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Investing
Small Amounts
by Gary Foreman
Dear
Gary,
I am
55 years old and will begin receiving a small pension from one of my old jobs.
The amount will be only $55 per month until I die. What would be the smartest
thing to do with it? Pay down credit card debt, invest it, sock it away in the
bank as a rainy day fund? I lost 85% of my portfolio when the stock market
tanked and have very little left for retirement, so I'm afraid to get back into
mutual funds. Does anything else look good these days?
Erica, Sioux Falls SD
Erica has a good opportunity. While $55 a month isn't a huge
amount of money, it can add up. For instance if Erica manages to save the money
and earn just 2% it will be worth $7,300 when she's 65. Or if she manages to
earn 10% it will be worth over $11,250 in ten years. So it's important to get a
good return on the money and not let it disappear each month.
She should consider two factors in making a decision. Her time
frame and ability to take risks with the money.
Erica's goal will determine her time frame. If she wants to save
for retirement, she'll have a ten year horizon. However, if she wants the money
ready for the next budget crunch, she'll need to think in terms of having the
money readily available.
If she takes a longer view she'll be able to choose a riskier
investment without actually taking on more risk. Let me explain. A stock mutual
fund is unpredictable in any single year. You wouldn't choose the mutual fund if
you wanted to make sure that you could get all of your original investment out
at any time you wanted.
On the other hand, a money fund is very predictable. Your
principal is always available.
But suppose that Erica's horizon is ten years. The mutual fund
becomes much more predictable. That's because ten years is long enough for good
years to overcome any bad years. And the mutual fund will average a higher
return than the money market fund over a ten year period.
Erica's willingness to take risk is also a consideration. Some
people can't handle a mutual fund loss. Even if past results suggested that it
would only be temporary. As a rule no investment should cause you to lose sleep.
If you are not comfortable with an investment you shouldn't make it.
Now that we've set a framework, let's look at some of Erica's
ideas. Using the money to pay off credit cards could be her best option. First,
she has access to the money any time she wants. Paying down her balance will
leave more credit available for new charges.
The other advantage of paying off credit cards is knowing
exactly how much she's earning. Erica will earn the interest rate of the loan
that being paid off. So a credit card that charges you 14.5% will earn you
exactly that. If she used the $55 each month to reduce debt she could eliminate
a $14,900 balance over ten years. And that would eliminate over $200 of credit
card minimum payments each month.
Erica could invest the money in a variety of places. One problem
is that it's hard to invest smaller amounts. Even if she saves up the money and
invests it once a year, there's still only $660 to work with. She'd probably
need to select a mutual fund. They're designed to handle small dollar
investments.
Erica may think of stock investments when mutual funds are
mentioned. Given her stock experience she might be concerned. But not all mutual
funds invest in stocks. Some invest in bonds, or a mixture of stocks and bonds.
She also shouldn't confuse her recent stock experience with the
performance of most mutual funds. A general purpose stock fund will not lose
85%. Certainly not before you have warning and time to get out.
What 'looks good these days' usually isn't a good way to invest.
Very few people are able to predict the future well enough to time markets. Most
of us are better off taking a slow, steady and predictable path to wealth
accumulation.
As a general rule, it's usually advisable to pay off debts
before investing. That's because the interest rates for borrowing money are
usually higher than those paid for investing money.
One exception to paying debt first is when you can invest in a
401k plan where your employer matches part or all of your contribution. That
match significantly boosts the return.
Gary Foreman is a former financial planner who currently edits The
Dollar Stretcher website <www.TheDollarStretcher.com>
and ezines. You'll find hundreds of articles to help stretch your day
and your dollar!
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