You're planning to start investing your hard-earned dollars, and that's a great idea.
But before you get started, you may be wondering: how much to invest in the stock market?
And you are not the only one: many are afraid that the stock market is not for them, but rather reserved for the rich.
However, you don't need to have J-Lo's fortune to start investing your money... as long as you do it properly and within your means.
In this article, let's discuss how much to invest in the stock market, but also how to invest your money according to the amount you have to invest.
What is the ideal amount to invest in the stock market?
You may be expecting me to give you an exact amount, and to explain why.
But at the risk of disappointing you, I can't just throw a magic number at you that would fit all situations.
However, I can help you understand how much you could invest based on your own situation. So stick with me for the rest of this article, because we're going to cover a lot of ground - including how to invest in the stock market within your means.
The first thing to know is that you should only invest money that you don't need to live on.
Before you start investing your money in the stock market, you should be in a stable financial situation, be able to pay your bills on time, be able to save regularly, and most importantly have solid precautionary savings.
Note
Precautionary savings is a sum of money that you put aside to cover unforeseen expenses or life accidents that could occur in the future.
It should not be invested in the stock market but should remain in a savings account or insecure investments (such as dollar funds).
Experts generally recommend setting aside between 3 and 6 months of expenses for your emergency fund.
Secondly, don't invest money in the stock market that you may need in the near future, or even in the next 3-5 years.
Why not?
While stock markets tend to increase in value over the long term, they can fluctuate wildly, sometimes falling for months at a time, before rising again.
Example
Let's imagine that you want to buy a house in 3 years and that you invest in the stock market the 40 000 $ that you want to use as a deposit.
Problem: halfway through, the markets start to fall. By the time you need to withdraw your money, the value of your investments has dropped by 30%: you only have $28,000 left. Ouch. This will force you to postpone, suspend or completely rethink your project.
Conversely, if you don't need your money in 20 years, it doesn't matter if the markets drop by 5, 10, or 30% in a year: you still have many years to catch up.
Then, as you approach the date when you will need to withdraw your money (for example, your retirement), you will gradually secure your investments by moving all or part of them to a secure investment over the years. I won't go into detail in this article for simplicity's sake, but understand that the stock market should be considered as a long-term investment.
The importance of brokerage fees
This is an essential element to take into account when trying to figure out how much to invest in the stock market.
To invest money from a PEA or a securities account (two French tax wrappers that allow you to invest in the stock market), you have to "place an order" - that is, buy or sell securities.
This order will be executed for you by an intermediary (the bank or broker with which you have opened your account, such as DEGIRO, Bourse Direct, etc.), which will be remunerated on these orders via brokerage fees.
Depending on the broker you use, the fees associated with this order can be more or less important.
It is generally a percentage of the transaction amount, to which a minimum amount is sometimes added. To take the example of a traditional bank (here CIC), the stock exchange order is charged 0,60% with 8,15 $ minimum! And these rates apply to buying AND selling... So you lose a big part of your investments in fees.
Example
Let's take a more reasonable example of 0.1% fees, with a minimum of 4 $.
If you invest $100, you already have $4 in fees when you buy, then $4 when you sell.
This amounts to 8 $ in total or 8% of your basic investment! Which is really huge.
So you will already have to earn more than the brokerage fees if you want to hope to earn something on your investments.
The lesson to learn from this is not to go through your traditional bank to invest in the stock market (sorry CIC!), but to prefer online brokers who generally have much less outrageous rates.
But it is also to understand how much brokerage fees can impact you if you have a small budget to invest and to make your decisions accordingly. If there is a minimum order fee, the smaller your investment, the more you will be penalized.
If the broker does not charge a minimum fee but only a percentage, the impact will be less for small orders - provided you still find a broker with the lowest possible fee.
The problem of diversification
The second thing that will impact how much you should invest in the stock market is your ability to diversify properly.
One of the keys to success in the stock market is what is called diversification. Or simply put, it means "not putting all your eggs in one basket".
Experts generally recommend diversifying between different asset classes (stocks, bonds, real estate, etc.), but also within the asset classes themselves.
Example
Let's say you only have $200 to invest, which is barely enough to buy the shares of one or two companies.
If the value of one of them (or worse, both) falls and never goes back to the price you bought it at, a huge part of your investment goes up in smoke.
And since no one can see into the future (or if you can write me to tell me whether or not there will be a new season of The OA someday), there is no guarantee that the companies you invest in now will always be winners.
Already, choosing winning stocks consistently over the long term is extremely difficult, and very often a losing proposition (we'll go into more detail on this point later).
But if you are not diversified at all, it is really shooting yourself in the foot. Besides, good diversification requires you to invest in different sectors, geographical areas, etc.
Investing in one or two stocks is much riskier than a portfolio containing ten stocks, for example. This is more like a casino than an investment.
And the reality is that it is very difficult to be diversified by investing only a few hundred or even thousands of dollars in the stock market. You'll need to have a fairly large amount of money to get started.
But does that mean that investing in the stock market is not for you if you don't have thousands of dollars to invest? Not at all. There is even a way to invest in a very diversified way starting from only a few dozen dollars: ETFs.
Active vs. passive management with ETFs
In our example above, I told you that on a PEA and a CTO, you pay fees every time you place an order.
If you decide to invest in an "active" way, i.e. to buy individual shares and to look for reselling and buying others frequently, it is thus a significant amount of fees that you will pay.
Yet this is still the image many of us have when we think of investing in the stock market. In reality, there is not only active management. Passive management - especially via ETFs - exists, and it offers many advantages...
Investing in ETFs: what are they?
ETFs (Exchange Traded Funds, also known as trackers) are investment funds that work a little differently: they are managed in a so-called passive way.
They are a kind of large basket of securities, which you can buy and sell as you would with an individual share.
The advantage of ETFs is that they allow you to invest in hundreds of companies in different sectors or geographical areas with one click.
More concretely, ETFs follow a benchmark index and aim to give you the same performance as this index.
Example
For example, an S&P500 ETF will track the performance of the S&P500 index, which is based on the 500 largest companies listed on the US stock market.
And the results are far from mediocre: between 2010 and 2020, the annual performance of the S&P500 was 13.6%.
Another example: a CAC40 ETF will itself invest in the 40 stocks that make up the CAC40. All you have to do is invest in the ETF, knowing that investing in the 40 CAC40 companies yourself would require you to spend thousands of dollars.
What you also need to know is that you have a much better chance of succeeding in the stock market by investing in ETFs than by choosing individual stocks.
A recent study showed that in 2019, after 10 years, 85% of investment funds in the US were underperforming the S&P500. And we are talking about investment professionals, whose career and profession it is to buy individual stocks to build their portfolios.
Individual investors are not much luckier - far from it - and a good part of them do not outperform the major indexes, but even worse, lose money in the stock market.
Why try in vain to beat the market when you can simply buy the market via an ETF?
And ETFs are not just for the budget-conscious: they are a great investment for the vast majority of investors.
Warren Buffett - Speaking of passive investing in the S&P500, a broad U.S. index
Note
If you buy ETFs from a PEA or CTO, you will also have to pay brokerage fees.
The difference is that ETFs are investments to be considered for the long term and that you should absolutely not "trade" (i.e. buy and sell frequently). The impact of fees is therefore much less important than for "active" traders or investors who will multiply the operations.
However, this should not prevent you from looking for a broker with the lowest possible fees.
I personally use Fortuneo for my PEA, and DEGIRO for my securities account.
And to invest in ETFs, you don't need to invest hundreds or thousands of dollars: most of them are available for only a few dozen dollars.
For example, the LYXOR UCITS ETF PEA MSCI WORLD which tracks the MSCI World index (which invests in more than 1,550 companies in 23 countries) is selling at the time of writing this article for only $24.
Even better: the broker Trade Republic allows you, for example, to invest in ETFs from as little as $10 per month or per quarter.
You create what Trade Republic calls a Programmed Investment Plan, select an ETF, and then you can invest only a handful of dollars in it.
Note
When investing in ETFs, you will have to pay an annual management fee.
These are fees charged annually by the ETF itself.
The advantage: they are extremely low, unlike the fees charged by traditional investment funds (0.33% on average).
Attention
This article is for information purposes only. Before making any financial decisions, consult a (real) financial advisor.
Investing carries a risk of loss.
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