The surprising benefits of 'micro-investing'

Summary: The practise of making regular deposits into an investment platform to achieve growth can reduce risk and deliver long-term returns.

Key take-out: For the value of your small change, you could develop a surprisingly sophisticated investment portfolio.

Micro-investing platforms, allowing people to aggregate small amounts of money into a more significant sum, are becoming increasingly popular.

These types of investment platforms simply allow people to deposit a small, regular amount of money into an account as little as a couple of dollars on a daily or weekly basis, which compounds over time.

The more I have thought about micro-investing, the more I think that it may be a more profound addition to the investment landscape than it appears at first glance.

A gentle introduction to volatility

I think the biggest challenge for investors is around reacting to market volatility. I often refer to a US based study that the financial services firm Dalbar produce each year, which finds that because of the way investors tend to withdraw money from the sharemarket when prices fall, and invest more when prices rise, they generally capture less than half of the average share market return that's on offer.

Micro-investing provides a very gentle exposure to market volatility as investors are using such small, seemingly insignificant amounts of money and also very gradually growing a portfolio over time.

A person who borrows $30,000 through a margin loan faces a $3000 loss in the case of a market decline of 10 per cent.

A person starting out with a microfinance portfolio of $1,000 faces a far more modest loss of $100, while being able to use the market downturn to continue to invest in small, regular amounts while prices are low.

Filling the superannuation gap

One statistic that surprises me follows that it was not until July 1, 2002, that the compulsory superannuation contributions increased to 9 per cent.

In 2013 and 2014 those contributions increased to 9.25 per cent and then 9.5 per cent respectively. The point of raising these figures is that while we know that there is a ‘superannuation shortfall' between what most people would like at retirement, and what they actually end up with, relatively recent increases in superannuation contributions mean that gap is closing. Micro-investing might be able to close that gap further.

Consider a person who jumps into micro-investing at the age of 18 and continues that habit until retirement at the age of 65.They invest $35 a week over this period, with investments increasing with inflation. Assuming a rate of investment earnings of 6 per cent per year above inflation, the balance of the portfolio at age 65 will be around $340,000 in today's dollars.

For a person or couple earning a reasonable income and building a superannuation portfolio, and perhaps having paid off a mortgage, then this extra $340,000 will put them in a much better position to be funding their own retirement.

Albert Einstein is said to have described compound interest as the “eighth wonder of the world”. Micro-investing may be a great way to participate in this wonder with small regular investments, exposure to the superior (albeit volatile) investment returns from growth assets and the re-investment of income as it is received by the portfolio.

Start saving with a surprisingly sophisticated investment portfolio

One of the challenges for many people looking to get started on the investing path is that most managed investments include a minimum of $1000-plus. Micro-investing, on the other hand, provides a nice solution to that problem, presenting a well-diversified portfolio accessible with small amounts of money.

Charlie Munger, from Berkshire Hathaway, had the following suggestion for people:

“Spend less than you make; always be saving something. Over time it will begin to amount to something. This is such a no brainer.”

My observations are that most people live on one side or another of a tenuous financial balancing act, either saving a little more than they earn, or spending a little more than they earn and then struggling with credit cards and consumer debt. Micro-investing seems to be a handy system to try and keep yourself on the much happier saving side of the equation, potentially building that saving habit from early.

It was an enthusiastic friend of mine by the name of John, who introduced me to the idea of micro-investing and since I'm always keen to give new financial systems a go, I took the opportunity, and jumped in.

Seven months on I still haven't really noticed the money coming out of my bank account and going into my ‘electronic piggy bank'. I've not only accumulated around $2700 with little effort, I can see the long-term benefit of sustaining this habit.

At a broader level I can see how useful micro-investing potentially is in helping develop saving habits, building a pool of wealth that supplements superannuation savings and helping people understand market volatility and accessing the power of compounding investment returns.

For more information on making regular automatic investment contributions, contact the InvestSMART portfolio services team on invest@investsmart.com.au