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Saving up your first $5,000 is arguably the hardest five grand you'll ever save – but, once you put it to work, compound interest can start to do the heavy lifting for you. If you’ve never invested before, deciding what to do with your savings can be daunting, so here we hope to set you on your way. With the rise of online brokers, investing has never been simpler and you can get started with as little as a few hundred dollars.
Before you dive into stocks or other assets, be sure you have enough saved as an emergency fund in case any large expenses, such as medical bills, suddenly appear. Aim for six months’ worth of living expenses as a minimum.
You should also pay off any high cost debt, such as credit cards and personal loans, before you buy stocks. The interest savings are likely to exceed your investment returns.
Funds allocated to the sharemarket must stay invested for long periods to ride out the volatility. If you’ll need access to your funds within the next 5 years, stick your $5,000 in a high interest savings account.
It’s usually more difficult to access the funds (you won’t be able to withdraw them at an ATM, for example) but the extra interest will add up compared to what you would receive in your everyday account. There are many choices when it comes to savings accounts, so it’s important to do your research and read reviews to pick the one that’s right for you
Once you’ve paid off your credit card and put enough money away for emergencies and large future expenses, you’re ready to start investing in ‘growth assets’, such as stocks and funds.
Almost no amount is too small. I’m all for starting young with, say, $500, rather than saving for a larger amount. True, you’ll lose a large chunk of your return to fees, but think of it as an education expense. No amount of reading will teach you what it’s like to invest until you have real money on the line.
You’ve probably heard the whole ‘don’t put all your eggs in one basket’ mantra, and with stocks it’s especially important. However, with small amounts it’s impossible to diversify adequately without losing a significant chunk of your return to fees. If you, say, spread your $5,000 over 10 stocks, you might lose $400, or 8%, of your capital just on the usual $20 broker commission to buy and sell.
Investing your money in an index or mutual fund may be the better option. Index funds, such as those by Vanguard, don’t try to beat the market and instead buy a little of everything. You’ll only get an average return, but pay very little in fees, which will add up over time.
Alternatively, you can go with an active fund manager, such as Intelligent Investor, which charge more in fees but – if they’re worth their salt – can focus on the best opportunities and hopefully earn an above average return for you. Both types of fund managers will substantially lessen your risk by spreading your money across dozens of stocks.
Without tooting our own horn too much, the Intelligent Investor portfolios have beaten the market by 3.2 – 5.8% a year since their inception in 2001. Annual fees are less than 1% for your first $5,000 (and go down from there).
If you prefer the idea of managing your money directly, you should aim to eventually own 10-20 stocks. But with $5,000, buying that many stocks would likely cause too much loss of return to fees for it to be feasible, so starting out with the money spread evenly across, say, three companies might make more sense.
Make no mistake, though, this is a highly concentrated portfolio and adds risk. You should be prepared for large swings in the total value of your portfolio. With this in mind, remember it’s the stocks with the least downside – which are also unlikely to be the ones that could triple overnight – that should form the core of your portfolio.
If you’re investing amounts under $5,000, it’s probably better to buy the stocks in one hit. If, however, you have more to invest, consider ‘dollar cost averaging’ by buying some today and then adding to your position gradually over time.
As for what specific stocks to buy, stick to what you know. Before you invest, ask yourself if you could explain to a 10 year old what the company’s product or service is and how it makes money. When you’re just starting out, it’s best to stick to large high-quality companies (the ‘blue chips’). Leave the speculative miners, less established companies (‘small caps’) and biotechs for when you’re more experienced.
For a list of the stocks we believe are trading below their intrinsic value and offer the best potential for good returns, we currently have 21 recommendations on our Buy list.
To unlock Intelligent Investor stock research and buy recommendations, take out a 15-day free membership.