Gather Little by Little

Last week, I discussed why I really like index mutual funds. Some readers might prefer to trade ETFs (Exchange Traded Fund) directly, in order to replicate stock market indices with lower fees. However, there are 2 major inconveniences with ETFs when you are investing smaller amounts (i.e. less than $10,000):

#1 You are limited in your trades due to your small amount (you shouldn’t buy 5 or 6 ETFs with 10K)

#2 Transaction fees will eat up a lot of your yield (if you buy an ETF with $3,000 and you buying cost is $10 and your selling cost is $10, this represents close to 1% already).

This is why I prefer index mutual funds since they don’t carry transaction fees AND they allow for preauthorized systematic investments too.

Why Setting Up a preauthorized Investment plan?

If you have $10,000 or less to invest, this probably means that you are accumulating for retirement and that you have several years to prepare. Therefore, it is important to setup an automatic investment plan in order to participate in the stock market as soon as possible.

#1 Pay Yourself First

When it comes down to investing their savings, most people wait until a specific time of the year (the beginning or the end of the year in most cases) and drop a bigger amount into their retirement savings account. They prefer to do so since they think they can’t do much with $100 at a time. Yet they are wrong.

With any type of mutual fund, they can set an automatic preauthorized investment payment plan for as little as $25 per month (depending on the mutual fund). The most important advantage of this strategy is that it ensures that the amount you want to put aside for retirement is actually working for you.

Once it is taken from your account (or pay check) on a bi-weekly or monthly basis, you don’t have to think about putting money aside. You simply live with a different level of disposable income and your Roth IRA is growing without any pain.

Paying yourself first is definitely the best way to ensure a comfortable retirement. Look your Roth IRA contribution like a debt payment and you are your most important creditor (you owe it to yourself and your future!)  We have all heard how no one else is going to look after us financially.

#2 Dollar Cost Averaging

While this is not a major advantage, being able to enter in the market gradually as it goes up or as it goes down still averages a greater yield in your portfolio than attempts to time the markets.

Instead of trying to time the market and buy shares at their lowest, you continuously invest no matter what happens. Therefore, you are not always buying at the lowest price, but you are not always buying at the highest price either.

Therefore, you are averaging the cost of your shares. This will help smooth your investment statement balance from quarter to quarter. While the stock markets drop, you will keep buying more mutual fund shares at lower prices which will bring your overall balance higher. Remember the all important strategy to buy low! This won’t make you make more money immediately, but you will have more shares in the markets when it goes up again. Therefore, you will be in a better position to recuperate your losses.

Final Thought

I think what I appreciate the most about systematic investment plans is the fact that you don’t feel it after the initial few months. You struggle a bit during the first pay checks since you were used to spending it all and there is less to spend now that you have decided to take care of your retirement.

However, after a few weeks, you get used to your “new” disposable income and you find a way to live with it. Next time you get a raise in salary, you just have to increase your investment contribution with the same percentage so you can benefit from a part of your raise and add more money to your retirement savings account.

Author: Mike.