How to Invest in the Stock Market with a Small Amount of Capital

Retail equity investments have increased at a staggering pace since the stock market crash last year, propelled by the remote lifestyle that facilitated day trading as well as easier access to information and trading tools. The recovery in global economies has precipitated the market rally, as evident from the S&P 500 index’s 43.61% gains over the past year.

The United Kingdom’s FTSE 100 index has gained 20.06% over this period.

Stock market investments have historically provided the highest returns compared to other asset classes such as bonds or gold, making it an attractive choice among investors worldwide.

However, contrary to popular opinion, investors can begin trading with small amounts of capital, thanks to multiple new equity instruments introduced over the past couple of decades. Keeping up with the recent market news and industry trends can help investors reap solid gains through minimal investments.

Let’s take a look at the multiple ways by which retail investors can access the stock markets with limited capital and benefit from generous returns.

Exchange-Traded Funds (ETFs)

ETFs pool investments from investors to allocate capital in a basket of securities generally focused on a particular industry. The shares of such ETFs are designed through creation blocks, which are traded on stock exchanges. ETFs can be actively or passively managed.

Actively managed ETFs aim to maximize returns by capitalizing on the market movements, thereby bearing high risk. Passively managed ETFs, on the other hand, seek to replicate an index’s price performance. Such ETFs closely follow a benchmark index’s investment strategies and underlying securities, thereby generating nearly the same returns. As a result, passively managed ETFs tend to have a relatively lower risk compared to its counterpart.

Shares of an ETF can be traded just like equity securities during the market hours, at their Net Asset Value (NAV). The share price of an ETF tends to be identical for open-end funds, wherein new investments lead to the creation of additional shares. For closed-end funds, however, only a limited number of shares are issued during the initial IPO, following which they are traded in the secondary markets. Thus, the share prices depend on market forces and are different from the NAV.

Contract for differences

Another way to trade in the stock market is by using leverage instruments such as contract for differences or CFDs. A CFD is basically a financial contract that allows investors to trade securities over the short-term.

For example, if an investor wants to purchase a CFD of Apple stock which is trading at a hypothetical price of $100, the broker will generally want a down payment of 5% or $5 to complete the trade. In case the trader wants to buy 100 Apple shares worth $10,000 the total down payment will be $500.

Now after a month if Apple stock rises to $120 per share, the trader can exit the position with a total profit of $20 per share or $2,000. Alternatively, the trader can also lose $2,000 if the stock declines by 20%.
The use of leverage is a high-risk high-return game and should be played only by the most experienced traders.

401(k) Accounts

These accounts are offered by employers to employees, in which both parties make a contribution that can be invested in a pool of assets as per the employees’ choice. Investments made into 401(k) accounts are excluded from income tax calculations, making it ideal for working individuals planning to allocate a part of their salary into equity investments.

The base proportion of salary to be invested is decided upon by the employee, following which the employer matches the contribution, subject to pre-set limits. Also, employees can make after-tax investments in such accounts, provided the plan is offered by employers.

Traditional 401(k) accounts charge income tax upon withdrawal, typically occurring at retirement. Alternatively, investors can also choose designated “Roth” 401(k) accounts, in which the investment is taxed immediately during the contribution. However, the withdrawal is tax-advantaged.

Employees below the age of 50 can invest a maximum of $19,500 annually in 401(k) accounts. The limit is increased to $26,000 for people above 50. It should be noted that 401(k) account investments cannot be liquidated easily. Thus, investors should plan out their financials thoroughly and assess their short and long-term needs before opening a 401(k) account.

Every contribution made by the two parties can be invested in stock markets to purchase ETFs, allowing the investor to build long-term wealth.

Penny Stocks

Penny stocks are the riskiest choice among the three, as it requires investing in lesser-known companies having limited background information. These stocks, generally under $5, have immense growth potential, as the companies gradually gain significance.

Penny stocks are often traded over-the-counter, as underlying companies do not meet the prerequisites of listing or don’t have sufficient funds for a proper initial public offering (IPO). Such companies are often called multi-baggers, as their share prices tend to gain at an exponential rate in a bull market.

Investor optimism combined with positive developments and fundamental growth history over the past quarters are some of the key factors driving their growth. In this article you can take a look at some of the best penny stocks trading under $10.

While investors can bet on penny stocks with relatively low capital, the risk factor is extremely high. As these stocks are generally unheard of, they have low liquidity and a high big ask spread. Also, it might take some time for investors to witness solid gains on their investment, given the time frame required for companies to grow in the market.

Ensuring the fundamental strength or growth potential of such companies is crucial, otherwise, an investor might get caught in a “value trap”. Penny stocks have a high-risk high-return correlation.

Conclusion

Investors having a basic understanding of the stock markets should opt for pooled investment options such as ETFs or mutual funds, wherein all the decisions are taken by a highly experienced fund manager.

Retail investors having some knowledge regarding the markets, on the other hand, can allocate their funds directly in equity securities and derivatives, depending upon their investment goals. People willing to assume the high risk for high returns should invest in penny stocks, with more cautious investors can stick to the established industry giants or blue-chip stocks.


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