Active vs. passive investing (and which one’s right for you)
To start, it’s important to know that there are two types of investing: active and passive.
Active investing is when you take a hands-on role managing your investments, often on a weekly or even daily basis. You’re essentially your own portfolio manager, buying, selling and trading stocks with the goal of seizing market opportunities and beating the performance of an index fund (i.e. beating a passive investing strategy). Day trading is the most active form of active investing.
Passive investing is the “fire and forget” strategy that most people (and even professional investors) follow. It involves picking the right investments once and simply holding onto them for the long-term. Passive investors may move things around once or twice a year but, by and large, they let their portfolios age and mature without regular, manual intervention.
More: Actively managed vs passively managed funds
I bring these up to shatter a common myth about investing: you don’t need to day trade to make money off the stock market.
In fact, it’s better if you don’t. According to research by S&P Dow Jones Indices, passive funds tend to outperform their active counterparts. Furthermore, less than 1% of day traders earn enough money to cover their own trading fees. Yikes.
That’s one reason why at Investor Junkie we focus on following a simple yet effective wealth-building strategy that even professional investors like Warren Buffet follow. All six of the investing strategies on this list take less than 30 minutes to set up – some less than five.
So, without further ado, let’s talk about how to start (passively) investing with little money.
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1. Use a microsavings app
A solid first step to investing with little money is to open a microsavings account.
A microsavings account is the same as a regular savings account but with lower barriers for entry. Regular savings accounts often have requirements like:
- A $500 or higher initial deposit
- A daily minimum balance requirement
- Limited monthly withdrawals
Worst of all, if you breach any of these account requirements, you could be subject to fees that could wipe out all of your hard-earned interest in a flash.
Thankfully, banks that offer microsavings accounts seem to better understand that fees and thresholds kinda defeat the whole point of having a savings account in the first place. Chime®, for example, has a daily minimum balance “requirement” of $0.01 and will never charge you a fee.
The other advantage of a microsavings account over other forms of investing is liquidity. You can typically withdraw from a microsavings account balance up to five, 10 or even unlimited times per month, so it’s a good place to keep an emergency fund.
By contrast, “withdrawing” from your stock portfolio requires you to sell off shares, incurring trade fees, capital gains taxes, and in the case of your 401(k), additional penalties.
Although microsavings accounts are essentially risk-free and liquid, the chief drawback is that they don’t earn much money. According to the FDIC, the national average interest rate for a savings account is a pithy 0.06% APY — and although it’s easy to find a microsavings account offering 0.50%, that’s still well below the rate of inflation.
I’d recommend using your microsavings account as a staging point for your other investments. You can have a portion of your paycheck automatically routed there each month where it can live separately from your checking account, generating a nice trickle of interest until you invest it using one of the other five methods on this list.
More: Best microsaving apps
- Risk-free: Savings accounts are FDIC-insured and will never lose equity.
- Liquid: Unlike other investments, withdrawing from your microsavings account is instant, tax-free and penalty-free.
- Separates your investable cash from your checking account: Microsavings accounts provide a convenient “staging point” for your investable capital away from your regular spending money.
- Extremely low interest rates: Even with a high-yield microsavings account you’ll barely be earning 0.50% APY, so you won’t want to keep your investable capital there for long.
- “Gotcha” fees: Savings accounts will occasionally have “gotcha” fees buried in the fine print that could wipe out your interest overnight. Read the terms and conditions twice.
2. Enroll in your employer’s retirement account (or open a Roth IRA)
You might be surprised to hear that the smartest investments you’ll make in your life — the ones that’ll accelerate your financial independence — are often the dullest sounding on paper.
Perhaps the smartest money move you’ll ever make is to opt into your employer’s retirement account. There are several reasons why it’s a no-brainer:
- 401(k)s are extremely low-risk
- They generate a reliable 5 to 8% returns annually
- You can make pre-tax contributions, meaning you only pay taxes on them when you withdraw at retirement (and you’re in a lower tax bracket)
- Your employer will match your monthly paycheck contributions up to a certain percentage, typically around 3%. This is basically a 3% raise.
Now, how much should you invest into your retirement account?
To start, I strongly recommend that you put aside at least enough to maximize your employer matching. Any less and you’re simply leaving money on the table.
As mentioned above, most employers will match the first 3% of your gross annual earnings that you put aside for retirement. That means if you earn $40,000 per year, your employer will match up to $1,200 of your 401(k) contributions — so you should at least plan to put aside that much.
The rest depends on both your investment risk tolerance and your pre-retirement goals. For more, check out our guide on how to invest for retirement.
Now, if you’re self-employed and don’t have access to an employer-sponsored 401(k), you can still open an Individual Retirement Account, or IRA. Although these accounts don’t include employer matching, both Traditional IRAs and Roth IRAs offer many of the same tax benefits as 401(k)s and even more flexibility.
Investing in your retirement account may not be as sexy or exciting as day trading, but it’s perhaps the single easiest way to build wealth in your sleep. After all, every dollar saved for retirement at 25 becomes nearly $22 by 65.
- Employer matching is free money: Most employers will match up to 3% of your gross annual income that you contribute to your 401(k).
- Low-risk: Retirement accounts are managed with stable, long-term gains in mind and are among the lowest-risk ways to consistently earn 5 to 8% annual returns.
- Turn $1 into $20: Thanks to reliable, average annual returns spread across decades, every dollar you invest by age 25 becomes nearly $22 by age 65.
- Largely illiquid: You cannot withdraw from your 401(k) or IRA without moderate to severe tax penalties, so it’s best to consider that money locked away in a vault and inaccessible until retirement.
- Less fun for the self-employed: Although they’re available to everyone and arguably more flexible than 401(k)s, IRAs do not get the added bonus of employer matching.
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3. Invest with a robo advisor
The term “robo-advisor” probably conjures an image of an animatronic Jordan Belfort picking stocks for you. While robo advisors haven’t quite taken physical form (yet), they are essentially AI-powered portfolio managers.
For decades we’ve relied on human financial advisors to invest and multiply our money for us. And while they generally do a good job (Jordan Belfort notwithstanding), human wealth advisors still have to earn a living and occasionally go to sleep. AI advisors don’t.
So how does investing with a robo-advisor work?
When you sign up with a robo-advisor like Betterment, the program will ask you for the same basic info that a human financial advisor would:
- Your age and personal information
- Your investment goals (e.g. buy a house by 2025)
- Your risk tolerance
- Your investment account preferences (e.g. no international stocks, focus on bonds, etc.)
Then, the AI goes bleep bloop and chooses the ideal portfolio to match your goals, tolerance and stated preferences. In many cases these portfolios aren’t 100% bespoke for each client, but minor variations on existing portfolios that the AI or its human overlords have already designed for high performance.
Most robo advisors can also perform automatic portfolio rebalancing. If you change up your investing goals, increase your risk tolerance or simply want to “tighten up” your portfolio, you can do all three in just a few short clicks. A human financial advisor might need a day or two to see your message and then manually readjust the portfolio.
All in all, “hiring” a robo advisor is a convenient, affordable and accessible way to maximize a passive investing strategy — whether you’re investing in an IRA or a more aggressive midterm portfolio. They’re not a 100% replacement for a human advisor who can better understand your personal goals and guide you with a human touch, but they’re undeniably a cheaper and more convenient place to start.
More: Best robo-advisors guide
- Removes all the guesswork from investing: Why risk choosing your own stocks and exchange-traded funds (ETFs) when you can have a highly sophisticated AI do it for you?
- Nearly free: Robo-advisors can charge as low as 0.1%, which is just $1 for every $1,000 invested. This is virtually negligible as far as management fees go.
- Automatic portfolio rebalancing: With a single click (or even on an automated schedule), you can have your robo advisor tweak or tighten up your portfolio to stay zeroed on your investment goals.
- Flexibility may be limited: Depending on which robo advisor you go with, you may not have much input regarding which stocks and ETFs you’re investing in.
- Minimum initial deposit requirements: Some robo-advisors require an initial deposit amount of $500 or more to get started.
- Can’t replace the human factor: While some robo-advisors do offer à la carte access to human financial advisors, you may not get all the benefits of building a long-term, 1-1 relationship with a human-led firm.
4. Invest in commission-free index funds and ETFs
Many investors, especially passive investors, prefer pouring their money into ETFs and index funds over individual stocks.
Exchange-traded funds are like big bundles of stock, bonds or other commodities that trade in shares just like regular stock. A single ETF can contain anywhere from a dozen to several hundred individual stocks, so buying shares of that ETF can instantly grant you broad and diverse exposure.
ETFs lend both convenience and diversity to your investment account, and are always connected by a theme. There are blockchain ETFs, space technology ETFs and even ETFs that follow the specific shopping habits of millennials.
Index funds are ETFs that track an entire market index. For example, there are index funds designed to mirror the overall performance of the S&P 500, the Dow Jones Industrial Average and other indices. When you buy shares of the ever-popular Vanguard 500 Index Fund ETF (VOO), you’re quintessentially investing in the S&P 500 as a whole.
Index funds are passive investor darlings because they tend to provide high and reliable returns over the long-term. Here, for example, is VOO’s lifetime performance:
Heck, even world famous investors love index funds. Warren Buffet is famous for saying: “I just think that the best thing to do is buy 90% in an S&P 500 index fund.”
Finally, it’s worth noting that pretty much any investing app these days will also allow you to buy ETFs and index funds. Check out our list of the best online stock brokers.
- Convenience: ETFs and index funds enable you to invest in dozens, and sometimes hundreds of companies at once in a single click.
- Stability: Due to their inherent diversity, ETFs and index funds provide more long-term stability than most individual stocks.
- Strong performance: While stability and performance seldom go hand-in-hand, index funds are the exception. S&P 500 index funds famously provide a steady 10% APY in average annual returns over the long-term.
- Still subject to market conditions: No stock market investment is immune from losing value, even crashing.
- Not actively managed: Most ETFs are designed once and cast into the market; they are not actively managed like a mutual fund.
5) Invest in target date mutual funds
Remember back when your robo advisor asked about your investment horizon, a.k.a. when you plan to sell your holdings and cash out? Why does that matter?
Well, your horizon can make a big difference on what investments you make (or are made on your behalf). Generally speaking, there are three investment horizons:
- Short-term: Under 3 years
- Medium-term: 3 to 10 years
- Long-term: 10 years or longer
The shorter your horizon, the less risk you want in the portfolio. After all, if you’re planning to cash out soon to buy a house, you don’t want your down payment money in a risky portfolio that loses 30% of its value right before closing.
That’s why target date mutual funds can be extremely effective if you have a specific horizon in mind. These specialized funds dynamically lower their risk over time until investors like you can exit with a safe, predictable amount of cash.
In that way, target date mutual funds are like trains. They have a human conductor and a predetermined stopping point, so everyone who wants to go there just hops aboard, relaxes and exits when the time is right.
For example, the Vanguard Target Retirement 2025 Fund currently has less risk in the portfolio than the Vanguard Target Retirement 2055 Fund. The “passengers” of the former are about to disembark, so the conductor is reducing speed, or reducing the risk in the portfolio.
If you like the security of knowing that your investment, however small, is being actively managed with your horizon in mind, target date mutual funds are a safe, smart option.
More: Robo-advisors vs target date funds
- One-and-done investment vehicles: Many investors consider target date mutual funds to be reliable one-stop shops for all the money they’ll need by a certain date.
- Better tailored to your investment goals: Target date mutual funds dynamically adjust their risk to ensure a smooth “exit” from your investment.
- Active management: Although mutual funds don’t automatically (or even often) outperform index funds, the comfort of knowing your money is being actively managed may be worth the performance tradeoff.
- High minimum investment: Many target date mutual funds, such as those curated by Vanguard, have a minimum investment of $1,000+.
- More expensive: Target date mutual funds have higher expense ratios than passive ETFs to help cover the costs associated with actively maintaining them.
6. Buy fractional shares of stock
All this talk about retirement, index funds and other safe and sensible forms of investing… is it really so wrong and reckless to buy individual stocks these days?
Not at all! And while we’re on the subject, I want to make something totally clear: even with a small amount of capital to start, it’s actually better to have a diverse mix of investments.
For example, you can have a medium-risk portfolio that’s 50% index funds, 25% ETFs and 25% individual stocks. Or, you can have your robo-advisor handle the bulk of your wealth, and keep 10% in a YOLO fund that you put in high-risk, high-reward investments.
Let’s say you have $50 in your YOLO fund and want to buy shares of a highly speculative stock like Tesla (TSLA). However, TLSA trades at $1,088.47. It’ll be a minute or two before you can afford to buy even one full share.
Thankfully, most online brokerages like Public will now let you buy fractional shares. With $50 you can buy 0.046 of a share of TSLA and your fractional share will entitle you to the exact same benefits as a full share, just on a smaller scale. You can even sell a fraction of your fractional share!
While fractional shares are convenient, they’re no less risky than full shares. Buying individual stock is the riskiest investment you can make in the stock market because a single company’s share price can fluctuate wildly on a short- and even long-term basis.
There are simply too many variables to predict tomorrow’s share price, which is why many investors prefer the diversity of ETFs or index funds.
Even still, allocating a small portion of your portfolio to handpicked stocks can not only be exciting and educational — it can be highly rewarding.
More: What is fractional share investing?
- Enables investment in high-value stocks: Fractional shares enable small-cap investors to buy into expensive stocks, driving values even higher.
- No trade fees: Your preferred investment app should let you trade fractional (and full) shares for free.
- High risk, high reward: Shares of individual companies may grow in value significantly faster than ETFs or index funds.
- Requires research: Handpicking the right stocks can require hours of due diligence (and don’t trust the front page of r/wallstreetbets).
- High risk, high reward: Individual stocks are the riskiest investments you can make in the stock market because their performance is largely unpredictable and they’re not insulated by diversity.
The bottom line
Even if you can only invest just $50 a month to start, there are tons of places where you can stash and watch it multiply. Buying up fractional shares of an S&P 500 index fund is an excellent place to start, as is maximizing your employer’s 401(k) matching. Honestly, lots of folks stop there and do just fine.
But as your income grows, you might consider linking up with a human (or robo) advisor, stashing down payment money into a target date mutual fund, or even hand picking some speculative stocks with a small percentage of your portfolio.
There really aren’t any wrong answers here — as long as you continue investing and learning, your money will continue to grow right alongside you
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