Micro-investing is the process of routinely investing small amounts of money. Many people participate because it is easy to set up, and the amounts of money invested each time are so small that you won’t even notice the money has gone into an investment account. Micro-investing may be particularly appealing to people new to investing, who don’t have much money saved up, are intimidated by it, or don’t believe they can afford to invest. Let’s review what Micro-Investing is and what it gets right and wrong.
In This Article
How Does Micro-Investing work?
There are a number of Micro-Investing apps with a low barrier to entry and the ability to connect your debit card to round up your loose change, one of the most popular apps being Acorns. Once your account is linked, the App will round up your purchases to the nearest dollar and automatically invest the difference. For example: if you spend $13.25 on lunch, the App will round it up 75 cents to the nearest dollar, which would be $14. As a result, you would buy 75 cents of investments. And, this would continue to occur every time you make a purchase. Pretty simple, now let’s continue and look at two components that Micro-Investing gets right: Automation & Diversification.
The Financial Strategies That Micro-Investing Gets Right
Automating your investments so that they consistently occur over a long time is one of the ingredients of a successful financial plan and is essential to reaching your goals; you can literally ‘set it and forget it.’ Consistently investing in the stock market has the added advantage of evening out market volatility. When market prices are down, you will naturally buy more stocks since they have become ‘cheaper.’ When the market is up, you will buy less since prices are higher. This is also referred to as ‘dollar-cost-averaging.’
Diversification is spreading your investments broadly to minimize the risk of having ‘all of your eggs in one basket,’ and the easiest way to accomplish this with stocks is through the purchase of different types of index or exchange-traded funds (ETF’s). These are the best way to invest in the stock market because they provide instant stock diversification at a low cost.
Despite utilizing automation and diversification to its advantage, Micro-Investing falls short for the following reasons.
The Financial Strategies That Micro-Investing Gets Wrong
- Short-term savings don’t belong in an investment account: if you need to save up an emergency fund, buy a car or put a down payment on a house, the last place you should put the money is in the stock market. Stock market investments are very difficult to predict over the short term so if you need cash, keep it in cash. Don’t risk it.
- Investing when you should be paying down debts is a mistake: especially credit cards, school loans, personal loans, car loans, etc. Always address the highest interest debts first and eliminate them before investing in a taxable investment account like those used for Micro-Investing.
- Confusing spending for financial progress: Spending money is the opposite of saving. Many people who are participating in rounding up their spare change feel good when they spend money because that means they are saving, right? Well, that isn’t necessarily the case. For example, if you spend $100.01 (therefore, invest 99 cents by rounding up to the nearest dollar), but you should never have spent that $100 to begin with-you just lost much more than you invested!
- Feeling a sense of accomplishment that is out of proportion to the amount of financial progress you are making: This is the biggest danger of Micro-Investing; rounding up your spare change will not be adequate to reach your long-term goals. If you want to learn how to identify how much you need to save to reach your goals, it all starts with your Savings Rate.
Micro-Investing distracts us from the fact that financial progress does not begin with a taxable brokerage account like these. Financial progress begins with eliminating consumer debt, building up an emergency fund of cash, and contributing at least 15% to your retirement accounts. The key to the growth of your investments is that you have an adequate Savings Rate and that your investments are bought and held over several decades so you can enjoy the power of compound interest. If you are looking to save (and not necessarily invest), consider a high-yield savings account where you can set up automatic transfers; you don’t need a micro-investing app for that.