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Once you’ve successfully secured an income, balanced the budget and built up an emergency fund, it’s time to think about how to best employ the excess cash generated from the surplus.  Everyone starts somewhere, but all great things come from small beginnings! Let’s discuss a range of ideas that small investors can use to get started.

The first decision to be made is what purpose this cash will serve.

Ask yourself these questions: Is it for retirement? Is it for a future house purchase? What about future education expenses? Is it simply to save up for a vacation later this year? This will help determine what sort of account is ideal (taxable, IRA, Roth IRA, 529, etc.) as well as the strategy to be employed based on risk/reward factors.

Here are just a few ideas to consider when thinking about the range of options available to small investors:

• Savings account
• Certificates of Deposit
• Fractional share investing
• Shares of stock
• Mutual funds
• Exchange Traded Funds (ETFs)
• Employer-sponsored retirement plan (such as a 401k or 403b)
• Paying off debt
• Education for future earning potential

Savings Account

The benefits of having a savings account at a bank is that it will not lose value, assuming the bank remains in business and is insured by the FDIC up to $250,000 per depositor.

This is a good option if the purpose of the funds is short-term, meaning that the cash will be called upon to pay for an upcoming expense within the next twelve months.

The money is readily accessible and is not required to wait until a maturity date to be withdrawn.

The downside is that this is not likely an investment that is going to maintain purchasing power in line with inflation. Keeping too much in a savings account for too long is bound to work against an investor, particularly if their plan depends on at least maintaining the same purchasing power over many years.

Certificates of Deposit (CDs)

This generally produces a higher interest rate than a savings account, due to the fact that the invested amount is locked in for a period of time (for example, one year) during which the investor cannot access the funds without a penalty.

Think of it this way: banks are paying you for the benefit of having the cash long-term, making it less likely they will have to pay out the amount back to the investor before the maturity date.

This can be a useful investment for more medium-term goals. For example, if there is a goal to renovate the kitchen in the next year or two, but it is not something which is going to require an emergency withdrawal, then using a certificate of deposit might be beneficial to keep the cash amount growing.

The downside is that, depending on the inflation rate, it may or may not keep up with inflation. You may still risk losing purchasing power over time, but you will still be ahead of where you would be if the funds were left in cash.

The upside is that you will be paid the interest regardless of market movement; this allows you to avoid the risk associated with investing in a stock or bond.

For more ideas about low-risk investing, follow this article with Do Risk-Free Investments Exist?

Fractional Share Investing

If you have a very small amount to invest, and you’re willing to put it at some level of risk, then investing in fractional shares may be an option. While typically one thinks in terms of investing in whole shares of a stock or ETF, the price of a whole share may be more than one has available to invest at the time.

Investing in fractional shares can make it easier to periodically invest a set amount of cash in a stock or ETF without needing to worry about its price being lower or higher from month to month. It also makes it much easier to diversify across several companies, sectors or styles with only a very small investment.

Of course, investing in fractional shares is going to carry with it the same risk as investing in whole shares: there is always the risk of loss of value. By remaining diversified, however, the company-specific risk can be largely reduced so that what happens to the overall economy is the greater influence on your portfolio value than what happens with one specific company.

Many online brokerage platforms now offer the purchase of fractional shares, giving you easy access to the power of diversity with even a small starting amount.

Shares of Stock

Alternatively, you may have sufficient funds to purchase whole shares of stock. Before doing so, it’s extremely important to understand the risks being taken on by ownership in a share of a company.

If the company goes under, there is the risk of stock value going to zero.

A word against penny stocks: risk of loss is especially high for “penny stocks,” which should be avoided entirely. If you choose to speculate in penny stocks (gambling against the odds), anything more than 5% of your total portfolio amount would be far too much risk for very unlikely reward. I’ll say it again: penny stocks should be avoided, no matter how attractive their story is. They are worth pennies or a few dollars for a reason.

Excluding penny stocks, the stock market holistically has the capacity and likelihood to grow in value above and beyond the rate of inflation over the long-term. The reason for this is their ability to become more efficient in their operations and expand their customer base.

Investing more than you can afford to lose in a single company takes on too much risk for not enough chance of the desired reward. But investing in a diversified mix of stocks (different styles, sizes and/or sectors) helps reduce unnecessary risk (termed “unsystematic risk”) and make the risk/reward ratio much more attractive. It’s all about weighting the odds in your favor.

To learn more about balancing risk and reward, check out Asset Allocation: Are You Getting Your Best Return?

Mutual Funds

If you’re less interested in choosing your own assets to be included in your investment portfolio, a mutual fund is one way to allow a professional manager to make investing decisions for you within the confines of their stated goal.

If you are investing outside of an employer-sponsored retirement account (such as a 401k or 403b), there are two main share classes that are generally available: A shares and C shares. You will want to familiarize yourself with the difference, because the fees are charged differently between the two. A shares structure their fees with the long-term investor in mind, and C shares structure fees that are often more suited to a shorter time horizon.

The downside of mutual funds is that there is, of course, a fee associated with them. Keep in mind that some investing platforms may also offer other “share classes,” as they are called, that may have lower fees than A or C shares.

If you were buying and selling individual stocks and bonds yourself, then transaction fees (if applicable) would be the main thing to consider. But having a professional manager can free up your time to focus on your specific expertise and earnings potential, as well as providing you the downtime that many prefer instead of researching and concerning themselves with markets day-to-day.

Exchange Traded Funds (ETFs)

While mutual funds are bought or sold at end-of-day prices, exchange traded funds can be bought and sold intraday at any time during open market hours. That means they can be bought and sold faster. This aspect is not exactly a huge difference to the long-term investor.

ETFs, like mutual funds, are pooled investments containing many assets within a share. They tend to be cheaper than mutual funds, because they are often more passively managed than are mutual funds. Depending on one’s risk tolerance and objectives, passive versus active management may be one consideration when deciding between ETFs and mutual funds.

Employer-sponsored retirement plan (a 401k or 403b)

There are various types of retirement plans sponsored through an employer, two of the most common ones being a 401(k) or 403(b), or the Roth version of either. While each one will allow for different investment choices, the participant will usually be able to select among a limited number of mutual funds, and sometimes stock shares, ETFs, or other investments.

Mutual fund fees within an employer-sponsored retirement plan are usually cheaper than A or C share mutual funds.

The reason that assets within an employer-sponsored retirement plan are often ideal for small investors is because it’s very easy to simply allow your employer to withhold a certain percentage or dollar value from each paycheck to automatically save into your plan.

It’s important to remember that you usually still need to make choices within the options that they provide, but it can provide a simple and automatic way to make sure you invest regularly and on time.

Paying Off Debt

While this isn’t an investment vehicle, per se, it’s an option to consider if 1) cash flow is tight, 2) the interest on the loan is high or 3) you want more equivalent return than a savings account or certificate will provide, but not so much that you have to take on market risk.

This might be a good choice under a variety of circumstances, particularly for medium-term goals that you’re looking to achieve in 1-5 years.

Also remember, though it may be comfortable to be debt-free, it’s not always the most effective action to take if you’re comfortably able to cover the debt payments that feature a low interest rate. If you’re a long-term investor, there are better ways to employ capital.

So, for example, if someone is 55 and planning to retire by age 60, they might reasonably consider putting their excess income toward the payoff of their mortgage rather than investing in an all-equity strategy that may or may not be higher after the completion of five years. Because cash flow is going to be a major focus once they give up their earned income in five years, paying off debt may be crucial to their long-term success.

If he or she is paying a mortgage interest rate of 4%, then it’s as though each payment made on the principal is the equivalent of a 4% annual return on investment without being subject to market risk.

Education for Future Earning Potential

Investing in yourself can be one of the greatest uses of excess cash, especially if you still have many years before average retirement age. There are a number of credentials that can be pursued, with of course a college degree being perhaps the most obvious, but also such things as Microsoft Certifications, for example. Coursera also offers excellent programs for earning certificates and furthering your education.

Depending on your chosen line of work, you might do a web search of credentials that could be earned, or simply courses that can be taken to improve your knowledge as well as your marketability. This brings the money-making process much closer to home, and allows you to wield more control over your individual day-to-day financial situation in the present.

Conclusion

This is not a comprehensive list of all assets or strategies that are available to a small investor, but this may provide a start to thinking about the best employment for your excess cash in the early days.

As author Robert Kiyosaki teaches with his game Cash Flow, you start out with small deals. When I first started investing at my first job, I could only afford about $3,000/year. It was difficult to convince myself that it was making a difference to my future, but many small habits over time added up. And they can for you too!

Though small investments may not seem like much in the moment, if you invest wisely, the odds are that a well-diversified portfolio will grow with time and eventually allow for the big deals when they come along.

As they say, the first million is the hardest. But when the momentum shifts from trading time for money to allowing your money to work for you, you free up your time in order to accelerate the scaling of your residual income.

The proverb rightly states, “A journey of a thousand miles begins with a single step.”