Sat. Jan 28th, 2023

Pros, Cons of Investing Small Amounts

Big investments may lead to big returns but there’s a case to be made for investing on a smaller scale.

“New apps that use your spare change to save are a financial lifesaver for those who are drowning when it comes to investing and saving,” says Tiffany Welka, a financial advisor and accredited wealth management advisor at VFG Associates.

“These types of apps cancel out any excuse that you need a ton of money to start investing,” she says.

Companies such as Acorns, Robinhood and Stash make it possible to build a portfolio incrementally by investing small amounts. Acorns, for example, links to an investor’s checking account. The app then rounds up purchases and invests the difference. So spending $25.49 at the grocery store would result in a round-up amount of $0.51 to be invested.

Investors may have their choice of preset portfolios they can invest in, which often contain a mix of low-cost exchange-traded funds, or ETFs. These are mutual funds that trade on an exchange like a stock. Robinhood and Stash allow investors to choose from individual stocks and ETFs.

Robinhood has no minimum balance requirement. Acorns and Stash require a $5 initial investment. Robinhood trades are commission-free, making it suited for low-fee investing and comparable to many brokerage account options that charge $0 commission fees. Acorns and Stash have monthly fees as low as $1.[ 

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These and similar platforms aim to simplify investing money for beginners.

People typically invest based on what they can afford, says Nicholas LaMaina, senior vice president, head of product management and strategy at TradeStation. Making small investments may be a good option for those who don’t have in-depth knowledge of investing or don’t have much money to commit to the stock market.

“Because of this, these apps can serve a very important role in the industry in introducing the basics of investing to a large number of people,” LaMaina says.

But just how effective is micro-investing when it comes to big returns? And are these apps good ways to invest a little money from a cost perspective?

Here’s how the pros, cons of investing small amounts measure up.

  • Pro: Encourages consistent investing.
  • Con: It may not be enough to meet retirement goals.
  • Pro: Easy introduction to the stock market.
  • Con: Diversification may be limited.

Pro: Encourages Consistent Investing

Time is one of the most important assets an investor can have. When paired with regular investment contributions, investors can benefit greatly from the power of compounding interest.

Apps and online investment platforms that automate small investments can help instill the investing habit, says Jeffrey Corliss, managing director, partner at RDM Financial Group at HighTower.

“It can be a forced saving, so that people do not have to think about it,” he says.

Once an investing routine is established, it can pave the way to investing larger amounts of money.

“You always have to start somewhere,” Welka says. “Usually, over time, when you realize how much you were able to invest with just a small contribution, you want to start saving more.”

Investing automatically with smaller amounts of money can also speak to an inherent bias that may cloud investment decision-making.

“One of the biggest behavioral biases that humans succumb to is the one toward immediate gratification over delayed gratification,” says Robert Johnson, a professor of finance at the Heider College of Business at Creighton University.

“It’s very difficult for many people to imagine their future self and giving up that vacation or new car today in lieu of having money to retire on in the distant future,” he says.

Automating can help overcome that, Johnson says. Even when it involves smaller amounts, it can be one of the best ways to invest for someone who struggles with prioritizing short- and long-term financial goals.[ 

READ: 8 Best Investing Podcasts Investors Should Know About. ]

Con: It May Not Be Enough to Meet Retirement Goals

Using a micro-investing app or purchasing fractional shares of stock can help get the ball rolling on wealth building. But an investor who relies solely on those avenues may find themselves short-changed when it comes to creating a secure retirement.

“It’s important to understand how much you need to save to meet future spending goals,” says Michael Finke, professor of wealth management at The American College of Financial Services. “A goal like retirement is going to require much more than spare change with today’s interest rates and expensive stock prices.”

For beginning investors, there’s often a simple solution for filling the gap: contributing to an employer’s sponsored retirement plan.

Employer-sponsored plans such as a 401(k), allow for automated investing on a tax-advantaged basis. When an employer offers a matching contribution, that’s essentially free money that shouldn’t be passed up.

“A one-for-one match is like earning an immediate 100% return on investments,” Finke says. “These automatic investments in 401(k)s are often highly efficient target-date funds whose expenses are even lower than those offered in micro-investing apps.”

Micro-investment apps can lull investors in a false sense of security about what they can realistically achieve. Investing small amounts of money through the app should be a supplement to, not a substitute for, contributing to a 401(k) or an individual retirement account, Johnson says.

Pro: Easy Introduction to the Stock Market

The stock market is like a buffet and investors have numerous options for filling up their plates. While variety has its merits, it can be overwhelming for the beginner investor who’s still trying to determine makes a stock different from a mutual fund. For example, bigger fund companies may offer hundreds or thousands of options to sort through.

Corliss says ETFs can be a good low-cost entry point for those just getting started in the stock market. “You’re able to select various ETFs that give you exposure to a broad index that may have hundreds of companies within it.”[ 

SEE: 7 Types of Popular Investment Portfolios. ]

That can be helpful for the individual who is still unsure of their risk tolerance or doesn’t understand their risk capacity. The former means how much risk an investor is comfortable with; the latter refers to how much risk is necessary to reach investment goals.

One thing to keep in mind, however, is cost.

“Especially when you have a small investment balance, fees can be even more impactful, eating into your balance quickly,” LaMaina says.

With many online brokerages moving toward commission-free trading, investing small through a passive investing app that charges trading or monthly account fees may lose some appeal.

Con: Diversification May Be Limited

Investors need to understand what investing with spare change or in small amounts can and can’t do for them.

“Passive micro-investing, while simple and convenient, can only take you so far,” LaMaina says. “If your objective is to have more control over your investment options and risk appetite to yield higher returns, you may quickly outgrow the services offered by many of these micro-investing apps.”

Opting for an online brokerage instead may open up new opportunities to invest money beyond stocks or ETFs.

For example, many digital investing platforms include traditional mutual funds, index funds, bonds, options, foreign currency, futures and hedge funds in the investment mix. While moving away from low-risk investments into higher-risk ones could up the potential for losses, it can also increase the potential for returns.

Bottom line, having a greater variety of investments to choose from can increase diversification, which is important whether you have a lot of money to invest or a little.

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