Investing With A Low Income

Stock exchanges. ETFs. Money market. Bonds. Shareholding. Assets and liabilities. Diversified portfolios. For a new investor, the flood of unfamiliar jargon can be foreign, frightening, and downright intimidating. Add to that the complication of a low income, and the stage is set for unwise investments, wasted funds, and a (potentially indefinitely) delayed retirement. This is the prospect that many people face today: single parents, recent college grads, newlyweds, and even middle-aged men and women whose youthful frivolities have left them crippled with debt. Should these people even be considering investing?

I would argue that not only should low-income households consider investing, but it can even allow these people to thrive in ways that they did not think possible. Thriving financially begins before investments start, with the choice to get personal finances under control. Complete stability is not necessary, but each person needs to understand his financial position. This allows the young, single mother to know how much leeway she has for investment risk, or a recent graduate to know how much debt should be eliminated before beginning to invest. The second step to financial well-being is investment education. Uninformed investment can be disastrous, and low-income people have less margin for error than others who have more financial breathing room. Finally, thriving starts small. Certain investments are better to establish as your foundation than others, so it is important to learn exactly what those introductory investments are and where they can be found.

Financial Control

What is financial control?

In one of its most basic forms, financial control means that you are cushioned from surprise expenses. Financial control can also mean that you are out of debt, or are quickly approaching that goal. It can mean that you have money tucked away to help cover large expenses such as the purchase of a new car or a new house. Ultimately, you have financial control when you are calling the shots about where your money goes and how much of an impact it has on your life. Debt is the natural enemy of financial control. As long as you are in debt, you are not in control of where and when your money leaves you – your debt collector is. Debt demands a certain portion of your income, whether you can afford it or not. Can you see why it is important to get out of debt as quickly as possible? Before you have the freedom to invest money as you see fit, you need to free yourself from the shackles of debt.

How do I get out of debt?

According to Eric Tyson, “paying off your debts may be your best high-return, low-risk investment.”[1] Many forms of consumer debt, such as credit card or auto loan debt, have high interest rates that claim large chunks of money. If you were to choose to invest your money, rather than use it to pay off your debts, you would have to maintain a rate of return that was higher than both your debt interest rates and inflation rates combined. With the economy the way that it is and some credit card interest rates at over 20%[2], it is nearly impossible to achieve such high returns.

Christian financial expert Dave Ramsey advocates what he calls “The Seven Baby Steps” to getting out of debt.[3] He guides people to first establish an emergency fund of $1,000, which helps in case of unexpected expenses such as the loss of a job, car trouble, etc. Next, debts are aggressively paid off from smallest to largest, mortgage aside. In the case of similar amounts, pay off the debt with the higher interest rate first. The goal here is to quickly pay off several small debts to keep you motivated, because you see noticeable results. The third step is to expand your emergency fund to cover three to six months’ living expenses.  This will provide a bigger safety net in the case of unexpected events. Only after these first three crucial steps are accomplished does Ramsey encourage you to begin investing.

Investment Education

Now that you understand the importance of getting out of debt and of gaining financial control, we can talk about what you can do with your money.

Investing versus saving

The concept of investing is closely related to that of saving. As Austin Pryor writes, “investing is simply giving up something now in order to have more of something later”.[4] Using this definition, one could argue that there is no difference at all between saving and investing. However, there is a key distinction between saving and investment: the degree of risk.

As a general rule of thumb, savings should be in a low-risk environment, focused more on “a return of my investment” rather than “a return on my investment.”[5] As Joshua Kennon writes, “Saving is the process of putting cold, hard cash aside and parking it in extremely safe and liquid securities or accounts.”[6] When referring to savings or investments, the term “liquid” means that the funds can be accessed at short notice, at most a few days.

Investments, on the other hand, typically involve situations with higher risks and higher potential rewards. While saving involves putting money aside safely, investing uses money to make more money. Kennon writes, “Investing is the process of using money to buy an asset that you think will generate a safe and acceptable return over time, making you wealthier with each passing year.”[7]

Savings accounts

Before looking into some of the more common investment opportunities, we will consider some options within savings. The most basic form of savings (aside from the piggy bank) is the savings account. As Karen Blumenthal writes, “savings accounts are often the first step in a financial journey.”[8] Unfortunately, savings accounts do not provide the security that they once did. With national interest rates averaging at 1% or less for both savings and money market deposit accounts[9], these two account types do not even keep up with the estimated 1.6% annual inflation rate of 2010.[10] However, these accounts are easily procured, as they are available practically any bank near you, so these accounts hold the benefit of ease of accessibility.

Certificates of Deposit

Certificates of deposit (CDs) are another readily available option for your savings. Unlike savings accounts, CDs “[lock] your money in at a set interest rate for a certain period of time.”[11] For example, you may find a 6-month CD with a fixed interest rate of 3%. Typically, the interest rates for CDs are higher than those of savings or money market accounts because you forfeit access to your money for the length of the CD. Should you choose to withdraw funds early, you will pay both penalty and early withdrawal fees. One last downside to CDs is that current CDs rates are set at 1.15% with minimum deposits ranging from $1,000 to $25,000.[12]

Money market

The money market is the collective name describing all the different ways in which governments, banks, businesses, and securities dealers borrow and lend money for short periods of time.[13] These money market loans range in length from a few days to a few months, but never last for longer than a year.

Be careful not to confuse money market accounts with money market funds. A money market account, also called a money market deposit account, is run by a bank and typically offers a slightly higher interest rate than the bank’s other savings accounts. Money market mutual funds, on the other hand, are a type of mutual fund, which pays its investor all of the fund’s investment income after deducting a small management fee. While uninsured, money market funds provide both a high level of security and a higher interest rate than savings accounts. Money market funds are also required by law to invest in low-risk securities.[14]

Money market funds, though often overlooked, are recommended for holding emergency funds, since they usually have interest rates that are about one percent higher than savings accounts.[15] Additionally, many money market funds can have checks written from them. It is a bit too unwieldy to use a money market fund to replace your checking account and some money market funds limit the number of checking transactions and the amount that can be withdrawn. However, if you had an emergency, you could write a check, which is exactly why you have your emergency fund.

What are the most common forms of investment?

When you first start looking at investment options, it can be overwhelming. It can seem like everywhere you look there are different investment options. However, there is hope! Most types of investment are either stocks, bonds, or some combination of the two.

Stocks

When you first think of investing, chances are stocks were the first thing that came to mind. Perhaps the easiest way to explain the concept of stocks is by explaining what they do. As Blumenthal states, “stocks, also known as equities, represent ownership in a company.”[16] In other words, when you buy a stock in a company, you own part of that company. Stocks are referred to as shares, and the person who owns the stocks is called the shareholder. Shareholders benefit from the company’s profits; conversely, if a company’s profits are declining, its stock also loses value.

Companies sell stocks to fund growth or new projects. When companies first make their stocks available to the public, it is referred to as their IPO or initial public offering. Their stocks are labeled by one- to four-letter tags that represent a company. Once on the market, stocks can be bought, sold, and traded. Though a company may purchase its stocks back, just as anyone else can purchase its stock, stocks will never expire so long as the company remains open to the market.

Stocks are traded on stock exchanges, which are giant marketplaces where buyers and sellers come together. Investors operate through stock brokers by calling them up and giving them orders of what to do, whether that is buying more stock, or selling stock at the best price that they can. To make investing in the stock market easier, many brokerage companies have advisors who, for a fee, are able to help investors to keep an eye on the market and make note of how the market is changing.

The stock market is highly liquid and there are pros and cons to this high liquidity. One benefit is that stocks can be sold easily and quickly, meaning you have quick access to whatever monetary value that the stocks hold. On the other hand, this liquidity also means that the value of stocks can quickly change. The terms “bull market” and “bear market” are used to help keep track, generally, of how the market is performing. A “bull market” is highly profitable; a “bear market,” on the other hand, is one that is quickly declining. To safeguard against potential losses due to the high liquidity of the market, investors should attempt to diversify their stock portfolios, that is, to buy a variety of stocks. This way, if some stocks lose some of their value, the investor still has their other stocks maintaining, or gaining, value. Diversification is a technique that applies to all sorts of investments, not merely stocks.

Bonds

While stocks are partial ownership of a company, bonds are a type of debt.[17] When a company sells bonds, the buyer is essentially taking an “I owe you” from the company. The investor is agreeing to lend the company a set amount of money, typically $1000, at a fixed interest rate. This allows the investor to protect their original investment amount, also known as the principle, while still establishing a steady stream of income.[18] Bonds are considered to be less risky investments than stocks, because they have a specific date that they are to be repaid, or reach “maturity,” whereas stocks are never “repaid”.

Maturity date is one of the key things to consider when building a bond portfolio. While bonds with closer maturity dates are more likely to retain their principle values, their interest rates are probably going to be lower. However, the further away a maturity date is, the more time there is for a potential drop in the market value of the bonds or for a company to default. Though the value of the bond will not change, interest rates may change. Since bonds have fixed interest rates, these do not change with the market. If, for whatever reason, an investor were to choose to sell her bond before the maturity date, current interest rates will affect how much money she is able to get for her bond. If interest rates have gone up, then she may have to sell her bond for less, since a potential buyer could purchase a new bond with a higher interest rate. However, if interest rates have gone down, the investor may be able to sell her interest rate for a premium, that is, an amount higher than her initial investment.

Default, when a company is unable to keep up on its interest payments or pay off the bonds when they mature, is an investor’s worst nightmare. Bonds are rated to help potential investors to evaluate the investment risk. Standard & Poor’s (S&P) and Moody’s are two companies that are best known for their bond ratings, each with nine rating levels ranging from AAA and Aaa to D and C, respectively.[19] As bond ratings progress from the top down the probability that the bond will be repaid decreases, although the interest rate may increase.

Since many investors will use bonds to increase the stability and security of their investments portfolios, most investors will only choose to buy bonds from the top three or four ratings; in S&P these ratings are AAA, AA, A, and BBB. There is a way to eliminate risk altogether, which is to purchase U.S. Treasury bonds. Bonds from the U.S. government are widely regarded as the world’s most creditworthy investments, though they often carry lower interest rates than corporate bonds.[20] However, as stated above, stated above most investors will buy corporate bonds from the top three or four ratings because these bonds are with financially strong companies and consistently beat U.S. Treasury bond interest rates.

Mutual Funds

If you have spent any time researching investing, chances are that you have run across these things called “mutual funds” and wondered what they are. Mutual funds are the average individual’s ticket into the professional investing world. These funds pool together the investments of many people into one big fund. Fund managers are then able to invest in more stocks or bonds and buy and sell at a lower cost than someone investing alone.[21] Mutual funds may invest in stocks, bonds, or a combination of the two. However, unlike bonds and stocks, they can only be traded at a specific time, after the regular stock trading has been completed for a day. When an investor looks to invest in a mutual fund, the share prices are based on the fund’s “net asset value,” which is its total assets divided by the number of shares outstanding.

Each mutual fund is limited in the types of securities that it is allowed to invest in. When the mutual fund was first created, a booklet called a “prospectus” was drafted. The prospectus, which is provided to all investors in a mutual fund, contains an explanation of the ground rules regarding how the fund will be invested.[22]

Mutual funds have many advantages that make them instrumental in the investment plans for new investors and veteran investors alike. Investors purchase shares in a mutual fund, which means that investing can begin with as little as $500.[23] Another benefit comes in the form of diversification. Since mutual fund investors are pooling their funds, a mutual fund enables an investor to have their funds diversified amongst, on average, around 200 securities.[24] A third big advantage to investing in mutual funds involves the professional services that are available to investors. Each fund is managed by a professional investment specialist who, by paying attention to how he is investing the full fund, is paying close attention to your investment, though it may be smaller than the investments of other people.[25] Additionally, there are a plethora of advisory services that exist for the express purpose of assisting investors in researching investment opportunities.[26]

Your First Investment

Determining Risk Tolerance

Before you begin investing, it is important to determine your personal risk tolerance. Risk is an inevitable fact of investment, and the common rule of thumb is that the greater the risk, the greater the potential reward. Another way of looking at it is the greater the risk, the higher the likelihood that the investment will be lost or devalued.

There are several factors that play into an investor’s risk tolerance. The first factor is you, the potential investor. The next thing to consider is the length of time that you plan on investing. The third factor is your investment goal. Finally, you must consider your income.

Not everyone responds to risk the same. Some people are daring, preferring to live life on the edge. For them, investment risk is the best part of investing. For others, it is much more important to have money in the end than it is to receive a good return for the investment. These people will be content will investments that only grow their investments at a rate that beats inflation, so long as all of their money remains intact. Most others fall somewhere in between these two extremes. As you begin to consider various investments, some will resonate with you more than others. Be cautious when considering investments that have high rewards, because it is easy to lose sight of the substantial risk that involved. On the other hand, you do not want to be so conservative (regarding risk, not political affiliation) that you bypass solid investment opportunities for fear of risk.

The second and third factors are somewhat related, since your investment goal typically dictates how much time you have to invest for it. Saving for retirement at 65? That gives you a set number of years and dictates a certain level of urgency for investing. Is your ten-year-old planning on going to college in eight or nine years? With only eight years to begin saving and investing for your child’s college education, the urgency is higher, but, at the same time, so is the necessity of keeping risk low. The last thing you want is to lose the money you had invested for your child’s education right before she needs it. Time is the investor’s most valuable asset; the more time there is for an investment to sit, the more opportunity there is for investments to recover from potential market downturns.[27]

The last factor to consider is your personal income. It is vitally important to avoid investing more than your budget allows. Investment should be a part of your regular budget, calculated in to the total figure, not merely scraps dredged up from excess in various areas. Your investing should not put an undue burden on your day-to-day life, though you may need to cut down on excesses in some areas. Investing is a long-term process, so only use money that you will not need for many years, or even decades[28] and only after establishing an emergency fund.

With these four factors brought into consideration, you should have a fairly good idea about what your risk tolerance level is at. For those with lower income, desperation should never lead to greater risk-taking. If anything, a tighter budget and a lower income should lead an investor to be even more careful with his funds. However, at the same time, it is important to be investing and you do not need a large amount of money to get started.

First Steps

As you consider investing, it is important that you recognize that, since time is your greatest ally, it is better to start sooner than later. After paying off all debt, other than a mortgage, get started as soon as you can. The ticket is a mutual fund. As I stated before, some mutual funds will allow you to open an account with as low as $500 or $1000.[29] Although you can look around on your own for the right mutual fund to get you started, there are professionals who are willing and able to help you find a fund suited to your needs.[30] Alternatively, you can get started on your own through companies like Vanguard and Fidelity Investments.

Within the mutual fund world, you want to be looking for index mutual funds. Index mutual funds seek to imitate the returns of a specific set of stocks or bonds.[31] The Standard & Poor’s 500 Stock Index, often referred to as the S&P 500, is one well known index that is made up of stocks of 500 well-known companies. Another option is a total stock market fund, which may invest in thousands of stocks. These funds aim to imitate the stock market as a whole and make a sound first investment because, as a whole, the stock market has beaten inflation by a wide margin.

You may be wondering what it costs to invest through a mutual fund. There are two types of mutual funds: load funds and no-load funds. Load funds have an active sales force of professionals who charge a sales fee as they offer recommendations for which funds would best suit your needs. An important thing to note is that loads may be charged at the beginning or when you sell, called a back-end load. When looking at funds, watch out for these back-end loads, because they may be disguised as no-load funds. No-load funds do not have these salespeople and, therefore, do not charge this sales fee.[32] The type of fund you decide to go with depends on whether or not you are willing to do some extra research and pursuit to find funds that you feel are right for you, but there is not a huge difference between their performances. This means that, in a no-load fund, you are investing the money that would have been paid as a sales fee in a load fund. Both load and no-load funds hire professionals who are responsible to invest to the best of their ability.[33] These mutual fund managers earn their profits through operating fees, which are based on the money that they are responsible for investing. Some mutual funds charge marketing (advertising) fees that they use to attract more investors. Lastly, some mutual funds charge exit fees which occur when you sell your shares.

Exchange traded funds, or ETFs, are another entry-level investment that may serve as a good starting place. ETFs are similar to mutual funds, but are sold on a specific exchange, similar to stocks.[34] One of the biggest draws of an ETF is that there is no minimum investment. This makes it highly desirable for someone who is just starting to invest. However, ETFs charge a commission fee each time that you buy or sell a share. If you are planning on investing in a lot of smaller deposits, stay away from ETFs. It would be wiser to save up a few of those deposits, and then begin investing in a mutual fund when you have enough money for the minimum investment.

One company that seeks to make investing easier for the beginning investor is Betterment. Betterment strips away all of the difficult research and work, providing a simple, user-friendly investment opportunity. At Betterment, your decisions are limited to investment goal, allocation between stocks and bonds, and frequency of deposits. They utilize index ETFs, but swallow all commission fees, and only charge a minimal annual management fee (less than one percent). This company’s investments are highly diversified, with their ETFs covering over 3,500 different companies.[35] Although this may not be the ideal place to start investing, this is a viable option for an investor who is working toward their minimum investment for a mutual fund.

Conclusion

Investment is often neglected, particularly among people with lower incomes. With so much confusing language, between the financial jargon and abbreviations, investing can be intimidating. Throw in the added pressure of managing money to the best of your ability and it can be downright overwhelming. However, the benefits of investing are well worth the struggle of learning.

One of the most important steps to investing is establishing control over your current financial situation. Draft up a budget. Save up a small emergency fund. Minimize and eliminate debt. Though you will not be investing during this time, use this time to educate yourself on investing opportunities and techniques. This essay serves as a solid foundation for your investment education, but you should continue to seek out new information. Finally, after defeating debt, begin investing. Time is your greatest ally, try to get started investing as soon as you can, even if you can only spare a few dollars a month. Investing in something like Betterment will allow those dollars to multiply as rapidly as possible, and, with your continued incremental deposits, you will be able to expand out into mutual funds and more before you know it.


Works Cited

Blumenthal, Karen. The Wall Street Journal Guide to Starting Your Financial Life. New York: Three Rivers Press, 2009.

“Bond Ratings.” Bondsonline.com. http://www.bondsonline.com/Bond_Ratings_Definitions.php (accessed December 11, 2011).

“Browse Credit Cards.” Chase.com. https://creditcards.chase.com/credit-card-search.aspx?actionid=1&advkw=LSBROWSEOPEN&MSC=LSBROWSEOPEN (accessed November 14, 2011).

Caldwell, Miriam. “Certificate of Deposit (cds).” About.com.http://moneyfor20s.about.com/od/basicsavingstools/g/Certofdep.htm (accessed November 15, 2011).

“CD Rates by Bankrate.cOm.” Bankrate.com. http://www.bankrate.com/funnel/cd-investments/cd-investment-results.aspx?local=false&tab=CD&prods=15&ic_id=CR_SearchCDMMAByLocation_default_CD_V1 (accessed November 15, 2011).

Kennon, Joshua. “Saving Vs. Investing: Finding the Right Balance between Saving and Investing.” About.com. http://beginnersinvest.about.com/od/savingsanddebtmanagement/a/saving-vs-investing.htm (accessed November 15, 2011).

Miller, Theodore J. Kiplinger’s Invest Your Way to Wealth. Washington, D.C.: Kiplinger Books, 1994.

“MMA Rates By.” Bankrate.com. http://www.bankrate.com/funnel/savings/savings-results.aspx?local=false&IRA=false&prods=33&ic_id=CR_searchMMASavingsRates_checking_MMASavings (accessed November 15, 2011).

“Money Market Funds.” U.S. Securities and Exchange Commission. http://www.sec.gov/answers/mfmmkt.htm (accessed December 12, 2011).

“Our investments.” Betterment LCC. https://www.betterment.com/investments/ (accessed December 13, 2011).

Pryor, Austin. Sound Mind Investing: A Step-By-Step Guide to Financial Stability and Growth. Chicago: Moody Press, 1993.

Ramsey, Dave. The Money Answer Book. Nashville: Thomas Nelson, 2010.

Tyson, Eric. Investing for Dummies. 4th ed. Hoboken, NJ: Wiley Publishing, Inc., 2006.

“What is a Money Market Account?” DaveRamsey.com, http://www.daveramsey.com/index.cfm?event=askdave/&intContentItemId=6161 (accessed December 12, 2011).

“The World Factbook.” CIA.gov. https://www.cia.gov/library/publications/the-world-factbook/fields/2092.html (accessed November 15, 2011).


[1] Eric Tyson, Investing for Dummies, 4th ed. (Hoboken, NJ: Wiley Publishing, Inc., 2006), 49.

[2] “Browse Credit Cards.” Chase.com. https://creditcards.chase.com/credit-card-search.aspx?actionid=1&advkw=LSBROWSEOPEN&MSC=LSBROWSEOPEN (accessed November 14, 2011).

[3] Dave Ramsey, The Money Answer Book, (Nashville: Thomas Neslson, 2010), 4.

[4] Austin Pryor, Sound Mind Investing: A Step-By-Step Guide to Financial Stability and Growth, (Chicago: Moody Press, 1993), 1-5.

[5] Theodore J. Miller, Kiplinger’s Invest Your Way to Wealth, (Washington, D.C.: Kiplinger Books, 1994), 35.

[6] Joshua Kennon, “Saving Vs. Investing: Finding the Right Balance between Saving and Investing,” About.com, http://beginnersinvest.about.com/od/savingsanddebtmanagement/a/saving-vs-investing.htm (accessed November 15, 2011).

[7] Kennon. Paragraph 4.

[8] Karen Blumenthal, The Wall Street Journal Guide to Starting Your Financial Life, (New York: Three Rivers Press, 2009),14.

[9] “MMA Rates By,” Bankrate.com, http://www.bankrate.com/funnel/savings/savings-results.aspx?local=false&IRA=false&prods=33&ic_id=CR_searchMMASavingsRates_checking_MMASavings (accessed November 15, 2011).

[10] “The World Factbook,” CIA.gov, https://www.cia.gov/library/publications/the-world-factbook/fields/2092.html (accessed November 15, 2011).

[11] Miriam Caldwell, “Certificate of Deposit (cds),” About.com, http://moneyfor20s.about.com/od/basicsavingstools/g/Certofdep.htm  (accessed November 15, 2011).

[12] “CD Rates by Bankrate.com,” Bankrate.com, http://www.bankrate.com/funnel/cd-investments/cd-investment-results.aspx?local=false&tab=CD&prods=15&ic_id=CR_SearchCDMMAByLocation_default_CD_V1 (accessed November 15, 2011).

[13] Miller, 42.

[14] “Money Market Funds.” U.S. Securities and Exchange Commission, http://www.sec.gov/answers/mfmmkt.htm (accessed December 12, 2011).

[15] “What is a Money Market Account?” DaveRamsey.com, http://www.daveramsey.com/index.cfm?event=askdave/&intContentItemId=6161 (accessed December 12, 2011).

[16] Blumenthal, 231.

[17] Blumenthal, 237.

[18] Pryor, 3-14.

[19] “Bond Ratings,” Bondsonline.com, http://www.bondsonline.com/Bond_Ratings_Definitions.php (accessed December 11, 2011).

[20] Pryor, 3-17.

[21] Blumenthal, 244.

[22] Pryor, 2-4.

[23] Pryor, 2-5.

[24] Pryor, 2-6.

[25] Pryor, 2-7—2-8.

[26] Pryor, 2-10.

[27] Tyson, 63.

[28] Blumenthal, 219.

[29] Blumenthal, 220.

[30] Go to http://www.daveramsey.com/elp/investing/ to find professional investing experts that will help you in your investment journey, whether you are just starting to invest or have been researching and studying for a while.

[31] Blumenthal, 220.

[32] Pryor, 2-16.

[33] Pryor, 2-18.

[34] Tyson, 167.

[35] “Our investments.” Betterment LCC, https://www.betterment.com/investments/ (accessed December 13, 2011).

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