Monday, June 30, 2014

Too Little Capital To Invest?

If you only had $5,000, should you even bother investing your money?

AK recently wrote a blog post today giving his 2 cent for a reader who asked about information about starting to invest. This is actually a very common questions, and I get this question a lot from my friends as well. AK then referred readers to his final statement in another post that he had titled, "Is investing for stocks suitable for you?".

His final paragraph is which he brings reader's attention to is:
"Although I feel that we should learn about investing as early as possible in life, I agree that investing in stocks, for various reasons, might not be suitable for everybody at one point or another in their lives." - AK
Now, personally because this statement is quite vague, I will have to agree with AK.

Investing in stocks is definitely dependent on the context. Nothing is a perfect fit for everybody at every point of life. This applies to a lot of things in life. You have slippers, dress shoes, sports shoes. Different things for different occasions. Even different people have different preferences regarding the style of sport shoes or dress shoes they want to wear. There is no one-size fit all magical formula.

However, the point that I would like to contest is regarding another portion of his blog post, which is about beginning to invest with a small amount of capital:
"From time to time, I receive emails from readers and, from time to time, there would be a reader who says he has $5,000 or less to invest with. The question is usually what should he invest in? Personally, I feel that the pertinent question is if he should be investing at all? Well, if I had only $5,000 or less to invest with, I wouldn't.  
I think the money is better left in an emergency fund. It is too little to really make any big difference to a person's financial well-being even if he were to achieve, say, a 10% return a year. After 7 years, that $5,000 would become $10,000 perhaps but there is also a chance that he could suffer financial loss in that 7 years. There is no guarantee that he could get back his money if he should need it."- AK
It is not to say that I don't agree with him here again, but I think the point can be misinterpreted by most.

I think the concept and the methods behind investing is the same regardless of what initial capital of your investment portfolio. Whether you have $2,000 to invest or $100,000 to invest, the concepts are the same. The only difference that I can see is that a larger portfolio has (1) better economics of scale, (2) access to more investment tools and (3) less lumpy rebalancing weights.

This means that a larger portfolio will generally incur less costs when making transactions. A larger portfolio can also access different investment vehicles due to minimum dollar amount required by some investments. Finally, and probably the most important, is that a larger portfolio can rebalance more finely to target allocation weights, rather than big chunky lumps due to inability to maneuver with limited smaller lots.

If you've been in the game a while, you would know that the arbitrary dollar amount matter less than the percentage changes. A $5,000 portfolio that makes 10% in a year, will also make 10% a year if it was scaled up to $100,000. Perhaps, the returns would be even more because of access to better investment vehicles (SPDR STI ETF instead of Nikko STI ETF) and finer rebalancing.

My 2 cents

If I had a friend who was asking me about starting to invest, I would recommend to adopt the Bucket Approach.

In the Bucket Approach, one would first create an Emergency Fund that he can draw from in emergency scenarios. Based on his current job security, projected liabilities and some margin of safety for personal comfort, this emergency fund should be filled up with anywhere between 3 months to a year of monthly expenses to help tide over any emergency situations.

Once this emergency bucket is finally fully funded, it should be clearly marked out and segregated from the rest of his funds. I would suggest a Fixed Deposit, Money Market Fund or a conservative short-term bond fund. Keeping your emergency money out of your current account / savings account removes the temptation and ease of accessing your sacred money.

Subsequently, all excess money that is saved can then be channeled towards an Investment Fund. When you know that even if the stock market blows up and goes to zero, you still have enough savings to last you for a while, you're less likely to make behavioral mistakes and therefore succeed in the long run because you are able to stomach the volatility better.

Once you have started your investment fund, definitely think of adding more capital for investing. Whether you add $100 or $1000 a month, and if your portfolio is $1,000 or $100,000, your principles and investment strategy should still be the same regardless.

I think risk tolerance should be irrespective of a portfolio size. What do you think? If you have a smaller portfolio should you be taking on more risks to generate a larger dollar return?

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