Brilliant Money Strategies: How to Invest on a Budget

Introduction to How to Invest on a Budget

Investing is one of the most important things you can do to set yourself up for a strong financial future. However, many people feel intimidated by investing. Some believe that investing is too confusing for them. Or that they are not wealthy enough to invest. Luckily, investing is much easier than many people think. Plus, you can get started investing with very little money! Indeed, you should start investing as early as you can to take the most advantage of investing’s benefits, even if it means investing a small amount each month.

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Want more convincing? Let’s say you invested $100 a month in a broad market index fund (I’ll discuss these below). We’ll also assume that fund returns 10% on average, which is in line with the past performance of the stock market. After 20 years, you would have invested $24,000. However, because of compounding, you would have earned $77,000! If you invested that money for 25 years it would be worth $134,000! So even small amounts really add up over time.

In the post, I’ll go over how to start investing on a budget. I’ll discuss what to invest in, how much to invest, and what to consider when opening an investment account. But first, what does it mean to invest?

What Does it Mean to Invest?

Many people believe that investing is like gambling. And while there are some very risky ways of investing, if you follow the recommendations of most financial advisors, investing in the stock market is one of the safest things you can do. 

There are a variety of different types of investment products. However, in general, an investment is when you put your money towards something you believe will increase in value over time. As a result, it will earn you money if you sell it later. The most popular things to invest in are physical assets like real estate, a single business, or a collection of businesses that are pooled together in a mutual fund, index fund, or exchange-traded fund (ETF). 

When you invest in a physical asset, you’re assuming that someone will pay more for it later than you bought it for. When you invest in a single business you’re assuming that business will do progressively better and earn more over time. And when you invest in a collection of businesses, you’re assuming that, on average, those businesses will do better over time. 

One of the main examples of a collection of business is the S&P500. The S&P500 includes the 500 largest businesses in the U.S. If you invest in the S&P500, you basically assume that the 500 largest businesses will, over time, do well. Given that the S&P500 updates itself as businesses grow and shrink, this is a much safer assumption than guessing that a single business will do well over time or that the house you bought will be worth more in a couple of years.

The Difference Between Investing and Speculating

So you can see that there are a range of types of investments. And many of these financial products are much safer than gambling. After all, real estate and businesses have and create value. Their worth is based on the value they produce or the use value they have. In many cases, we have good reasons to assume these things will increase in value over time. However, it’s important to note that there are some investments that are almost as risky as gambling.

For example, cryptocurrency, paintings, and collectibles largely do not have any use value. Their value is based on the level of demand people associate with them. And that level of demand is generally based on what people think other people believe about cryptocurrency and valuables like artwork, jewelry, or Beanie Babies. These are not safe investments because they don’t carry any real value.

In fact, they are not really considered investments. Rather, if you purchase these things you are speculating, rather than investing. If you want to buy cryptocurrency or a painting or the Princess Diana beanie baby, that’s totally fine. Just make sure you’re investing money you’re okay with losing because these assets do not reliably increase in value. For many budget investors, these kinds of speculations will not be the best option.

So to sum up, investing is putting your money towards something that has and produces value under the assumption that thing will increase in value over time. Speculating is putting your money into things whose value is based largely on demand and people’s perceptions.

What Should You Invest In?

So what should you invest in? There are lots of investment choices out there. If you want to invest on a budget, it can be hard to know what to focus your hard-earned money on. Luckily, there are a few standout investment choices.

Index Funds and ETFs: The Best Investment for Most Budget Investors

For most of us who invest on a budget, the best investment consists of index funds or exchange-traded funds (ETFs). Index funds and ETFs are pools of investments that fall into particular categories. For example, there are index funds and ETFs based on the S&P500, as mentioned above. There are also funds based on a collection of thousands of smaller businesses, such as the Russell 2000. Individual investors who are interested in technology might invest in index funds or ETFs based on the Dow Jones, a collection of technology companies.

Index funds and ETFs are great for your investment portfolio because they include shares from a large number of businesses. They’re therefore much more diversified and safer than investing in a single business, which can tank if, for example, the CEO has an indiscretion or a product gets recalled.

You can even invest in multiple index funds to further diversify your portfolio. You might invest in an index fund based on the S&P500, an index fund based on emerging markets, and an index fund based on small businesses to ensure you’re invested in a wide variety of businesses that are influenced by very different things.

Plus, index funds and ETFs have great long-term returns. Since 1957, the S&P500 has returned about 10% per year. That means, based on past performance, if you invest $1,000 in an S&P500 index fund, you’ll earn, on average $100 in your first year, $110 in your second year, $131 in your third year, and so on. 

Mutual Funds: Index Funds’ More Expensive Counterpart

Mutual funds are similar to index funds and ETFs. They are pools of investments from different businesses. But they come with higher fees than index funds or ETFs. Plus, on average, they don’t have higher returns. Consequently, financial experts largely don’t recommend them anymore and they are not as good of an option for those who invest on a budget.

Fixed-Income Assets: A Good, Safe Investment… For Now

Fixed-income assets come with a super low level of risk. But they generally pay for that in terms of a low rate of return. Nevertheless, if you want to use your money soon (like in the next 5 years), they’re a great option for growing your money while making sure it’s there when you need it. If you want to invest in a fixed-income asset, you might invest in a bond, money market account, certificate of deposit (CD), or high-yield savings account (HYSA).

Because interest rates are so high as of this writing (November 2023), fixed-income assets can earn about 5% a year. That’s a pretty great interest rate for not much risk. Keep in mind though that in the long run, these kinds of investments have generally earned less than 2% a year and don’t keep up with inflation. As a result, they’re not a great long-term investment. However, for budget investors they’re a nice, safe option for saving money you’ll want in the next 5 years.

What About Individual Companies?

Last, but not least, you can invest in individual stocks (i.e. individual companies). As mentioned above, this is a risky strategy. Unless you have a higher risk tolerance, you likely want to avoid this strategy. Moreover, if you invest in individual stocks, you should only invest play money that you are okay with losing. For many people who invest on a budget, this will not be a great option.

How Much Should You Invest?

Financial experts generally recommend that you invest about 10-15% of your take-home pay for retirement. If you are hoping to invest for other financial goals, you should ideally invest more. And if you are starting to invest in your 40s or later, you may want to invest more to catch up. Investing less than 10% increases the chance that you will not have enough money for retirement and may have to work into your later 60s and beyond.

If you’re on a budget, this may sound like a lot of money. However, there’s a good chance you’re investing already if you have retirement savings. Indeed, retirement accounts such as a Roth IRA, traditional IRA, or 401K all count as long-term investments. Plus, you can include any employer match in that 10-15% goal. For example, if you contribute 5% to a 401K and your employer contributes 5%, you’ve hit that 10% investing target.

If you’re nowhere near close to investing 10-15% of your take-home pay, try investing a small amount of money each month. You might start by investing $25 monthly and increase that contribution by $25 each month. You can check out this post on making $50 fast if you want ideas for how to boost your income.

If you have that amount automatically deducted from your bank account monthly, you’ll be less likely to miss it. Setting up automatic investing is a good way of getting yourself in the habit of investing and ensuring that your investments are built into your monthly budget.

Where Should You Invest?

For most people, especially budget investors, investing in an employer-sponsored retirement plan or individual retirement account will be an ideal option. As mentioned above, you should aim to save 10-15% of your income for retirement. Many people, especially those on a budget, will find it difficult to invest more. 

Plus, you can invest in tax-deferred accounts like a traditional IRA or 401K where you don’t have to pay taxes on the money until you withdraw it. Alternatively, you can invest in retirement accounts like Roth IRAs where you pay the tax first and don’t have to pay any tax later. None of these accounts require you to pay capital gains. So they are a great option for avoiding additional taxes and fees.

If you’re confused about where to start, financial advisors frequently recommend that you start by contributing to your 401K up to the employer match. Once you’ve done this, max out your Roth IRA. After that, max out your 401K. If you have money left over, you might consider contributing to an individual (non-retirement) investment account, a health savings account (HSA), or an annuity.

How Often Should You Invest?

There are two ways of investing, you can invest your money as a large lump sum when it’s available or you can invest small amounts on a regular basis, such as monthly or biweekly. For many people, the latter will be the better option. 

The advantage of the latter option is that you can do what’s called dollar-cost averaging. Specifically, no one can perfectly time when the market will go up or down. By investing regularly each month, you smooth out the chance you’ll invest all your money right before a downturn. In some months you’ll invest and your money will go up the next day, in some months it will go down, and in others, it will stay the same. However, it will average out to generally improve over time. As mentioned above, setting up automatic monthly investing is an easy way of forcing yourself to get into this habit.

However, some people find it easier to invest a lump sum if, for example, they get a large chunk of money from tax returns or bonuses. The right answer to how often to invest will be based on your investment goals and financial situation.

What to Consider When Opening a Brokerage Account

So now you know you should aim to invest 10-15% of your income in a diversified set of investments, which likely include index funds or ETFs. You should also focus on retirement investment vehicles like IRAs or 401Ks. If you don’t have any of these accounts yet or if you want to open a brokerage account, you’ll need to consider which financial institution to open an account with. To inform this decision, you should consider a few things:

1. Do you bank with a company that offers brokerage accounts? 

If you already bank with a company that offers investment accounts, investing with that bank will likely be the easiest option for getting started as you can often simply transfer money from your checking or savings account to an investment account.

2. Does the company offer fractional shares? 

You might want to invest with a company that offers fractional shares. That means you can buy partial shares of investments and won’t be shut out of buying higher-cost investments.

3. Does the financial institution you’re considering offer all of the investment products and types of investment accounts you want? 

For example, if you want to invest in broad market index funds, emerging market index funds, and certificates of deposit (CDs), you’ll want to find a financial institution that offers high-quality products in all these areas. Vanguard, Charles Schwab, and Fidelity are usually great options.

4. Do they offer low-cost financial advice on your investment decisions or robo-advisors?

Seeking the advice of a financial advisor or having a robo-advisor develop your investment plan is a great way of feeling more confident in your investing decisions. If you think you’ll want to seek out these services, make sure your financial institution offers high-quality, relatively low-cost advice.

Ideally, you should seek out certified financial planners (CFPs) that charge a flat rate rather than a percentage of your returns, which very quickly eats into your earnings over time. CFPs are also charged to work in the interest of the investor so you’ll have a lower chance that they’ll try to scam you into buying products that are not in your best interest.

5. Is their online fund platform user-friendly? 

If their website is hard to use, you’re not going to be as likely to regularly invest. So this can be an important thing to review.

6. Do they have low fees? 

Make sure you’re not being charged a lot of hidden fees for your financial institution’s services.

Your next step is to actually open a brokerage account. You can find step by step instructions for opening an investment account, also called a brokerage account, at Department of Adulting. 

Other Considerations for Investing on a Budget

Investing for your future is arguably the best way of meeting your long-term goals. Indeed, investing in the stock market has historically been the only way of reliably beating inflation over time. However, before you start investing, there are a few things you should address.

First, make sure you have little to no high-interest debt. On average, the stock market returns 10% a year. However, if you pay more than that in credit card interest, any money you earn from the stock market will be undone. Plus, interest payments can quickly eat into your budget. So address credit card debt and other high interest debt first.

Second, if you don’t have an emergency fund, you should work to establish one. An emergency fund will help protect you against unforeseen circumstances like car repairs or medical bills. If you don’t have an emergency fund, these financial emergencies can force you to take out high interest debt and wreck your budget and spending plan.

You should aim to save 2 months of bare-bones living expenses in an emergency fund. If you don’t have one, you can start by saving $500 and work up from there. Save the money in a high-yield savings account (HYSA) so that it earns more interest than in a regular savings account and is still easily accessible.

Last, investing in the stock market should not be used for short-term savings goals that are less than 5 years away. In the long-term, the stock market has yielded reliable returns. However, it frequently goes both up and down in the short term.

Final Thoughts on How to Invest on a Budget

Many people believe that investing is complicated and requires a lot of money. The good news is that you can get started investing with even small amounts of money. Plus, the best investment options are generally the simplest. So what should you invest in and how much should you invest if you’re on a budget?

The short answer is that your investment strategy should be based on your long-term goals. A financial advisor or even robo advisor can help you evaluate these. For most people, a good rule of thumb will be to aim to invest 10-15% of their take home pay on a monthly basis in safe, diversified investments such as index funds and ETFs based on a broad swath of businesses and industries. If you don’t have much money to invest, start with small amounts and build up from there.

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Financial security is closer than you think. And investing safely and responsibly can help get you there. You can check out the other money saving posts on Frugal Nook for more ideas on how to save and budget your money for financial security.

In closing, remember that I am not a financial advisor. This information is solely provided for informational and entertainment purposes. Before making any financial decisions, speak with a certified financial planner about their investment advice.

About the Guest Author

This is a blog post by guest author, Christine Leibbrand, of Department of Adulting – a blog giving 20 to 30 year olds fun, well-researched, informed articles on things that are actually important to life. She writes about personal finance, fitness, mental health and other great topics to help and give guidance to others from what she has learned and experienced in life so far. Christine has a Master’s and PhD in Sociology, with specialties in Demography and Statistics and currently works as a Policy Development Analyst for the University of Washington.

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