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June 24, 2015

How to Invest $1000

By Dr. Benjamin Volk, Quantitative Investment Analyst for meetinvest:

Suppose you have just received your annual bonus at work, claimed an inheritance, won a contest, or have just saved up for a while and have $1000 to invest. The natural question to ask is: What can I do with my spare money? In this post, we will show you some clever and some not so clever ways on How to invest $1000:

1. YOU COULD PLAY THE LOTTERY

Why not make $1,000,000 out of your initial $1000? That is the dream of many people, and although such dreams are sweet, the reality usually doesn’t work out quite as well as our dreams. Let’s investigate whether buying lottery tickets for $1000 could be considered a smart way to invest $1000.

Assuming you would play the transnational EuroMillions lottery, you could, depending on where you live and the current exchange rate is, buy between 325 and 460 EuroMillions lottery tickets. That doesn’t sound too bad, does it? The problem with this approach, however, is the following:

The chances of winning the jackpot in the EuroMillions lottery are 1 in 116,531,800. So even if we assume that you could play 500 (different) lines with your $1000, your chances of winning the EuroMillions jackpot would be around 1 to 233,063. Just to give you a comparison: the chances of dying from the impact of an asteroid or comet in any given year are between 1 in 3,000 and 1 in 250,000.

So it is as likely that you die from the impact of an asteroid or comet in any given year, than it is to win the EuroMillions jackpot spending $1000 on a given draw. Oh and by the way, playing the US alternative Powerball won’t help either: spending $1000 on Powerball tickets, will give you a chance of about 1 in 390,500 to win the jackpot…

Now you could argue, that you do not need to win the jackpot to make some money, but looking at the expected return of playing the lottery isn’t really a reason to celebrate either: Using the average winning draw prizes we can calculate the expected return of playing the lottery to be roughly -47%. What that means, is that for each Euro or Dollar inserted in the game, one can expect to lose 47 cents. Or put equivalently: Buying lottery tickets for $1000 you can expect to lose $470… Doesn’t sound too appealing, does it?

2. YOU COULD GO TO THE NEXT CASINO AND PLAY ROULETTE

If you believe the movies, casinos are the place where dreams come true: “Everything on 18!”. Unfortunately, what works in movies does not necessarily work in real life… Let us have a look at what the expected return of playing roulette is. Taking the standard payouts (for instance 35 to 1 for a single number bet and 1 to 1 for a bet on black or red, or odd or even), the expected return for American roulette (“0” and a “00” field) is -5.26% and for French roulette (only a “0” field, no “00” field) -2.70%. Note that it doesn’t matter what kind of bets you place (so whether you bet on a single number, a row, a column or a colour) as the above percentages are the “best” expected return you can get.

So what does that mean now? It means that if for any dollar inserted into the game, you can expect to lose 5.26 cents in the case of American Roulette and 2.7 cents in the case of French (also called European) Roulette. So betting $1000 dollars, you should expect to lose $50.26 ($27) each time you play.

Although -5.26% (-2.7%) seems like a much better choice then -47%, an investment in which you are expected to lose money in the long run, can still hardly be qualified as “smart”.

3. INVESTING IN THE S&P 500 INDEX

Now let’s talk about “real” investments. If you have set your expectations accordingly and accept that an 8% annual return is good, you have an easy choice to make: invest in the “market”. The slogan of this passive investment strategy is best be phrased as “if you cannot beat the market, join it!”

So how do you exactly invest in the “market”? The easiest and most practical way is to invest in so called Exchange Traded Funds (ETFs for short), which track certain indices like the S&P 500 index, consisting of the largest 500 US listed companies, or the FTSE 100, consisting of the 100 largest UK listed companies. Beating the market usually refers to beating these benchmark indices.

So what could be your return if you would invest $1000 into an ETF tracking the S&P 500 index? Now as nobody can forecast the movements of the markets, we will have a look what an initial $1000 investment in an S&P 500 tracking ETF over the last 10 years would have gained. Assuming that dividends would have been reinvested and ignoring transaction costs for purchasing the ETF, investing $1000 into an S&P 500 ETF would have increased your balance by a nice $1150.63 to a total of $2150.63. That means you would have more than doubled your initial investment in these 10 years. In terms of annual return, you would have earned around 7.96% per year!

4. THE meetinvest APPROACH

If you want to take matters into your own hand, using one or several of the strategies featured on meetinvest might be the way to go. As an example to show you the kind of difference this could have made, we took one of our newest expert strategy – Patrick O’Shaughnessy’s Millennia – and calculated what your return would have been investing $1000 over the last 10 years.

To do the back-test, we bought at each months end, the 10 stocks of the Millennia screen with the highest Market cap. Only considering US listed stocks and assuming monthly rebalancing (at each months end), this (equally weighted) example would have produced a whopping gain of $3242.41! So starting with only $1000, you would now have $4242.41 in your account, which is equivalent to an astonishing 15.55% annualised return!

Now, although this number looks fantastic, we have to mention that the above calculation does not factor in transaction costs! But as not all the existing broker offer 0 transaction costs trading, as for instance robinhood.com does, we have to adjust the return above for transaction costs.

Given the nature of this investment strategy, we would have produced a relatively high turnover, resulting in around 500 transactions over these 10 years. Considering a transaction cost of $3 per transaction (which is a very high 3% of the $100 position size in our example) we still would have outperformed the S&P 500 index by almost $600 over these 10 years!

IN A NUTSHELL

Although return distributions such as playing the lottery or roulette seem tempting, they are not the smartest way on how to invest $1000. In the long run, the occasional high winners cannot make up for the very frequent small losses, which means that you are expected to lose money.

Investing passively into the market is a much better choice if your time horizon is sufficiently long. No doubt there are times in which the market can go down, the trend over the (very) long run is in general, upwards. If you prefer a more active investment style, then using a factor based approach might suit you well. It’s worth noting though, that the lower the (%-wise) transaction fees, the better this approach works.

So no matter whether you prefer a passive or more active approach, if you have some spare money and want to know how to invest $1000 (and not gamble with it), learning about investing is certainly worth the trouble!

Join the conversation! 3 Comments

  1. Hi Charles,

    Have you checked out our Free 5-Day Crash Course on Stock Investing for Beginners yet? Within, we discussed more in detail about getting started with investing in stocks. You can subscribe here: https://meetinvest.com/blog/beginners-course-stock-investing

    Reply

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