Ideally, we would all have $100k+ in our trading account. That way we could allocate at least $10k into 10 different positions as I suggest in my eBook. Commissions would be a rounding error on trades of that size. Obviously though, that’s not realistic for everyone. We all have to start somewhere and scraping together even $10,000 to invest is no small feat and an accomplishment one should be proud of.
Unfortunately though, it’s very difficult to grow an account of that size. With 10 positions of $1,000 a piece, commissions become much more of an issue. For example, taking into account a single entry and exit at $9.99 a trade at TD Ameritrade, you would start out each trade 2% in the hole! If you stagger your entry or exit, a strategy I sometimes advocate, you will have to make even MORE, just to break even!
All that said, here are my recommendations for those trying to grow a small account:
Passive Investment via VTI
Passive investing is not something we generally advocate here at DIY Investor. However, actively trading a small account is a great way to potentially have commissions and small losses grind the size of your account down to a nub. This is a case where it MAY be appropriate to consider putting that money into a low cost ETF that provides exposure to the ENTIRE US stock market. For this approach, I recommend the Vanguard Total Stock Market ETF (VTI) that sports a rock bottom fee of only 0.05%. Further, you could look to add to this position anytime the stock market sags. Obviously, this tactic is not without risk. You could happen to buy in at a multi-year stock market top and be forced to extend your hold time out for years or even DECADES just to be made whole. That said, the US stock market has an uninterrupted history of rising over the long haul and the ~2% annual dividend yield will help smooth out the bumps to some extent.
Reduce the number of positions and focus on ETFs
Instead of having 10 positions of $1k each in a $10k account, you could look at dividing the account into 4 positions of $2,500 each with at least 3 of these positions invested in ETFs (or cash). To state the obvious, stocks are risky; especially the high valuation, growth stocks that I prefer. Any of these companies can unexpectedly preannounce lowered earnings or growth guidance, announce a secondary offering, or have a scandal involving upper management come to light. In any of these types of situations, you could easily be facing a double-digit gap down overnight. With 10+ positions, a single blowup won’t have an outsized impact on your account the way it would if you only hold a few positions. One way to mitigate this risk, is to shun concentrated exposure in a single stock in favor of an ETF. ETFs provide instant diversification. They aren’t likely to fall apart the way an individual stock can. The flipside though is that ETFs generally won’t have the explosive upside potential of a growth stock. For example, with an ETF you’re not likely to see a near 15% gain in two weeks like we are with OCLR, our 821x model trade. But again, never forget that your primary job as a DIY Investor is to manage risk. Throwing caution to the wind because you let greed get the best of you is a fantastic way to blow up your account!
Add margin to double your purchasing power
If you know how grow to your investment account, it follows that the more money you have to invest, the more money you will make. Multi-millionaires from Warren Buffet to Donald Trump understand this and are therefore not shy about leveraging debt to compound their wealth at an accelerated pace. We can employ this very same tactic by adding margin to our trading account. With margin, the cash and securities in your account amount to a 50% down payment on a line of credit provided by the brokerage; effectively doubling your purchasing power. It should go without saying that while margin allows you to grow your account balance twice as fast, it can also destroy your investment capital at double speed as well. Use margin responsibly, if at all.
That said, if you are disciplined, I believe deploying margin is an excellent strategy for growing a small account. You can use it to increase your position size and/or add more positions. If you would like to pursue this tactic, one online broker stands head and shoulders above the rest; Interactive Brokers (IB). As I write this, an IB margin loan rate on an account size of less than $25,000 is 1.91% compared to TD Ameritrade’s 8.75%. Furthermore, the commissions are also significantly lower, provided you’re not completely inactive.
I used to have five trading accounts at five different brokers. Now, not counting my IRA, I basically ONLY use Interactive Brokers. Only you can decide if it’s appropriate to use margin in your account, but it is nice to have the option available. Whatever you do, never forget: USE MARGIN RESPONSIBLY!
Imagine you’ve been falsely imprisoned. Having exhausted every conceivable avenue to prove your innocence, you are forced to contemplate the very real possibility of spending the next several decades in jail.
Years of fighting the system have taken their toll. You begin to think that it might be easier to just accept your fate. It’s what anyone else in your position would do, you tell yourself. Besides, they provide all the necessities; food, shelter and clothing. The prison warden even rewards well behaved inmates with short yard breaks on the weekends.
Fortunately, you snap yourself out of it. Who are you kidding? You weren’t meant to live life as a captive. You were born to be free!
So you start plotting your escape. Every day you start chipping away at the walls that imprison you. Every chunk you break out brings you one step closer to your eventual liberation.
Now suppose someone you trust comes along and offers to help. More hands working together means you can reach your goal faster, so of course you gratefully accept.
The next day, while you’re busting your ass trying to make as much progress as you can, you start to wonder where this “helper” is. At the end of the month, he finally wanders in with a toothpick and chips a few grains of sand out of your escape tunnel before disappearing for another month.
At first you’re speechless. WTF? But it doesn’t take long for you to finally tell this dude, “You know what? Thanks but, nevermind.”
So in this simple parable of your quest for freedom, who does this ineffectual helper represent?
Your bank or credit union.
At my credit union, savings accounts pay a paltry 0.2% annually and a money market account isn’t much better at 0.3%.
So you’ve scrimped and saved your way to an impressive $50,000 and all your “helper” does is chip in a measly $12.50 in interest your first month. Ugh. Nevermind.