How much money do you need to start investing?
Ask any financial advisor how much money you need to start investing and the standard answer is usually $5,000 - sometimes $10,000 or even $20,000.
The reason is simple: from a financial perspective, those amounts make perfect sense. Every time you buy and sell a stock, you'll lose money in brokerage expenses, which usually run at $10-30 per trade before switching to a percentage for larger trades. So let's assume you lose $40 in transaction fees on each new investment. If you bought $500 worth of stock and sold it the following year, you would need an 8% capital gain just to break even. On small sums, brokerage takes a meaningful bite out of your return.
On top of this, your financial advisor is probably thinking about risk. Stocks are volatile and one of the fundamental mantras you should be reciting to yourself before you go to sleep each night is 'don't put all your eggs in one basket'. Spreading your money across 10-20 stocks reduces the odds that poor performance from any individual holding will do much damage to your portfolio. It's especially hard to get adequate diversification with small sums, because the more stocks you buy, the more brokerage fees will bite into your return.
If you want to minimise fees and risk, stick to the standard advice of waiting until you have at least $5,000 before taking the plunge.
Another way to look at it
Investing isn't only about managing risk and minimising fees, though. What causes most investors to fail is their own psychology. You need to be prepared for biases like anchoring, commitment bias, a fear of missing out and confirmation bias.
Mark Twain observed that 'a man who carries a cat by the tail learns something he can learn in no other way'. You can play the ASX Sharemarket Game all you like, but nothing will test your true emotional response when a stock moves against you until you have actual money on the line. And stocks will move against you; it's inevitable.
What's more, there's a language to investing. In a 2015 survey of Australia's financial literacy, people were asked about 'diversification' as an investing principle. Some 60% of the 4,100 respondents ticked 'I haven't heard of this' or 'I have heard of this but don't really understand it'. What must the response rate be for more advanced topics like price-earnings ratios, franking credits, or tax loss harvesting?
Taking the plunge only after you've painstakingly saved $5,000-10,000 is like moving to Spain and only then starting to work on your vocabulary. Sure, it might work, but you'll probably avoid a lot of clumsiness if you take a few Spanish lessons first.
So you might do better to think of your first bit of capital as an education expense. Once you've paid off your credit card and put enough cash away for emergencies, you're ready to start investing. Almost no amount is too small. I'm all for starting young with $500 - the ASX's 'minimum marketable parcel' - rather than saving for a larger portfolio.
You'll lose a chunk of your return to fees and the volatility will be extreme. You might even blow up the whole $500 by investing in a dud stock. But making mistakes when you only have $500 at risk is better than a $10,000 'learning experience' later on. You'll also get to know the language of investing sooner, which means you'll be better prepared when you have larger sums to invest - and a longer runway to let compounding work its magic.
Free trial offer: nabtrade customers are invited to take up a 15-day free trial to InvestSMART Premium.