Warning to New Investors: Starting Small May Cost You

New investors often ask, “How much money do you need to start investing?”

So How Much Do You Need?

Technically you need enough to open a brokerage account and buy one share of stock plus the commission. Some online brokers, like E*TRADE have a $500 minimum to open an account while TD Ameritrade has no minimum. So technically you could open an account with TD Ameritrade with say $10 and invest in one share of a $3 stock (TD Ameritrade charges $6.95 commission).

But How Much Should You Really Start With?

However, the real answer is that you should have much more than $10 or $20 before you start investing. If you only have enough to buy one or two shares at a time, the amount you will pay in commissions will severely eat into any gains you may earn. Let’s say you can buy two shares of stock of company ABC for $10 a share. If you use TD Ameritrade, you will pay $6.95 in commissions to buy the two shares. This means your $10 stock actually costs $13.48 per share ($10 share price plus $6.95 commission divided by 2). So you would need the stock price to increase over 34% just for you to break even on the purchase! Don’t forget you pay a commission on the sale as well, so add another $3.48 per share to your break even price and now you need the stock price to rise over 68% for you to be able to sell and not lose money.

Starting Small Can Be a Struggle

The above example is one reason why small investors often have a hard time making money. By buying in quantities that are too small, commissions cut into most of your gains making it harder to actually earn a profit. However, if you save up and wait to buy in larger quantities, then the commissions become a smaller cost per share. When starting out, I recommend buying enough shares so that the total commission only adds 5-10% to your break even price.  The lower you can get this percentage the better, but this is a good starting point. Over the past few years, the overall stock market has increase a little over 11% per year.  So if you can keep you commissions to 5-10%, on average you should be making money after a year.

By buying in quantities that are too small, commissions cut into most of your gains making it harder to actually earn a profit.

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Increase the Number of Shares You Purchase

If you could purchase 20 shares of a $10 stock, the commission would only add $.70 per share (factoring both the commission to buy and sell) to your break even, which means you only need the stock to increase 7% for you to reach break even instead of the 68% if you only purchased two shares. This break even price continues to drop the more you invest.  So in this example, around $200 would be the minimum you want to start with.

Start Saving. Like Now!

I don’t intend to discourage anyone from investing. I recommend putting as much money away as you can to invest, no matter how small it is. However, I just don’t recommend actually investing it in stocks until you have enough saved up (at least a few hundred dollars) to buy enough shares so that commissions don’t work against you. Why would you want to work hard to save money to invest just to lose it to commissions? Also, by having more saved up, you can better diversify your portfolio (which is another important topic you should research before investing). So if you only have $10-$20, open a savings account and keep adding to each month until you’ve reached your target amount.