How to Invest Small Amounts of Money Every Month
Congratulations! If you are investing set amounts of money every month, you are dollar cost averaging! That simply means that you are buying more stock when prices are lower and less when they are higher. Some folks think this is a great way to avoid volatility in the market because their investment "averages out" over time.
Many publicly traded companies have made it easy for those on tight budgets to buy stock through DRPs, also know as Drips. DRP stands for Dividend Reinvestment Plan. They and their cousins, Direct Stock Purchase Plans (DSPs), are great ways to invest small amounts of money cheaply by allowing you to bypass brokers (and their commissions) by buying stock directly from the companies or their agents.
More than 1,000 major corporations offer these types of stock plans, many of them with fees low enough (or free) to make it worthwhile to invest as little as $20 or $30 at a time. Once you are in the plan, you do not even have to buy a full share each time you make a contribution. Most Drip investors buy a set amount of stock on a monthly basis, thereby dollar cost averaging over the life of their investment.
Here is how they work: Drips allow you to reinvest dividends into more shares of stock and allow you to purchase stock in fractional amounts -- meaning that if you want to spend $100 buying shares of Microsoft, you can do so regardless of what the price of one share of Microsoft may be. So, if Microsoft is selling at $75 a share, you'll buy 1.33 shares of it with your $100; if the stock is selling at $125 a share, you will get 0.8 shares of Microsoft.
Many Drips will set up an automatic payment plan for you, so you never even miss the money you are setting aside for your future. While you have to keep good records for tax purposes, Dripping for dollars can be one of the surest, steadiest ways to build wealth over your lifetime.
However, what if you want to invest in a company that does not have a Drip plan? There are some Internet-based companies that offer many of the same services of regular Drip programs, with ultra-low commissions (less than a five-spot in most cases). Companies such as ShareBuilder allow you to set up Drip-like accounts where you can buy shares of any of 4,000 stocks (and many index funds) for as little as $4 per transaction.
Make sure you understand how these plans work. ShareBuilder charges a bit more to sell a stock ($15.95). That is not going to be a problem for Drip-type investors, but it is something to keep in mind if you think you will be an active trader. Also, like Drip investing generally, the share purchases for any of these companies are not made according to your schedule -- but all offer real-time trades for those few times you need to act quickly.
To evaluate whether these services are good deals, let's consider the rule of not allowing your trading cost to exceed 2% of your total transaction. The lowest fee available from ShareBuilder is $4, so that would mean you would want to invest at least $200 at a time to stay within the limit (2% of $200 = $4). If you cannot come up with $200 each month, though, just stash the cash in a savings account until you get there, and then make the transaction.