Strategies for Investing on a Budget

By Tamara Rutter | September 18, 2012

At The Motley Fool, we believe great investors are made, not born. That's why we're celebrating Worldwide Invest Better Day by zeroing in on the building blocks of investing.

Most of us wish we had more money to put to work. Luckily, there are countless ways to begin investing that don't require hundreds of thousands of dollars in starting capital. From direct purchase plans to choosing the right discount broker, here's how to master investing on a budget.

Basic training

A little money can go a long way if invested wisely. However, for your investments to grow, they need ample time to appreciate in value. A simple rule of thumb is to invest only money that you can afford to keep in the stock market for a minimum of five years. You'll also want to pay down any high-interest debt.

Now that we're debt-free and ready to rumble, let's scrape together some cash and explore our options.

DRIPs and direct stock purchase plans

A great way to save on brokerage fees is to buy stock directly from the company. One way to do that is through dividend reinvestment plans, sometimes called DRIPs. Direct stock purchase plans are another great way of investing without paying costly commissions. More than 1,000 publicly traded companies offer DRIPs, including favorites such as Johnson & Johnson (NYSE - JNJ) and Paychex (Nasdaq - PAYX) that don't charge fees. However, some companies do charge low fees to participate.

Because there are numerous ways to enroll in these stock plans, I encourage those interested to visit the Fool's DRIP Portfolio. There you'll find specific details on how to invest in DRIPs and a list of companies that offer such plans.

Discount brokers

Another way to invest in the stock market without getting hammered by pricey transaction fees is to use an online trading firm such as E*TRADE (Nasdaq - ETFC). Most discount brokerage firms let you buy and sell stocks at low, flat-rate commissions, and many offer worthwhile perks and incentives as well. For example, both TD AMERITRADE and E*TRADE offer investors commission-free Internet trading for the first 60 days after opening a new account.

However, you should carefully weigh the pros and cons of each discount broker before diving in head-first. Be aware that on top of trading commissions, some brokers will charge you other fees, such as maintenance fees, wire transfer fees, annual fees, or account inactivity fees -- to name just a few. The Motley Fool's Getting Started With Brokers tool lets you compare brokers to find the one that best fits your investment budget.

Invest in blue chips

Once you're up and running with a discount brokerage firm, you'll need to begin researching stocks. Most online brokers offer easy-to-use research tools and stock screeners. A good place to begin your search is with large-cap companies, often called "blue-chip" stocks. These are some of the largest corporations on the Dow Jones Industrial Average.

General Electric (NYSE - GE), which has a market cap of more than $230 billion, and Coca-Cola (NYSE - KO), whose market cap is above $170 billion, are both examples of blue-chip stocks. Similar to other blue-chip companies, GE and Coke both have a proven track record of stable profits, reliable growth, and uninterrupted dividend payouts that span not just years, but decades.

Dollar-cost averaging

Another great way to build wealth on a budget is by dollar-cost averaging. By investing a fixed amount of cash every month, you're able to buy more shares when prices are low and fewer shares when prices are high. Over the long haul, this strategy can provide a safe haven from Mr. Market's mood swings.

Index funds

The Dow and the S&P 500 are both examples of indexes. By choosing to invest in an index fund, such as the S&P 500, you're purchasing a mutual fund that buys shares of each of the 500 largest companies by market cap in the United States. The idea when investing in a broad-market index such as the S&P 500 is to mirror the performance of the overall stock market.

Unlike most mutual funds, index funds are not actively managed -- meaning a fund manager doesn't choose the fund's investments. That's a good thing, because it cuts down on the operating fees that funds charge you to pay a fund manager's salary.

Perhaps that's one reason an investment in an S&P 500 index fund has traditionally returned about 10% annually, whereas less than 20% of actively managed large-cap mutual funds outperformed the S&P 500 in the past 10 years. Therefore, if you're going to put your money to work in a fund, it's our Foolish belief that it's better off in an index fund. Overall, index investing can be a cheap way to get a diversified portfolio without the hassle of choosing individual stocks.

Foolish bottom line

You don't need hundreds of thousands of dollars to begin investing. In fact, small amounts of money invested over a long period of time will do the trick. As I mentioned earlier, if you're new to the game, a great place to start is with a leading blue-chip stock like General Electric. The company has proved over generations that it can withstand any economic storm and continue to reward shareholders.