Millennials are not great financial role models. Just a third of them are investing in the stock market. And that’s not because of laziness. It’s because they just don’t have the money. But in recent years, a new millennial trend has emerged from their paycheck-to-paycheck lifestyle. It’s called microinvesting.

[ad#Google Adsense 336×280-IA]This low-budget approach to retirement investing is similar to the robo-advisor phenomenon.

That’s another largely millennial trend in finance. Microinvesting combines low-maintenance, index fund-based allocation strategies with small, frequent contributions.

In other words, it means gradually building a lazy portfolio by investing your pocket change.

And a number of startups, including Acorns, Stash and Betterment, have created apps do just that.

Is this a groundbreaking innovation? Or is it just another fad for the young and broke? Below, we’re digging into this frugal millennial trend to find out.

The Case for Microinvesting

A key part of microinvesting is a simple, boring, low-activity portfolio strategy. And that’s a time-tested approach.

Long-term investors who stick to broad index funds often do better than the active traders. That’s why many of the world’s most popular portfolios use this “lazy” approach. Alex Green’s Gone Fishin’ Portfolio is just a special blend of index funds.

Gone Fishin’ investors just set it up and then rebalance occasionally. An investment in this “lazy” portfolio would have doubled in the last few years.

But simple allocation is only one piece of the microinvesting equation. The other half of the system is the “micro” part. It’s a contribution plan based on small, frequent deposits.

Acorns takes a particularly innovative approach to this. Users connect Acorns to their checking account. Then the app invests “spare change” by rounding up debit card transactions to the next dollar. It uses the rounded-up extra money to buy shares.

In other words, suppose you pay $1.70 for a coffee. The app will round the charge up to $2 and invest the extra $0.30 in your ETFs. That might not sound like much. But over a period of months or years, it can add up to a big contribution.

Acorns is the only microinvesting company to use the automatic rounding-up system. But almost all of its competitors encourage similar habits. Microinvesting depends on making small deposits of just a few dollars (or even less) several times a day.

And thanks to dollar cost averaging, this is one of the cheapest ways to buy ETFs and mutual funds. Say you want to invest $5000 in a mutual fund this year. If you do it all in one lump deposit, then you risk buying the fund at its highest price of the year.

But if you spread that $5000 across many little deposits throughout the year, then you end up buying the fund at its average price for the year. That means better returns going forward.

Tax Problems with Microinvesting

This millennial trend might sound like a great idea for everyone. But it still has some kinks that need to be worked out.

In particular, microinvesting products offer little in the way of tax protection. They’re not tax-advantaged retirement accounts. And that means that any time you sell, you’ll pay capital gains tax.

This is part of the reason why microinvesting is specifically catered to millennials. If you’re a broke college student or struggling graduate, then you’re probably in a very low tax bracket. You might even be exempt from capital gains tax altogether.

But if you’re a moderately successful person with a full-time job, capital gains tax could be a real problem. Since microinvesting accounts aren’t tax-advantaged, using them for long-term saving could land you a big bill from Uncle Sam.

The millennial habit of not saving or investing could one day become a big problem for society. We can’t be sure that Social Security will outlive them, especially given the challenges young people face in the labor market.

But microinvesting could be the nudge that they need to start planning for their futures. By combining small contributions with simple allocation strategies, this approach makes saving for retirement as low-stress as possible.

— Samuel Taube

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Source: Investment U