Investing with a Small Amount: Stocks or Mutual Funds?

There was a short Q&A in The Wall Street Journal yesterday where the question being asked is the following:

I would like to buy only a few stocks in certain companies. Are there any online brokers that handle people with only a couple hundred dollars in their account and don’t charge heavy fees for infrequent traders?

In the answer part, several popular online discount brokers, such as Firstrade, TradeKing, and Zecco, were mentioned as possible choices for investing with small amounts.

While I agree that the brokers mentioned are pretty cheap and don’t charge the so-call inactivity fee for small investors doing sporadic trades, the question I asked myself actually is: if one only has “a couple hundred dollars,” is buying “a few stocks” the best way to invest the money even if he/she goes with Zecco which charges no commission at all?

And my answer is No. If I have only a few hundreds to start investing, I will choose mutual funds over individual stocks because, no matter how good one’s stock picking skill is, the nature of individual stocks is volatile, at least in the short term. With mutual funds, the risk is lowered as one fund can invest in hundreds of stocks at the same time.

Then the problem with investing in mutual funds with a small amount of money is that most funds require a minimum initial investment which could be anywhere between $500 to $3,000 (most of Vanguard’s index funds require $3,000 initial investment). However, there are funds which waive the initial investments if an automatic investment plan is used. For instance, funds from T. Rowe Price don’t require any initial requirement when using their Automatic Asset Builder program with $50 monthly contribution and TRP has quite some good funds to choose from.

If I’d rather deal with a broker than a mutual fund company, I will use a commission-free broker like Zecco (Zecco does require a minimum of $2,500 to open an account though) to buy a low c0st, diversified exchange-traded fund (ETF) such as Vanguard Total Stock Market ETF (VTI) to give me the broad coverage of the stock market.

Though I may not get spectacular return from a mutual fund or ETF, I know my money won’t disappear in hours as could happen with individual stocks.

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13 Responses to “Investing with a Small Amount: Stocks or Mutual Funds?”

  1. CiaranFromChance |  Jan 13, 2008 at 1:09 pm

    Good advice. i think it applies whether you have a little or a lot to invest.

    I think it’s also worth mentioning that if you only have a few hundred dollars, it may be worth focusing on changing your habits and setting up a budget to build up those amounts.

    Also, I hope this investor has an emergency fund setup. That would be important to have before worrying about stocks or funds.

    Stumbled it btw:)

  2. Allea |  Jan 14, 2008 at 2:18 pm

    Interesting! Since i’m in this only-have-a-small-amount-of-money-to invest type of investors.

    I’m currently put as much as money i can save every month for the past few months, so i can accumulated enough amount for the minimum initial investment. For me $2500 is a lot of money. But i’m getting there, hopefully on March i will reach this goal along with a small amount of emergency money.

    But, i do have a question though, which one is better…Index Fund or ETF?

  3. Swamproot |  Jan 14, 2008 at 3:34 pm

    I recently opened a Sharebuilder account myself and wondered these same things. I have a lot of money going into my IRA at work (American Funds only, blech!) and T. Rowe Price for my Roth IRA, but I was wanting to get into Vanguard funds. I’m putting $100 a month right now into the money market fund with the intention of buying $500 a time into an etf once I have enough. I’m still deciding which etf(s), probably 3 that will make up a “Margarita portfolio”, including VTI.

    Then once I get $2500, I may transfer those assets to Zecco, or sell them all when I get $3000 to open a Vanguard account. Haven’t decided for sure yet. But at $500 the automatic purchase option of $4 puts the trading costs at less than %1, that’s still less than a third of what buying American Funds is costing me AT A DISCOUNTED RATE!

    After that I might use it to get etf positions in some asset classes I can’t get with my mutual funds, such as small cap value, TRP’s representative fund of this class is closed.

  4. Sun |  Jan 14, 2008 at 9:49 pm

    Allea: Each ETF tracks an index and that makes ETFs cheap since there isn’t much reach to find which company to invest in. If you can find an index fund and a ETF that tracks the same index, it’s usually the case that ETF is cheaper to own as ETFs have lower expense ratio than their mutual fund counterparts. So over the long-term, ETFs are cheaper to own.

    While ETFs’ expense ratios are relatively lower, you do have to pay commission to buy/sell ETFs as they are traded as stocks and most brokers charge commissions to trade ETFs. If you only have a small amount to invest each time, the commission could hurt you over time
    though ETFs themselves are cheapter, unless you use broker like Zecco which doesn’t charge commission. Also you can buy ETF at any time you like, much more flexible than buying a mutual fund.

    On the other hand, if you buy mutual funds from the fund company directly, there is usually no extra fees, though most fund companies do require a minimum initial investment. For ETFs, you can buy only 1 share :)

    In my opinion, if you plan to invest $100 every month, an index fund is a better option. If you want to invest $1200 once every year, then ETF may be better, given you don’t pay too much commission.

  5. Allea |  Jan 15, 2008 at 3:20 am

    Thank You for your response.

    FYI, i’m living outside US, and currently there’s only 1 Index funds and 2 ETF here. Not much of a choice. But the problem with this only 1 index funds is that there’s this 1% subscription fee everytime i wanted to add more units and 0,36% management fee, 0% redemption fee.

    Does this makes ETF a better choice if i had my $2500 on march? Considering that ETF also have buy & sell fee, along with the broker commission fee?

    I planned to hold it over long period of time for my retirement plan. I also planned to buy/add more units every month using dollar cost averaging after i make this first initial investment.

    I really need some opinions here.
    Thank you again!

  6. Sun |  Jan 16, 2008 at 10:03 pm

    If you have to pay a fee very time you make a purchase, whether it’s an index fund or a ETF, it may not be a good idea to do dollar cost averaging, especially when you only have a small amount to invest each time and the fees you pay could be a substantial amount comparing to the principal. If that’s the case, making a one-time purchase may be a better option.

    Whether to buy an index fund or ETF depends on the cost of investing in them in addition to their respective performance. From what you said, you will pay roughly 1.36% to buy mutual fund each time. How much will
    you pay to buy ETF? In my opinion, choosing the one with lower cost will do more good in the long term.

  7. Micahel |  Jan 18, 2008 at 11:45 am

    i wonder how i missed this blog? The explanation is very illustrative and you have also given plenty of point to make difference which will be useful for investors.

  8. Tom |  Jan 17, 2009 at 12:43 pm

    Great advice. I opened up a Firstrade account a few years ago when I was about 18 or so. What I found out what was what you mentioned above. A lot of the good mutual funds required at least $500-$1000. Instead of gathering that up at the time being, I invested my money into some blue chip stocks.