If you are looking to put a small amount of money to work, you're better off getting as much diversification as you can.
With investing, you have to get started somewhere, and $500 is a great place to begin. The key, however, is to build a foundation for the future with that cash.
Yes, you could buy a stock, but a better option will probably be an index-based pooled investment product, otherwise known as a fund. This is why you'll probably be best off with Vanguard Total Stock Market ETF (VTI 0.14%).
Saving is the key to your financial future
It isn't all that exciting, but the truth of the matter is that the first step toward a bright financial future is to live below your means. That's the only way that you will ever be able to save money to invest. Of course, before investing, you should probably create an emergency fund (in a bank account, CD, or other easily accessible but super safe account) with three to six months of living expenses in it. But once that's done, you'll be ready to start exploring Wall Street-related options.
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The thing with investing is that you can only buy so many shares of a stock with $500. Some stocks, like the Class A shares of Berkshire Hathaway (BRK.A -0.28%), are worth so much that you might not even be able to buy a single share. Companies in which you could buy a lot of shares, meanwhile, would likely be higher-risk penny stocks, which is not a space where most investors should be treading. To start, you want something conservative, and you want diversification.
The go-to for that combination is a fund, which is where a lot of investors pool their money together and give it to a financial professional to invest. Probably the best-known option here is a mutual fund, but most mutual funds require more than $500 to get in the door. Luckily, there's another option: exchange-traded funds (ETFs).
You will need a brokerage account
A brokerage account will be required to buy an ETF, but that's not a difficult thing to open up, and many brokers are happy to let you start with $500 (or less). The list is long, from E*Trade to Robinhood Markets. You'll have to fill out some forms and then send the broker your money.
After that's done, you should probably put your $500 into Vanguard Total Stock Market ETF. There are several reasons for this.
First, as noted, you will want to maximize the diversification you get with your $500. As Vanguard Total Stock Market ETF's name implies, it effectively owns a piece of the entire stock market.
There are over 3,700 stocks in the fund. It covers every market sector, with the largest exposure to technology, at roughly 31% of the portfolio. The smallest sector is basic materials, at just under 2%. There is a lot in between, like financials (10%), healthcare (12%), industrials (12%), and consumer discretionary (14%). You get the idea -- there's a broad mix of sectors and a lot of stocks in the ETF, providing you with a huge amount of diversification for a very small investment.
Vanguard Total Stock Market ETF is also extremely cheap to own. When you hire someone else to invest your money, which is what you are doing here, you have to pay them. The fee for that is called an expense ratio when you are talking about ETFs or mutual funds. This particular ETF has an ultra-low expense ratio of just 0.03%, compared to 1% or more for some mutual funds. You will be hard-pressed to find anything that would cost less to own than Vanguard Total Stock Market ETF.
You'll be able to build for the future
Putting your $500 into Vanguard Total Stock Market ETF will give you a foundation from which you can learn and grow, money-wise and knowledge-wise. There are some potential downsides, though.
You will never outperform the market, because what you own is the market. And, depending on the broker you choose, you will have to pay commissions (a trading fee) every time you buy or sell shares of the ETF (some brokers offer free trades, so you might want to make sure you work with one of them).
Neither of these issues are insurmountable headwinds and, frankly, most investors would be better off if they just did as well as the market and focused more of their time and energy on saving money as hard and fast as they can. But, to do that and invest, you still need a solid investment foundation, and that's exactly what Vanguard Total Stock Market ETF can provide even for as little as $500.
Reuben Gregg Brewer has no position in any of the stocks mentioned. The Motley Fool has positions in and recommends Berkshire Hathaway and Vanguard Index Funds - Vanguard Total Stock Market ETF. The Motley Fool has a disclosure policy.
