Yesterday I had a reader ask what his investment options were. After asking him to reconsider his current debt and income, he came to realize he wasn’t ready to invest at this time. But that doesn’t mean you are in the same place as he is, financially. So, today I decided to run down some of the investing options available to you.
When you start saving your money, instead of giving it to credit card companies every month, you’ll want that money not only to be safe, but to grow. The growth of your money is almost directly related to the risk you’re willing to take with it. Someone willing to take almost zero risk with their money will be lucky if they can keep up with inflation. While someone willing to take a slightly more educated risk, may reap larger rewards.
Before we look at our investment options I should point out that everything here is drawn from my own experiences and none of it may be right for you and your money situation. This is not me recommending you do anything specific with your money; this is simply me making you aware of some of your investing options.
Online Savings Account. Online savings accounts pay much higher interest rates than local banks typically pay. With the fed’s interest rate where it is, no one is paying much interest, but here is a list of some of the current best paying online savings accounts. According to that list, SmartyPig is currently paying 2% interest. Compare that to my local credit union, which is paying .03% (three-tenths of one percent) and you’ll clearly see the advantage. However, average annual inflation is 3-4%, so earning 2% interest is not a good long-term investing strategy, as your money will lose buying power every year. Online savings accounts should be used for your emergency fund and short-term savings only. Online savings accounts are protected by the FDIC, so you are guaranteed not to lose money in your account should the bank go out of business. Risk factor: low. Reward factor: low.
CDs and Savings Bonds. CDs and Government Savings Bonds pay a little bit better rates than online savings accounts, usually. The US Government even sells bonds that adjust at the same rate as inflation each year, to protect your money’s buying power over the life of the bond. CDs usually pay slightly better interest rates than savings accounts because you are agreeing to lock in your money for a given length of time. The longer you lock it in for, the better the rate. A ten-year CD will have a better interest rate than a three-year CD. Just make sure this is money you are not likely to need until the CD matures, or you will pay early redemption fees. Laddered one-year or six-month CDs can be used for your emergency fund. Laddering your CDs means you buy one per month over a one-year time frame. Then you have one bond maturing each and every month, in case you have an emergency and need to cash it. No emergency? Then roll it over into another one-year CD. CDs and Bonds may break-even with inflation each year, but they won’t make you rich. CDs are protected by the FDIC from losses. For the best CD rates, check out bankrate.com Risk factor: low. Reward factor: low.
Mutual Funds. I personally keep the majority of my long-term savings in mutual funds. Specifically, mutual funds that invest in real-estate and corporate bonds. You can look at my investment portfolio to see just how heavily I’m invested in mutual funds. The mutual fund I currently like is the TCW TOTAL RETURN BOND. TCW has an average ten-year annual return of +7.28%. Mutual funds invest in numerous stocks and bonds, spreading risk and diversifying for me automatically. Because of their diversification, mutual funds are typically less risky than owning individual stocks. However, depending on which stocks the mutual fund invests in, your money may still be exposed to numerous risks. The best way to evaluate and compare mutual funds is to look at their ten-year average annual returns. This is long-term investing/saving. You should also consider the expense ratio of your mutual fund, and any other fees that may be associated with it. In the short term, prices raise and prices fall, but in the long-term the market has averaged an annual return of about 10%. Risk factor; medium to high. Reward factor: medium to high.
Stocks. I don’t personally invest in individual stocks. All of my investments are in mutual funds, or target date retirement funds. However, you may wish to own individual stocks in a specific company. If you get in early, or while the stock is low, and then the company does well, you stand to make a lot of money. If you buy when the stock is high, thinking it has no where to go but up, you could lose quite a bit if the company does not continue to grow. It’s a bad idea to buy stock in a company simply because you like what the company does or makes. Your investments should not be emotionally motivated. You should use your head to invest, not your heart. Take a look at the company’s past track record. Take a look at their plans for the future. Can you reasonably deduce that this company will grow? If so, you should feel comfortable investing. If you don’t know, or haven’t looked into it, do not buy their stock. You have no guarantee in the stock market. You could make millions; you could lose everything and have no recourse. I highly recommend you stick to mutual funds and target date retirement funds. Risk factor: high. Reward factor: medium to high.
Online savings accounts can be applied for and opened on your home computer. CDs and Savings Bonds can be purchased from banks or online from Treasury Direct. Mutual Funds will need to be purchased from a brokerage firm. I use E*Trade, but you might also consider TD Ameritrade, T. Rowe Price or Charles Schwab, all of which can be applied for and opened online. Stocks also require a brokerage account.
All of the above are available for both retirement or non-retirement investing/savings accounts. Tomorrow we’ll discuss the differences between the two, the idea of dollar-cost averaging and why starting to save for your retirement now, rather than later, is so important.
{ 5 comments… read them below or add one }
I currently use PNC Bank for my checking and savings accounts. They split it between 3 accounts, a Checking, a Short-Term savings, and a Long-Term savings accounts under one name. The Short-Term Savings has 1% interest and the Long-Term Savings has 2%. How does this stack up next to something like SmartyPig? Am I getting the same amount of interest on what I have in my savings account now as I would if I got an account with SmartyPig?
@Nathan, they are the same rate so I wouldn’t switch banks, no. I would look into some CDs, Savings Bonds or Mutual Funds though to see if you can do better with your long-term savings. Just make sure you understand what you’re investing in before you invest.
I found this, using the site you offered to find the best deal, and wanted to know your view on it, as someone who’s dabbled in this sort of thing. I can spare 300-500$ for a year, especially considering i work maybe 2-3 days/week consistantly, and am bringing in a good 200$/month, and if this would helped me earn more money, I’d like to jump into it.
http://www.ally.com/high-yield-cd/index.html
@Nathan, you said your current account is already paying 2% though, and that CD is for 1.99%, which is lower. So, I don’t see how it would make you any more money?
Wouldn’t I gain more with Daily Compound Interest?