How to Start a Retirement Fund with Almost No Money

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Many people I talk to want to do a better job of saving for retirement but don’t know where to begin. Maybe their employer offers a 401(k), but they don’t feel like it’s enough, or maybe they have no 401(k) at all and desperately need to get something started.

Many people also don’t have much money to get started with. They might want to start investing as little as $20 per month. The fee structures of mutual funds and the transaction fees brokers have for purchasing securities can make investing small amounts of money at a time very impractical, but that aspect of the investment industry is changing, and there are some new opportunities for small-time investing that weren’t there only a few years ago.

The Employer Retirement Fund (401k/403b)

If your employer offers a 401(k) or (403)b, it is a great way to pull money out of each paycheck before you have a chance to spend that money on junk. The employer retirement fund is a great “pay yourself first” tool. If it is a traditional 401(k) or 403(b) and not a Roth, it can also provide some tax relief.

The important thing to be aware of is if your employer matches contributions and–if so–how much they match. My employer matches my 403(b) contributions dollar-for-dollar up to a certain percentage of my income. I calculated that percentage to come out to about $15 per paycheck, so I put $20 per paycheck into that fund to ensure I will get every penny that they will match.

The nice thing about employer funds is that contributions are automatic and go into mutual funds. The downside is that there is usually a limited number of investment options, and often the fees are not competitive with what you could find in the open market. That is why many people who have a 401(k) or 403(b) elect to get an IRA as well.

The Individual Retirement Account (IRA)

An IRA is a great way to invest for retirement and take advantage of the tax benefits of retirement accounts but to have much more control than employer plans offer. With the right broker, your IRA can give you access to thousands of stocks, bonds, ETFs, mutual funds, and more. Almost the entire world is at your fingertips, and you can make trades online in an instant.

I started a Roth IRA two years ago so that I could put individual stocks in my retirement savings. I chose Options House as my broker because of their low fees of $4.95 per transaction. Options House was bought out by E*trade, so now my account is with E*trade. Thankfully, E*trade customer added the benefit of access to commission-free ETFs. My Roth IRA has a modest account balance, which I have invested in 3 stocks and an ETF.  I use it to make investments that I believe to by high-risk/high-return long-term investments, like stocks that have fallen heavily out of favor or other unique opportunities.

The Problem with Investing Small Amounts of Money

Let’s say that you want to start a retirement account and put less than $100 per month into it. Even at the low end of commission fees you would be paying $4.95 per transaction. That is not very practical for small amounts of money.

For example, with $100 you could buy one share of Microsoft (MSFT) stock for $98.70, except you would really have to pay $103.65 with the transaction fee, a 5% premium. Then a month later if you wanted to buy another share you would have to pay the fee again. You could wait a few months until you have a few hundred dollars and buy multiple shares at a time, but you probably want to start earning a return on your money now.

Commission-Free ETFs

An easy way to put small amounts of money to work right away is to look for a broker that offers commission-free ETFs. Commision-free ETFs help fund providers attract inflows and help brokers attract customers. They are win-win-win for the fund providers, brokers, and investing customers. When I use my E*trade account, if I buy shares of the Vanguard Total Stock Market Index ETF (VTI), I’ll pay E*trade a $4.95 commission, then pay Vanguard a 0.04% expense ratio. However, if I purchase shares of the iShares S&P Total U.S. Stock Market ETF (ITOT), I’ll pay E*trade no commission, and I’ll pay iShares a 0.03% expense ratio. ITOT is currently trading at $62.68 per share, so I could invest as little as $63 dollars at a time and not get punished for buying so little at a time like I would if I had to pay the commission.

Commission-free ETFs also allow you to ease your way into a fund without being penalized. For example, I recently wrote about a technical opportunity to purchase the Global X MSCI SuperDividend Emerging Markets ETF (SDEM) at a bargain price. Technical trades often work best if you invest small amounts at strategic times, rather than going all-in at once. SDEM being a commission-free ETF for E*trade customers allowed me to trade that way. The technical breakout did not happen and the share price is down from my entry point, but I did not risk a large amount of money because I knew I could always buy more shares later on the way up if I proved to be right.

The Limitations of Commission-Free ETFs

There are some limitations to commission-free ETFs. Each broker has its own list, so what’s cheap on TD Ameritrade isn’t the same as what is cheap for Charles Schwab customers. You may find a fund in the category you want, but it might not be the best fund in that category, and often it is not the cheapest in terms of expense ratio either. Do not just jump into commission-free ETFs assuming they are cheap. Check the fund’s expense ratio to see what it is going to cost you long-term.

Commission-Free ETFs by Broker

Note that each broker has its own little policies like early sell redemption fees that you will want to pay attention to if you are comparing services.

I am probably most impressed with Schwab’s selection of commission-free ETFs and its overall platform, fee structure, and customer service, but all of these brokers have something valuable to offer if you are trying to invest small amounts of money at a time through commission-free ETFs.

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