A common misconception among people when they are getting started in investing is that they need a big sum of money in order to get started.
While it is possible to get started with limited funds, the main problem with investing a small amount of capital is that it can be difficult to diversify adequately. Investing is like anything else, you never want to put all your eggs in one basket, so even though beginner investors often get started with a small sum, it is still important to try to get diversified if possible.
Another problem with investing small amounts of capital is that you have less room for error. If you have $2,000 to play with, you really need to make sure that you choose a smart place to invest your money. It is hard enough to invest $2,000 to begin with, you definitely do not want to lose money or your first investment and have to try again with an even smaller amount.
If you are a beginning investor, or someone who has had a sudden windfall looking to put that money to work, keep reading. We are going to take a look at five different ways you can put your $2,000 to work in a way that not only minimizes your risk, but also target a nice return on your money.
1. Boost your retirement plan contributions
If you are not already maxing out your 401k or IRA, then consider using your extra money to do so before making any other investments. There are several reasons to convince you that this is a great place to put a little extra cash if you are not already maxed out.
For one, the amount you put into a 401k or tax-deferred retirement account reduces your pre-tax income, so you are basically getting tax-free money. Anytime you can get something tax-free you should consider it.
If you can adjust the payroll deductions that feed into your retirement account and contribute the extra $2,000 that way, your employer may match your contribution, instantly doubling your money.
Do not pass up the opportunity to max out your annual 401k contributions if you can help it, and it is the perfect place to start if you are not hitting your maximum contribution level already.
2. Index ETFs
Index exchange traded funds are great for beginner investors for two main reasons. The primary advantage of index funds is that they allow you to diversify over a wide basket of stocks with one single investment. The second, and more important advantage for our discussion is that you can get started with limited funds.
Index exchange-traded-funds, or ETFs, function like a regular stock. They are priced throughout the day, and you can get in and out of the funds at any time you need access to the cash. However, you should be aware that each time you buy or sell an index fund you are going to incur brokerage fees, so you want to be careful not to trade them too often or else commissions could really start to eat away at your returns.
I like index funds because they allow you great diversification, and take a lot of the homework out of the process. You simply decide that you are willing to accept the return that the overall market gets, and go with it. These are best suited for investors that are willing to get in and sit on an investment for a log time while the market does its thing. The market can be rocky, but the long-term trend is always higher. In most cases, you will not see any huge gains since the entire market rarely makes a huge leap, the other side of this coin is that you are also unlikely to see a big drop, since the entire market rarely moves sharply lower.
3. Mutual funds
Mutual funds are similar to the index exchange-traded funds mentioned earlier in that a single investment provides diversification over a basket of stocks. Unlike index funds, some mutual funds are comprised of stocks that are handpicked by investment professionals that keep a constant watch over the holdings of the fund.
There are some mutual funds that require more than $2,000 to open an account, but there are plenty of options for investors with a smaller starting amount.
What I like most about mutual funds is that you have professionals that constantly watch the fund and shuffle the holdings. But with this professional management, there are going to be fees. Be sure to find out what the annual fees are for funds that you consider, and if you are torn between different funds, go with the one with the lower fees.
The biggest downside to mutual funds is that you are not able to trade them during the day. They are priced at the end of each trading session, and given a net asset value, or NAV. Until the next day's closing bell, that NAV is the price for the mutual fund. This is because it becomes impossible for pricing services to keep real-time information on the fund because it holds so many different stocks.
Going the mutual fund route is fine, but be careful not to overdo it with mutual funds. Funds often hold the same securities, so investing in too many funds can result in duplicate investments. If you want to hold multiple mutual funds, make sure pick funds that don't have a lot of overlap so you don't get overexposed to a particular stock or sector.
4. Buy solid, dividend-paying stocks
A great way to start trading is with a solid dividend paying stock. Not only should you look for stocks that pay nice dividends (3%+), but also narrow your universe of stocks to those which have long histories of increasing their dividends year after year. These are typically stronger companies, and their consistent dividend payments will always attract investors.
If you are starting off with just $2,000, your options are going to be limited, but you should be able to establish reasonably sized positions in at least two stocks. Since you are buying just two stocks, you want to make sure that you pick companies in different industries.
With interest rates currently so low, dividend stocks have been a popular investment for traders looking for yield. While interest rates are expected to rise as the economy improves, dividend stocks will remain a favorite investment for many.
Solid companies like Coca-Cola (KO) and Johnson & Johnson (JNJ) are well-established industry leaders. Both companies have also raised their dividends for 50 years in a row.
5. Pay down debt
While paying down your debt may not sound like an investment vehicle, it really is. This is particularly true if you have debt that carries a high interest rate, like credit card or other short-term or revolving debt.
Assume for a second that you owe $2,000 on a credit card with a 14.9% annual interest rate. That translates to $280 a year in interest alone. You have to ask yourself if you are better off paying 14.9% on a credit card or trying to earn 14.9% in the market.
In most cases, you are better off paying down your debt. Even the most experienced and educated investors often fall short of earning 14.9% on their money in a year, so you are most likely better off paying down your debt. If you can make 10% on your investments, while at the same time paying 14.9% on your debt, you are still coming out on the losing end of things.
