2013-04-17

ETFs: Investing With $100

The Excuse: Fund Minimums


"Fund minimums are too high - I can't afford that."  This is a very common excuse I hear when I ask my peers why, instruction manual in hand, they haven't started investing yet.

It's true: many mutual funds require minimal initial investments of thousands of dollars.  Most Vanguard index mutual funds require $3,000 to get started, and the lowest-minimum Vanguard Target Retirement funds still require $1,000.  After the initial investment, additional automatic investments can be as small as $50.  For this reason, I typically recommend budgeting to save that $1000 minimum over several months, making the initial investment, then setting up automatic monthly investments at whatever level you can afford.

If you'd like to get started immediately and you're willing to do a little extra manual work, there is another option that maintains the advantages of an index mutual fund -  low expense ratios and broad diversification - while allowing you to invest in $50-100 increments.


The Caveat: High-Interest Debt


If you have high-interest debt from credit cards or other unsecured loans, don't even think about investing.  Accelerating the pay-down of high-interest debt is a risk-free way to avoid throwing money away on loan interest.

At the same time: don't even think about new clothes that aren't absolutely necessary, that Starbucks latte, trips into the city to catch dinner and a movie, or cable television.  Downsize your living situation, your dining plans, your entertainment, and your hobbies.  Make a list of all of the memberships you have and cancel the ones you don't use enough.  Cut down on expensive travel arrangements and learn to adventure locally.  Get reacquainted with the library and the great outdoors.  Borrow instead of buying, buy in bulk, and buy used.

Sign up for Mint.com and track your spending, then use this information to create a budget with ambitious debt-reduction goals.  You must eliminate harmful debt before you can progress to saving and investing for your future.

If you're high-interest debt-free, read on!


The Solution: Exchange Traded Funds (ETFs)


The Exchange Traded Fund (ETF) is an investment vehicle, like a stock or a mutual fund.  ETFs have experienced massive gains in popularity over the last few years:

ETFs explode in popularity (1)
A standard ETF has structural similarities to an index mutual fund: they are financial instruments that hold a collection of stocks, bonds, and commodities, often designed to follow the market fairings of a particular geographic region, sector, or market capitalization.  In a mutual fund, the manager must buy and sell the individual securities held by the fund when investors buy and sell shares of the mutual fund; in an ETF, the underlying securities are bundled together and traded between investors like a stock.  This difference in 'capital structure', in financial parlance, is the source of the practical differences between ETFs and mutual funds.

The share price of many popular ETFs is between $50-100; Vanguard offers ETF versions of most of its index mutual funds with no transaction fees, so you can buy as little as one share at a time (2)!

Once you build up $1000 worth of ETFs, you can sell them and use the proceeds to make the initial investment in a Vanguard mutual fund.


Trading ETFs


To trade ETFs within an IRA, you will need to open up a brokerage account that is linked to a money market account in your IRA.  If you are opening an IRA for the first time, you can choose to open the linked brokerage account by clicking on the 'Stocks, Bonds, ETFs (brokerage account)' box on this screen:


If you already have an IRA, add a linked brokerage account by clicking 'Add a new brokerage account...' on this screen:

Once your account is set up, you can transfer in money from a bank account in whatever increments you'd like.

Consider these popular options:
You'll notice that, since ETFs trade in the middle of the day like stocks, you have the option of placing 'market', 'limit', 'stop', or 'stop limit' orders to buy or sell ETF shares.  For beginner's purposes, it's safe to buy and sell with simple market orders.  Learn how the other order types work, and you're on your way to becoming a day trader!


Why Not Use ETFs All The Time?


Because you can't purchase fractional shares of an ETF and because shares change in value, they don't support automatic investments.  If your goal is to set up a system that requires as little human intervention as possible, to ensure that your investment isn't subject to your whims and isn't dependent on 'finding time' to take care of it, then mutual funds have the advantage.

Have questions specific to your situation?  Comment or contact me!


(1) The Economist: Exchange Traded Funds - http://www.economist.com/node/18864254
(2) Vanguard ETFs - https://personal.vanguard.com/us/funds/etf/all