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How Much Is Needed to Start Investing?

by Charles Rotblut, CFA

How Much Is Needed To Start Investing? Splash image

What is the minimum dollar amount needed to start investing? It is a question some members ask us and likely one that many others have, especially those who are new to investing.

Technically, you are only limited by the minimum amount required by a brokerage firm or mutual fund company to open an account. ShareBuilder, an online broker, has no required minimum account balance. More than 50 mutual funds included in our annual mutual fund guide have minimum purchase requirements of $100 or less, including funds offered by Fidelity, AssetMark, USAA and Oakmark.

Pragmatically, you should weigh the dollar amount you have available to invest against the actual costs of creating a diversified portfolio. Brokerage commissions for buying and selling stocks and exchange-traded funds (ETFs) increase significantly on a percentage basis as the dollar amount invested decreases. Mutual funds, conversely, charge a flat percentage fee. Commission-free ETFs, which are offered by some brokerage firms (including Charles Schwab, Fidelity and TD Ameritrade) are even more advantageous from a cost standpoint.

Stocks and Brokerage Commissions

Most online brokerage firms charge between $7 and $10 per trade. Though this does not sound like much, commissions can have a big impact on small accounts. For example, say you have $1,000 to invest in a single stock. Your buy and sell orders will each cost you $10, resulting in a transaction cost of $20. This equates to a 2% reduction in your actual returns. Once you start factoring in the costs, your profit may very well not justify the risk of trying to pick an individual stock, if you are investing a small amount in a taxable account.

If you have a larger sum of money, brokerage commissions quickly decline as a percentage of your investments. For instance, $10 to buy and sell equates to only 0.1% of a $10,000 investment. This “economy of scale” boosts your realized returns.

Beyond the costs of buying a single stock, you need to consider how many stocks you can actually buy. Studies suggest a minimum of 15 to 20 securities are required to build a diversified portfolio. Buying fewer, especially less than 10, increases the risk that a sharp decline in a single stock will significantly hurt your returns.

Mutual Fund Advantages

An alternative to buying individual stocks is to invest in a mutual fund. A no-load mutual fund does not charge you any money for buying or selling your shares from an account held with the mutual fund family. Rather, it charges a flat expense ratio. The amount charged varies, but the average domestic large-cap fund charges 1% annually.

The bigger advantage a mutual fund gives you is instant diversification. Rather than spending a lot of money on commissions for 15 or 20 stocks, you could get exposure to several hundred stocks for a flat fee.

ETFs Are Even Cheaper

The cheapest option is use a commission-free ETF. If you use a brokerage firm that waives the commission, you will incur no transaction costs. (Taxes may still be owed on realized capital gains or distributions, however.) The expense ratios are also lower than mutual funds, with some ETFs charging 0.1% or less.

There are three caveats, however. The first is that you will have to meet the minimum account balance required to open a brokerage account. The second is that the selection of commission-free ETFs is limited and, from a performance and strategy standpoint, you may be better off paying commissions to get the ETF you want. Three, both ETF and mutual fund capital gains and distributions can be subject to taxes, which hurts your realized returns. (You will not incur taxes on capital gains or dividends from for funds and stocks held in a tax-deferred account, such as an IRA. Taxes are due when a distribution is made from a traditional IRA account.)

—Charles Rotblut, CFA, Editor, AAII Journal

Charles Rotblut, CFA is a vice president at AAII and editor of the AAII Journal. Follow him on Twitter at twitter.com/CharlesRAAII.


Discussion

H from TX posted over 3 years ago:

You editors of these financial info pieces should STOP saying that tax deferred means NO taxes incurred as you did in the last sentence. I have read this over and over in various info articles and it is NOT correct. You will pay the taxes, just not annually, you wait until you take distributions; but you will pay taxes on tax deferred accounts such as IRA at some point. To DEFER is to DELAY or POSTPONE not eliminate!


Charles Rotblut from IL posted over 3 years ago:

To clarify, there are no capital gains taxes incurred when a profit is realized on a position held in an IRA. Taxes are owed, however, at the time a withdrawal is made from a traditional IRA.


Benjamin from MO posted over 3 years ago:

I have a question.Regarding having a limited amount of money to invest.Is it a good idea to buy a few shares of cheaper costing stocks initially and make additional purchases of those stocks as your money permits?


Charles from IL posted over 3 years ago:

Benjamin - The price of the stock does not matter. If you invest $10,000 into a stock trading at $5 or a stock trading at $100, your gain will still be the same. A 10% rise in either stock will give you $1,000 in unrealized gains (profits you have not realized because you have yet to sell the stock). So, find the best stock, regardless of its per share price. - Charles Rotblut


John from NJ posted over 2 years ago:

A financial adviser at my local bank(where I have my checking, etc) is strongly suggesting I buy a Mutual fund(bonds) that has a front load of 4.5%.
Is there any good reason to buy a fund with a front load? Do bank financial advisers or the bank get some of this load? John


Charles from IL posted over 2 years ago:

John-The front load means you will lose 4.5% of your investment right from the start. This means fund will have to generate a positive return of 4.71% just to get you back to break-even, and then, the fund will have to produce an additional positive return to either meet or beat its comparable index (e.g., the S&P 500). -Charles Rotblut, AAII


Elliot from NY posted over 2 years ago:

so technically speaking, if its a roth ira no taxes are owned at withdrawl..?


aku from OH posted over 2 years ago:

Elliot - Roth IRA no tax after you withdraw after age 59.5, anything prior to this would cost you a 10% penalty. However you can withdraw the principal contribution anytime you wish.
In traditional IRA you can not even withdraw principal because you already took the tax deductions.


Paul from CA posted 11 months ago:

Is there any disadvantage from transferring a 457(b) to a IRA or RothIRA, other than paying taxes if converted to a Roth? I am looking for greater flexibility as I can only invest in a list of 50, mostly subpar mutual funds currently. I have separated from the employer and can rollover at any time.


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