You don’t have to be rich to invest: How to invest with little money

If you’re interested in investing but not sure you have enough money to make it “worth it,” you’re not alone. Many new investors feel the same.

The good news: While it may have been true years ago that you needed hundreds or even thousands of dollars to begin investing, it’s simply not the case anymore. Waiting until you’re flush with cash to invest can limit your ability to build wealth.

Even if you don’t have a lot of cash now, there are plenty of ways to invest with little money. Here’s what to know.

Time in the market is very important when it comes to investing, thanks to a concept called compounding. Essentially, compounding means that you earn new returns on the gains you've previously made.

To demonstrate with a hypothetical example—excluding any taxes and fees that might apply to a real account to demonstrate the pure mathematical concept of compounding and not predicting any performance—let's say you invest $1,000 (that's your principal) and in one year, the account gains 5%. Your portfolio is now worth $1,050. Heading into year two, you now have the potential to earn returns on that larger sum. It may not seem like much at first, but over time compounding can make a big difference.

Keeping your gains invested, and re-investing payments you might receive such as interest on bonds or dividends from stocks, can also slowly help you build your portfolio’s value.

Just as you might have an automated savings plan for retirement or emergency savings, you can also set up recurring deposits to your brokerage account. You can choose how often and how much to transfer so it works for your budget. This will allow you to help build up your brokerage account at a pace that works for your finances.

There are a lot of investment vehicles to choose from. Here are a few ways to start investing with a little money.

Exchange-traded funds (ETF) or mutual funds:

• Built-in diversification: Mutual funds and ETFs are baskets of individual stocks, bonds, or other assets. When you buy a share of a fund, you get some built-in diversification since you’re invested in many companies, potentially in several different industries. This means you’re not as vulnerable to loss if a single company or industry takes a hit. 
• Affordability: ETFs sell by the share, and some start as low as $20. E*TRADE offers ETF fractional shares, through Automatic Investing with a minimum of only $25. Mutual funds may not be quite as affordable; they may require a minimum dollar amount, such as $100 or $1,000, to purchase a set number of shares based on that day’s share price. But, some have a $0 minimum.
• Commission-free: Commissions are service fees charged by some brokerage firms each time you buy or sell shares. ETFs and mutuals funds are commission-free at E*TRADE from Morgan Stanley.¹

Index funds:

• Mirror the market: Index funds are passively managed ETFs or mutual funds that aim to mirror the performance of a specific market index, such as the S&P 500. Investors can typically expect a return like that of the index. Actively managed ETFs and mutual funds, on the other hand, try to outperform the benchmark returns of a specific market index.
• Diversification: With one purchase, your portfolio can gain exposure to a wide swath of companies. For instance, one share of an index fund based on the S&P 500 provides exposure to all 500 stocks in the index.
• Index funds also have lower expense ratios, also known as fees charged by some fund managers, expressed as a percentage of its total assets under management (AUM). Due to index funds’ largely passive nature, they tend to have lower expense ratios than ETFs or mutual funds that are actively managed (though most ETFs are passively managed) making them lower-cost investments.
• You can’t invest directly in a market index, but you can invest indirectly by buying shares of funds that seek to mimic the performance of indexes like the S&P 500 Index, the Russell 2000 Index, and the Nasdaq 100. The Bloomberg U.S. Aggregate Bond Index is the benchmark index for the U.S. bond market and includes Treasury bonds, municipal bonds, and even taxable corporate bonds. Note that several brokers offer index funds that track the same market index, but they may use different approaches, leading to variations in performance.
• Use E*TRADE’s ETF screener to search for index funds under “fund characteristics.” Clicking on the fund name for a specific fund will display what investment strategy the fund seeks to adopt. 

Always carefully read a mutual fund, ETF, or index fund’s prospectus before buying shares. Pay special attention to:

• A fund’s objectives
• Its historical performance
• Any fees you might have to pay

If you’re looking to fund your account, and subsequently end up comparing two funds that have the same historical returns, it’s important to note that the fund with the lower total cost will generally produce a higher final return.

The bottom line is that knowing how to invest with little money can be empowering, and there are several ways to get started. Be sure to keep in mind your individual risk tolerance, financial goals, and timelines ahead of diving in.