$5,000 to Invest
Q: If I have 5k to invest, what should I do with it? I see articles on this topic on financial websites, but they always seem to recommend things like index funds. What would you suggest?
A: "7 best ways to invest $5,000" or "How to invest $5,000" or "What to do with $5,000" or "10 stocks to buy if you have $5,000." These kinds of articles are a dime a dozen online. Most of them are just naked clickbait, but they do answer a genuine interest in what novice or amateur investors can do with relatively modest amounts of capital. A lot of these pieces recommend specific stocks, which should give anyone immediate pause – those posts can become out-of-date very quickly, even if their recommended stocks were good options in the first place (a big if). Others put heavy emphasis on index funds, which is something I have cautioned against.
So, what would I recommend for someone with a small-to-modest amount of capital to invest?
First, the amount matters. It's hard to replicate my own approach with relatively small-dollar amounts, so this is a situation where I wouldn’t necessarily recommend copycatting my strategy. To be frank, at modest amounts I don’t think there’s any harm in putting it into an index fund.
But if you’re willing to put in a little more effort and if you feel like you can identify a company or two that has attributes that exceed what you put into an index fund, then you might try to focus on some of those companies instead of an index fund.
Let's think of this in terms of four quadrants defined by quality and valuation (see figure below). If you plotted all companies held in an index fund, you’d probably end up with a spread across all four quadrants.
From a value investor perspective, however, one of those quadrants is vastly superior to the others: high quality companies with relatively low valuations.
Why High Quality? How many underperforming companies go on to do great things? Sure, there are going to be some success stories, but they’re rare. You’re really playing the lottery at that point. I'd rather find a company that has a record of strength. It doesn’t have to be elite, but at least above average – maybe something operating in a duopoly where there's only a handful of competitors, and they've owned the industry for a long time. If you want to figure out what steps I take to try to define such companies, read about how I conduct due diligence.
Why Low Valuation? Valuation can kill even otherwise smart investments. You can nail the company, but if you overpay, you're going to have a hard time making good money. Every asset has a price that's justifiable and another that’s completely unjustifiable at a different level. If I find a company that's high quality/low valuation, then I want to dig in now. Otherwise, I put them on a list to wait for a situation where the market is reacting to something short-term or superficial, and value falls while the company itself remains strong.
Of course, as with everything, the devil is in the details. How do you determine whether something is overvalued or not? Beyond the due diligence I conduct, it also helps to be guided by a well-reasoned, underlying investment philosophy. For more information about that, read How GDS Invests.