Traditionally, investing has been viewed as a privilege reserved only for the wealthy — those with money to burn gambling on the ebb and flow of the stock market. However, with the recent rise of app-based, free-to-use investment platforms, the barrier to entry has never been lower; even on tight budgets, it is entirely possible to tie spare cash into low-risk, lower-yield investments.
In a time when inflation is at its highest since 2008, investing can be the key to ensuring your hard-earned money keeps its value. This article examines four essential tips for getting the most out of the stock market on a tight budget.
The stock market conversation is dominated by “self-made” investment gurus and analysts with significant wealth encouraging risky investment strategies. While it’s fun to dream of being the next overnight stock market success, the average investor cannot afford to use these strategies — the risk is far too significant.
The hard truth is that most investment influencers are independently wealthy — but most people are not. Before making any investment, it’s important to understand how much risk you can take, even if that means making fewer investments.
Typically, the goal of the average investor is to earn at least a 10% return, or profit, over time. That goal may be smaller for investors on tighter budgets; even in years of record inflation, a return of just over 2% will ensure that your cash doesn’t lose its value. Remember: a gain is a gain, no matter how small — and all gains compound (see next section for more on this).
Compounding is the main reason why the stock market can be an effective tool for making money, or at least preserving its value. Compounding works like this: let’s say you put $1,000 into an index fund, a popular type of investment that seeks to provide the same returns as the market as a whole. After six months, your investment generates an additional $100 — a 10% return. Your investment is now worth $1,100. As your investment continues to grow in value, the additional $100 return grows with it, generating a return of its own. It can take a long time to really get going — often over the course of several decades — but regularly putting money into compounding investments can generate a huge return in the future.
Every investor dreams of hitting the perfect investment at the right time and allowing the value to compound until it becomes a fortune. However, investments can lose value as easily as they appreciate, or gain value. The best way to avoid taking a loss is by sticking to low-risk, lower-yield investments. For this reason, Exchange Traded Funds (ETFs) are wildly popular among budget investors.
Put simply, ETFs are package deals that bundle a myriad of different stocks, commodities, bonds, and more into one bundled investment. ETFs are popular because they are among the least expensive and easiest routes to a well-diversified portfolio. For example, if you invest in a single company within the energy sector, your investment is directly tied to that specific company’s performance. With an energy sector ETF, however, your investment is connected to the energy industry’s performance as a whole.
A common stock market rookie mistake is panic selling: selling a stock the moment it loses any value. While it may be tempting to sell falling stocks at first, doing so may lock in your losses before you make any gains.
Once you tie up money in an investment, you should only withdraw it when certain conditions are met: (1) If the investment has met your predetermined goal — also known as “maturing” — (2) or if you need the cash right now. As mentioned previously, a tight-budget investor may shoot for a 5% return (profit), while a more financially secure investor may set their target at 10% or beyond.
Of course, you don’t have to withdraw once your investment matures. If you choose to withdraw, you lock in, or realize, your gains (profit). The advantage of locking in your gains is that your investment is no longer at the mercy of the stock market; it now sits safe and secure in your bank account. Of course, the primary disadvantage of this is that your investment no longer has any potential to compound. Also, you must pay additional taxes on your gains once you withdraw them.
The swirling currents of the stock market are intimidating, but it’s never been easier for anyone to test the water. Powered by the rise of free-to-use, app-based trading platforms, the democratization of the stock market has been a massive win for people everywhere looking to protect their savings from losing value in the face of inflation.
At current inflation, cash is losing almost 2% of its value each year. Meanwhile, VOO, a Vanguard ETF tied to the general performance of the stock market, showed a 1-year return of 34.35% in September of 2021 — more than three times the goal of an average investor. While there are no guarantees of a 30-plus-percent return — lightning rarely strikes twice in the same place, after all — smart, safe, diverse investments can be your ticket to maintaining or even increasing the value of your hard-earned cash.
Please note: Mission Lane is not a financial advisor and readers should consult an advisor before pursuing any of the recommendations included in this article.