Got $500 to Invest in Stocks? Put It in This Index Fund. | The Motley Fool (2024)

For most investors, starting out will require building from a small base. That's normal. It takes time to create a large nest egg and you have to start somewhere. But it is important to recognize that starting small doesn't mean you can't build a good stock portfolio. It just means you have to go about it in a slightly different manner. If you have as little as $500 to invest in stocks, this is the index fund you should consider putting it in. Here's why.

ETFs are well structured for small investors

With $500 you can afford to buy a lot of different stocks, since many stocks have share prices below that figure. But you won't be able to buy a lot of different stocks at one time. And you won't be able to buy a lot of shares of whatever stock you choose to buy. (Yes, you could buy high-risk penny stocks, which trade for just pennies a share, but that's not a great plan for any investor, let alone a new investor.) Luckily, there's a better way to do it.

The quick answer is to buy an exchange traded fund, or ETF. ETFs are pooled investment vehicles, which means that they bring together money from a lot of different people and then use the larger, collective pool to invest. This allows the ETF to create a larger, more diversified portfolio than each individual investor would have been able to create on their own. The investors in the ETF have to pay someone to manage the ETF, with a fee known as an expense ratio, but the cost is usually quite modest. For the benefit of instant diversification this is usually a cost well worth paying.

Meanwhile, a lot of brokerage firms (you will need a brokerage account) offer free trading of ETF shares, so the costs are very low all around. That remains true even as you add more to your position over time by saving money and buying additional shares of the ETF. When you have enough money in the ETF and want to start trying your hand at buying individual stocks, you can just sell some of the ETF shares and buy the individual stocks you want to own. In other words, an ETF is a great stepping stone investment as you grow your portfolio, though you really don't need to move beyond a good diversified ETF if you don't want to.

For most investors starting with a modest stake, like $500, a nearly perfect ETF investment is the SPDR S&P 500 ETF Trust (SPY -0.13%).

The SPDR S&P 500 Trust ETF is a core holding

The SPDR S&P 500 Trust tracks the , as the name implies. The S&P 500 is one of the broadest stock market gauges, which basically means this one ETF allows you to own "the market." But this S&P 500 isn't just a random collection of stocks. The members of the index are selected so that the collective group of holdings represents the broader economy. So you aren't just getting a broad stock market proxy, you are also getting a broad U.S. economy proxy. And it gets updated regularly to ensure that the stocks on the list are the right ones.

On top of this, the S&P 500 is market cap weighted. This means that the largest stocks are given the heaviest weightings in the index. The largest companies are usually the best-performing stocks, so the SPDR S&P 500 Trust gives you broad market exposure that leans more heavily toward the best-performing stocks. During market transitions from bull to bear and vice versa, the largest stocks might not be the best ones to own, but most of the time market cap weighting is a net win for investors.

Then there's the cost, with the SPDR S&P 500 Trust having an expense ratio of just 0.09%. There are cheaper ETFs out there, but that's a very small expense ratio. Given the size of the portfolio and the goal of the ETF, the dividend yield is fairly modest at just 1.4% or so. If you are trying to build an income-focused portfolio, the SPDR S&P 500 Trust probably won't be a good fit, but for most other types of investors, particularly those just starting out, it will be a great option. You should probably set up dividend reinvestment, which instructs your broker to use any dividends to automatically buy more shares.

A great foundation to start with or own forever

One of the best things about the SPDR S&P 500 Trust is that the S&P 500 index is used by investors to track the market, so it is always being talked about in the media. You should be able to get a quick read on what's going on with the ETF without much effort at all. It is a great foundational investment that allows you to start investing and learn at the same time. In fact, you might even decide that it is the only stock exposure you ever want to own.