Though financial books, websites, and TV broadcasts often concentrate on big-money investing, it’s possible to build wealth even if you start investing on a tight budget. Successful low-budget investing requires you to carefully select your investments based on your income, risk tolerance, goals, age, and other factors.
Determine Your Investment Goals
Before anything else, you need to define your investment goals, as they will help guide all of your financial decisions.
There are three guiding principles that you can use to determine your goals:
- Safety: If your top goal is keeping your hard-earned money safe while getting a modest return, you will gravitate toward low-risk investments. While no investments are 100% safe, some come very close. For example, government-backed bonds in economically stable countries like the U.S. are quite secure. If your goal is to keep your money safe, these and other buy-and-hold blue-chip securities are the best choices.
- Income: If your focus is on generating passive income, then you should look for investment opportunities that facilitate that goal. However, you will likely need to take on a bit more risk if you want regular profits from dividend stocks, options sales, or bonds with lower ratings.
- Growth: If your goal is to grow your initial capital, you should focus on capital gains. Capital growth assets come in different forms, including stocks, funds, real estate, precious metals, and collectibles. Growth-focused investments can have different risk factors, so it’s possible to balance growth and safety goals.
Consider these three core principles to make decisions about which investments are right for you, as well as your short- and long-term finances.
Set a Sustainable Investment Budget
A sustainable budget allows you to meet your needs with your income alone. If your income just meets your needs, then you won’t have any money for investing. However, you can also create a budget that allows you to add to your investments regularly.
Consider forgoing nonessential expenses. Downgrading to one streaming service or making coffee at home instead of getting it from the shop can free up some income for investing.
Because no investment is guaranteed to be safe, you should use disposable income for investing. If you lose money on your investment, you still have the funds you need to live your daily life.
Understand Your Risk Tolerance
In the world of investing, you must balance risk and reward. In general, the higher the risk, the higher the potential reward. All markets fluctuate based on fear and greed in equal measure. Before you start investing, it’s crucial to know how much risk you’re willing to take on.
Investors with a high risk tolerance tend to be more aggressive, going for growth securities with high volatility. Investors who prefer less danger prioritize safety and a sustainable investment income.
The first step to defining your risk tolerance is to figure out how much disposable income you have. You should then ask yourself what percentage of loss you’re willing to accept. If you are only willing to lose 10% of your disposable income, then you should not bet more than one-tenth of your investment savings on any single trade.
Diversify Existing Accounts
Regardless of your risk tolerance, you should never bet all your money on a single investment. Diversification helps reduce risk by spreading your investments across different asset classes, sectors, and markets. The goal is to limit the impact of any single loss and help you remain profitable with your investments regardless of what happens in a particular market or sector.
If you have a 401(k) or IRA, which holds investments that will fund your retirement, you can diversify your retirement portfolio to decrease the risks of a downturn causing irreparable harm to your retirement funds. Ideally, you should split the money in your retirement account between different types of assets with different levels of risk. With this approach, your investment can survive even if the markets do not always move in your favor.
Purchase a CD or a Bond
If you have a low risk tolerance, consider investing in a CD (certificate of deposit) or bond.
CDs are offered by banks and credit unions. They function like savings accounts, except they usually have higher rates of return. To get these higher earnings, you cannot access your money until the term elapses. CD terms can last for as little as three months or as long as 10 years.
The big disadvantage with CDs is that the rate of return might be overshadowed by the rate of inflation, which would lead to you losing money. Long-term CDs may avoid this issue because they often offer higher interest rates.
Bonds are loans you give to the government or companies for a set period at a fixed interest rate. Non-government bonds are rated according to risk. The safest you can get is an AAA-rated bond. A- and AA-rated bonds are also relatively safe and often offer a slightly higher interest rate to go along with a marginally higher risk of default. Anything below A is a “junk bond.” These bonds carry a very high risk of default, but they pay high interest rates, making them a good option for very aggressive investors.
Open a High-yield Savings Account
A high-yield savings account pays a higher interest rate than a standard bank account. Since 2020, high-yield savings account holders can make as many withdrawals or deposits as they want without penalties. Before this rule change, you could make six transactions per month.
Most accounts have a minimum balance requirement, and you won’t get a higher interest rate if your balance drops below the threshold.
Another drawback of savings accounts is that the interest payments may not keep up with inflation. For example, the annual inflation rate in February 2022 was 7.9%, but the top high-yield savings accounts at major banks topped out at 0.5% in early 2022, so the account would be losing value if you withdrew the balance at that time.
Explore New and Nontraditional Investment Types
You can also look beyond the most common types of assets to find other short- and long-term investment options. Research these alternatives to see if they meet your goals, risk tolerance levels, and the other variables that you use to select the best investments.
Cryptocurrency is a form of digital money that uses a decentralized platform for transactions. Everything is governed by code and the authenticity of transactions is safeguarded by complex cryptographic security.
Cryptocurrencies have grown very popular over the last decade, and while they are still quite volatile, they are a feasible long-term investment. To invest in cryptocurrencies, you need a wallet that holds a public key, or crypto address, where you can send and receive funds. You also have a private key and secret passwords to secure your account.
Because of their novelty and volatility, cryptocurrencies are only for those with a high risk tolerance or who want to use a small portion of their diversified portfolio on high-risk, high-reward bets.
Fractional shares allow you to buy a partial share of an asset, instead of a whole asset. This can make expensive investments more accessible, making them a great low-budget investment option. They let you enjoy popular stocks and assets without exceeding your budget — including cryptocurrency and exchange-traded funds.
Fractional shares are offered in different ways by different brokers, making it difficult to transfer them from one broker to another. You would first have to sell the fractional share and obtain the cash, and then buy new fractional shares from the new broker.
Fractional shares are also more of a short-term investment option than a long-term one. You use them to open a position, and then convert them to full shares once you have a large enough investment.
Exchange-traded Funds (ETFs)
An ETF is a fund consisting of different securities that you can trade like regular company stock. ETFs are generally more affordable than many of their constituent stocks and bonds, making them a great option for investors on a budget.
Due to their high liquidity and availability on most exchanges, they can be used for short-, medium- and long-term investment strategies. However, watch out for with ETFs is the trading cost. If you frequently invest very small amounts in ETFs, the fees could eat into your profits.