have more than their share of burned-out cases, but also a high number of people that decided to chuck it all and start their life again.

Key West is delightful in its acceptance of eccentricity, but also in the variety of ages of those who have decided to re-start their lives in some radically new way. The first morning our waitress was in her 70s, with a sequined beret, fingerless gloves, and a few other items of clothing people 20 years younger might hesitate to wear. On the way down, the plane seat right in front of us was occupied by another femme d’un certain âge who was head to toe in red velvet, and who I later saw in the airport kissing the much younger husband she had mentioned. Gives one hope, non?

But the point of this tale is to address all the guilt and regrets I hear this time of year, along with the resolutions to do better. Sure, I’ve got a few regrets myself. Okay, maybe a hundred. What I saw while in Key West was what I think most of us who are baby boomers (or younger) have experienced—you may have to restart your life several times. There are a few people among my clients and acquaintances that knew they wanted to be lawyers at 20 and will retire from that same profession at 66. But far more common is the person who started out as an attorney and is now a shaman, the investment banker who re-trained in Chinese medicine, the corporate executive who retired early to paint, and the divorcée who started an entrepreneurial venture. Technology and the demand for skills has moved so swiftly in the past 30 years that few of us could have known what training we needed “back then”. Few of us planned to get a divorce when we said, “I do”, and all of us believed when pregnant that our children would sail brilliantly from pre-school through the Ivy League to a high paying job, a devoted partner, and a long and healthy life. If only.

Then there are the regrets about not having saved enough, made poor investment choices, and bankrolled a relative or child that turned out to be a black hole. Our brilliant children sprout terrible problems, our competent and ambitious spouse develops a chronic illness, our boss is unreasonable, our co-workers insane, our company gives us the shaft.

What can you do about that history? Truly, nothing. None of us can re-write the past, control another’s behavior, or singlehandedly manage our employer or our clients. Didn’t lose the weight you planned, didn’t meet your savings goal? Um, me too.

On several mornings in Key West, I found myself waking up depressed. I, too, wanted to chuck it all and re-start in some tropical paradise where stress was low, seafood was plentiful, and I didn’t need a winter coat ever again. Or move to Paris. Or sell the house and keep only what fit in a back pack. Or…or…

Once I had my coffee and was able to shake off the effects of the previous night’s tropical drinks, I was able to think this through.

Just about every decision we make seems right at the time. Most of us try to make good decisions based on what we know at that point, or make bad decisions because we’re just too stressed out over something else to focus down. And, every time you make a decision, you close down other possibilities. This is why so many people have great ideas for a novel, but so few of us actually write one. Artistic types in particular may get stuck on the dime because even finished works are never as good as they were in the imagination.

A trip to Key West gave me plenty of examples of the possibilities of alternatives and creating a life different from the past, and people who courageously face what it takes to make that change. We can’t change the past, but we can re-boot and aim toward a different future. As long as you’re alive, it’s possible.