Reading Seeking Alpha articles is one of the best ways for investors of all levels of sophistication to up their game, and the comment streams are often just as valuable as the articles, if not more so. One thing that can be somewhat intimidating, however, is the fact that a lot of Seeking Alpha contributors and commenters appear to have way more money to invest than some of us do. It's not uncommon to read comments that say things like "I closed out my position when XXX was trading at $YYY.YY and made $100,000" and that sort of thing.
While the focus on big dollars is entirely appropriate, sometimes I wonder how much of the investing advice found on Seeking Alpha is appropriate for those of us who regularly invest but do so with relatively small amounts. Is the advice found here suitable for what I call "small potatoes" investors?
Generally speaking, I think the answer to this question is yes: good investing is good investing, regardless of the amount being invested. However, as those of us who seldom have more than a few hundred dollars to invest per month know, there are certain dilemmas we routinely face and these are the subject of this article.
How Much Money Should One Accumulate Before Making a Stock Purchase?
The first dilemma faced by the small potatoes investor is how much money to accumulate before making a stock purchase. If you can only invest $250 per month, should you immediately invest that $250 or should you wait until you've accumulated, say, $1,000 before making a stock purchase?
The reason it matters, of course, is because of the commissions you have to pay your broker every time you purchase a stock. I use ShareBuilder, and they charge $6.95 per trade. This means that if I wait to make a stock purchase until I have $1,000, I'm only going to pay $6.95 in commissions (0.695%). Alternatively, if I make a purchase every time I have $250, I'll end up paying $27.80 (2.78%) in commissions.
How much does that difference matter? The difference between the cost of commissions in the two scenarios described above is $20.85 [(4 x $6.95) - $6.95]. If you take that amount and assume a historically conservative 8% annual price growth over the course of the next 30 years, you end up with $209.81 in today's dollars. The corresponding amount in future dollars is $86.44 based on a 3% annual inflation rate. At more than 8% of your initial investment, then, this is a fairly substantial amount to lose.
In theory, if one took this observation to its logical conclusion, one would never invest but would instead simply keep accumulating larger and larger sums so as to render the commission cost a less and less significant percentage of one's investment. In reality, of course, this makes no sense because by delaying investing one would be missing out on the gains that were occurring while one waited. This example does, however, illustrate the point that one can miss out on a substantial portion of potential returns just by purchasing stocks in increments that are too small.
In my own investing, I've chosen somewhat of a middle ground between the two poles discussed above. I usually purchase stocks once I accumulate $500 or $600 in investible funds.
How to Build a Portfolio
A related dilemma for the small potatoes investor concerns how to go about constructing a portfolio. My impression is that for many investors buying a stock is something that is done all at once. For small potatoes investors, by contrast, establishing a full position in a stock may take years. This is because (1) one is investing only small amounts at a time; and (2) because the suitability of a company for investment may change over time, necessitating waiting for months or years until the company again becomes suitable for investment.
These issues raise the question: is it better to slowly build up a single position over time, or to first invest small amounts in a diverse set of stocks and then to make additional purchases of those stocks as opportunities in the market arise?
As an initial matter, slowly building a single position over time contains the same sort of risk that investing in a single stock always does, in the sense that a portfolio with one position or a mere handful of positions lacks diversification. On the other hand, given a significantly lengthy time frame, perhaps this isn't as big of a deal as it initially seems. If you invest in a single company over the course of one year, then a single different company over the course of the following year, and so on, after 30 to 40 years it may not matter that you constructed your portfolio in this way because you will end up with a properly diversified portfolio nonetheless.
The chief problem with this approach in my opinion is that it does not allow one to take advantage of the changing landscape of opportunities that develop in the market over the course of a year. If a year ago, I had decided that I would spend the next year investing in, say, Intel (NASDAQ:INTC), this might be a fine decision, but sticking to it would mean that I would not have been able to take advantage of other opportunities that may in fact have presented a better use of my investment dollars. Companies like Chevron (NYSE:CVX), McDonald's (NYSE:MCD), Target (NYSE:TGT), or countless others seem to have run into temporary trouble in one form or another lately, and not being able to invest in them may represent a substantial missed opportunity.
For this reason, I've taken the approach of investing small amounts in a number of companies initially. I will then add to these positions over the years as opportunities arise. This allows me to be more nimble in the seizure of opportunities. For example, a few months ago I had no intention of investing in Target, but after its recent troubles it has a dividend yield of over 3%, a 40+ year history of increasing it, and looks attractive by other measures, and so I initiated a position earlier today. Responding to this opportunity would not have been possible if I had instead elected to focus on investing in a single stock at a time.
Whether to Reinvest Dividends
Another dilemma faced by the small potatoes investor is the question of whether to automatically reinvest dividends or not. As an abstract matter, I tend to agree with many others that it is best to let dividends accumulate and then to select a suitable candidate for investment of those funds.
However, a small potatoes investor may not receive enough dividend income to make this a practical approach. If one's annual dividend income is a few hundred dollars, I do not think it makes sense to wait until one has accumulated, say, $1,000 because this could take 5 years.
For this reason, I automatically reinvest dividends for the time being, but plan to put a halt to this once my annual dividend income reaches a level at which manually reinvesting them makes more sense from a practical standpoint.
Being a small potatoes investor often feels a bit lonely. Nonetheless, I think it is important for those of us who count ourselves among their ranks to figure out how to address the dilemmas that we face. While many of the principles of investing will be the same regardless of the amount invested, we face special considerations when it comes to how much money to accumulate before investing, how to construct a portfolio, and whether or not to automatically reinvest dividends. In this article, I've laid out how I approach each of these dilemmas, but I'm very curious to hear how others approach them.