How a Financially Savvy College Student Would Invest $500
Have a small amount of savings that you want to invest? Meet Kyla. She is an honors student at Western Kentucky and she knows a thing or two about finance. In fact, she has an entire blog dedicated to a number of different investing strategies.
In this post, we decided to tap this financially savvy expert to share her advice to the average college student on how to invest an extra $500 in the bank to help you start making money with your savings.
Whether it’s money you received from a loving relative or earned from an internship, make sure you are being smart with it. Okay take it away Kyla!
College students and money. When the two are mentioned together, it seems that the phrase “not enough” should go in front of the word money. The sad saga of college students and not enough money.
Not enough money to handle the tuition payments, the car payments, the rent, all the expenses that officially make you an “adult”. It seems like every dollar that we earn passes right through our hands, off to pay some outstanding bill. On the occasions where we actually have a surplus, where we make more than we owe, it’s time for celebration. And the best way to celebrate is let that money make you more money!
Here’s where we utilize the stock market to our advantage. The market, which seems so abstract and confusing, is actually a really great place to invest your money (most of the time). Rather than letting your hard-earned cash sit in the bank, or underneath your mattress, we can utilize the intricacies of the marketplace to generate returns on our investment- let our money make money.
I’m going to describe two different ways that we, as college students, can invest in the market by either buying and holding stock or employing options.
The first is considered a “passive” strategy, where we buy, wait a few years, and then collect our profits. The last way is “active” which allows us to get out of the trade in about 45 days and use the laws of probability to our advantage. Don’t worry this all a lot easier than you think.
So let’s say that you earned $500 from a summer internship. Rather than placing it in a savings account, you decide to explore the different possibilities that the stock market offers you.
When we buy stock, it’s best to invest in companies that we know with products that we support. We would only buy stock if we expect the price of the stock to increase, thus we would only buy stock if we expect that the company is going to do well. Stick with companies that you know and love to start out with.
So if you really love yoga pants, buy Lululemon’s stock. Or if you love iPhones and iPads and iEverything, buy Apple’s stock. Target is a versatile company that has products that appeal to everyone, so let’s put our $500 in that stock for now.
Target is currently trading for $65, so we can buy 7 shares of it for $455. The good part about buying stock is that the potential profit is theoretically unlimited- the price of Target can keep on going up until infinity, which technically means that our profit literally infinite! Also, our potential risk is capped at what we invest in the company, in this case, $455 (7 shares x $65 stock price).
However, buying stock is pretty expensive, and we only can make money if the stock increases in price, which happens only 50% of the time. We can look at probabilities to get a gauge of where the stock should be in a certain amount of time. For example, there’s an 18% chance that the stock price will be above $70 in 33 days. But we normally invest in stock, meaning that we are planning to hold on it for far longer than 33 days (more like a few years). In that time period of a few years, the stock can do really well, or do really poorly.
Just to give you a gauge of median yearly returns, the SPY, which is an ETF (a particular type of stock) and common benchmark that tracks the market as a whole, has a yearly return of about 5.8%. Extrapolating that to our Target trade, that means we should make $25 a year with our 7 shares ($455*.058).
But it never works quite like that. According to a study of 30 broad stocks done by tastytrade.com, buying shares like we did in Target is profitable only 59% of the time. Also, the largest loss experienced was 65% of the original investment. In our case, we would lose almost $300!
Buying and holding stock is considered a passive investing strategy. We simply put our money in a stock, and cross our fingers that it will rise over time. With active investing, we rely on probabilities to deliver our profits, not blind expectation.
Active investing multiplies our returns, reduces our risk and the amount of time we spend in the trade, and uses the passage of time to our advantage. When we buy stock we can only make money 50% of the time. We spend a lot of time analyzing different stocks, reading market reports and financial artilces to make sure we are picking the “right” stock. But any stock that we pick is essentially a coin flip- a 50/50 shot to make money.
But why should college students care about active investing? To put it this way, why shouldn’t they care? As I mentioned earlier, we all need more money. Active investing is a way to achieve that goal.
Buying stock is passive trading. Let’s talk active trading.
Active trading is basically a bunch of different strategies that we can employ using “baby versions” of stocks, which are called options. There are 2 categories of options: calls and puts. Depending on the price of the stock that they track, these options cost anywhere from 1 cent to about $8.
Active trading involves combining calls and puts into different strategies. So rather than simply buying the stock outright, we would perhaps buy a put and sell a put (likewise, we could sell a call and buy a call. Or sell 2 puts. Or sell 3 calls and buy 1 put- the strategies on options are truly infinite!).
Most of us have savings accounts that we put our money in, earning about a 0.03% rate of return, if we’re lucky. “You’ll go broke saving money”, as the saying goes. That’s why we need to invest. However, when we invest in just stocks, utilizing the buy and hold strategy, our rate of return varies dramatically. With a 50% chance of earning a profit, the returns we might get on passive investing are decided by what is essentially a coin flip.
We simply buy, hold, and hope. But I like to consider us a generation of “do-ers”- people who hope, but also go and align the stars for themselves. Blaze our own paths. Push ourselves to create an environment for success. So let’s not simply hope anymore with our money.
Let’s broaden our universe and enter the world of options. Let’s risk ONE to make one, rather than risking it ALL. Contrary to popular belief, options do not complicate investing. Rather they provide leverage, enabling us to use strategies that cost less than $100 and have a high chance of making money (65%+) and can be implemented if we believe that the stock is going to go up, go down, or simply remain at the current price.
Compare that to buying stock. Simply buying often costs upwards of $200, depending on the stock we choose and the number of shares we purchase, and we only have a 50% chance of making money because we only make money if the stock price increases.
It takes just as much time to put on a put credit spread as it does to buy 1 share of stock. The difference? In one, you can place the trade wherever you please to generate whatever credit and probability of profit you desire. In the other, you are obligated to buy the stock at the price it is at, getting no credit, and settling for that 50% chance.
That’s another thing with active trading. Because we trade in 45 day cycles with options, we get our profits way sooner than we would if we traded stock. With stock, you generally have to wait a while (at least a year). What sounds better? A steady income provided by options, enabling you to put money to use when you need to, or locking your money away for a 1 year plus?
It is important to note that active traders can have a passive portfolio that they trade active strategies against. But the key thing to note is that when we limit how much we can make, like we do with options, we can increase the chance that we will make money. Sounds a little counterintuitive, but it makes sense. When we cap our upside, we increase the likelihood that we will experience success.
It’s kind of like setting the bar low for yourself. You say, “Okay, I’ll study for this exam and write this paper.” But in reality, you could be studying, writing the article, completing some reading assignments, and doing some MindSumo projects! But because you gave yourself a lot of time to do a few things, the probability that you get them done should be high.
But active trading is more about just making money (although you can read all about how to do that on my blog scanlonstocks.wordpress.com). It’s about learning to critically analyze the information given to you to place bets on the marketplace, using the laws of probability to our advantage. You don’t need to know any advanced math (trust me). The trading platform does it all for you.
No more sitting back and hoping the market will work for you. This is about jumping in and paving your own path. It’s about self-empowerment. It’s about taking calculated risks, and learning more about ourselves and the world that we live in.
The key thing to take away is that there is a lot that you can do with $500. You could simply put it in your savings account, getting about $0.03 cents per year, or you could place it in the market. When you move into the market, you could buy stock, and let it sit through market fluctuations for a few years.
OR you take control of your finances and utilize options to your advantage.
Options can be implemented in all types of stocks, which makes them incredible tools to profit from different market environments. The biggest setback with buying stock is that the stock HAS to increase in price. When we play with options, the stock can go up, down, and all around, and we can still make money. This empowers us to use our money to make money over shorter time periods. We can use the passage of time to generate additional profits. We can also manipulate probabilities, rather than settling for a 50% chance of being successful. So, basically, use your money to make money, and actively trade!
Looking for a way to earn a few extra dollars to invest? Don’t forget to check out our challenges on the MindSumo contest page.