You have cleared your credit card debt, canceled unused service subscriptions, found ways to reduce expenses, and now your monthly income exceeds your expenses.
You are saving money.
So, what do you plan to do with this money?
The simplest option might be to leave the money in a current account, but inflation will erode its value. If you have $5,000 in your current account and the inflation rate is 2%, you are essentially paying $100 a year to keep the money in the account.
A better idea is to move the money to a place where it can work for you.
You can lend the money to others through a bank. Or you can invest in an asset, like shares of a company that you anticipate will increase in value. When the time is right, you can sell this asset for a profit. Both of these methods can provide you with a hedge against inflation and should also help your money attract more money.
No matter which investment option you choose for your savings, a fundamental principle applies:
Higher returns require higher risks and/or longer commitment periods.
To attract money into high-risk investments, borrowers must provide an incentive to investors. This incentive often comes in the form of a promise of higher returns in the future. Venture capitalists expect to exchange their investment for a share of the company. They assume that most investments will fail, but one or two successes out of ten are enough to make up for all the losses.
If you want borrowers to return the money to you in a shorter period, you must give up higher interest rates. As you agree to commit funds for a longer period, borrowers will pay you more money.
This means that when exploring different savings options, you need to keep risk and commitment periods in mind.
You should also assume that any investment proposal promising high returns with almost no risk is likely to be unrealistic.
To achieve high returns, you must accept higher losses risks and lock funds in for a long period.
The simplest way to invest savings is to transfer money from a current account to a savings account in a bank. (These accounts are sometimes also called “money market” accounts, although money market accounts usually allow check writing).
The money in the savings account is safe. The Federal Deposit Insurance Corporation (FDIC), a government agency, insures your bank account deposits. As long as the total amount in your deposits and savings accounts does not exceed $250,000, you will always be able to retrieve this money. If the bank goes bankrupt, the FDIC will cover the balance.
You can also access your savings at any time. You do not need to make any commitments. If your balance falls below a certain level, the bank may choose to charge a monthly fee, but you can always access your funds.
The cost of this risk-free, no-commitment option is very low interest rates. Some “high-yield savings accounts” can offer rates higher than regular bank savings accounts, which may seem generous. When the Federal Reserve raises interest rates, these rates also increase. But currently, putting money in a savings account may not yield much return. The interest you earn is likely to be insufficient to keep up with inflation.
You can view traditional bank savings accounts as a low-risk, no-commitment option, but the return they provide is minimal.
Banks pay interest on your savings because they lend out the money. They lend money to corporations, offer mortgages, cover overdrafts. They charge interest on these loans and then share a very small portion—nowadays a very tiny portion—with depositors.
However, banks are not the only ones who can borrow money and generate interest.
Governments also need to borrow money. And since governments can always repay debt by putting pressure on taxpayers, their risk level depends on the political system’s stability. A “bond” from a government with a history of defaults (such as Venezuela) would be worth far less than a bond from the U.S. government.
These bonds come in two forms:
Treasury bills (T-Bills),
with a face value and a specific maturity date. For example, it might promise to pay $20,000 to the holder on August 1, 2025. The Treasury Department sells these Treasury bills at a price below face value. You might pay $19,000 now and receive $20,000 in a few years.
The profit on this is called the discount rate, usually expressed as a percentage, such as 5%.
However, you do not have to wait until the Treasury bill matures to sell it. If you buy a five-year Treasury bill, you can sell it before the maturity date to earn a profit.
Treasury notes operate similarly but do not pay a fixed amount at maturity. Instead, they pay fixed interest every six months. The shortest maturity period can be as short as two years.
You can purchase Treasury bills and Treasury notes through the Treasury Department website or your bank. However, their rates are usually very low.
Treasury bills and Treasury notes are ways in which governments borrow money. But both governments and companies can issue
Bonds.
These are also debt obligations. You lend money to the borrower—whether it’s a company or the government—and in return, you receive a certificate promising to repay a fixed amount at the end of the loan term.
Like any other debt obligation, you can sell these certificates below face value to retrieve some of your money early. So, if you buy a $1,000 bond that will pay $1,100 back in three years, you might sell it for $1,050 eighteen months later.
Bonds come with different levels of risk. Government bonds typically have lower risks, hence lower interest payments. Companies are more likely to go bankrupt, so corporate bonds carry higher risks and higher interest payments.
However, in practice, individual investors often purchase a basket of bonds—a bond fund or an exchange-traded fund (ETF). Instead of lumping all your funds into one loan, you buy multiple bonds from various companies. If one company fails, you won’t lose all your funds. The interest income will be the average of the entire portfolio.
Bonds are relatively reliable. If you purchase bonds from strong, well-established companies, you can expect this investment to pay off. The downside is that bond yields are typically low, especially when overall interest rates are low.
Overall, bond reliability usually makes them an essential part of an investment portfolio. They ensure that some of your savings are safe, earning interest that will return to you.
Bonds are a relatively safe part of a saving investment strategy. By choosing reputable companies or ETFs, you should feel more secure. These companies and governments will pay you back with interest.
Stocks and shares have higher risks. When you own a share, you own a portion of the company. For example, purchasing one share of Amazon stock might cost over $3,400. This price only grants you ownership of one share out of over 504 million issued by the company. But you become one of the owners of Amazon.
Having this share can provide you with three benefits.
It may give you voting rights. Shares are generally divided into voting and non-voting shares. Voting shares allow owners to participate in company decisions. This right is critical for large institutional investors seeking to maintain control but carries less significance for individual investors with a limited stake.
More importantly, shares can bring dividends. Not all shares pay dividends, but those that do distribute a portion of the company’s profits to shareholders. Every quarter, you will receive notice of the dividend payment received.
If you own enough dividend-paying shares—and the company you own continues to profit—you might find yourself relying on the income generated by these companies. It requires a substantial investment. If the dividend yield is 3%, a $1 million investment would only yield $30,000 in returns per year. Nevertheless, these dividends could provide you with a useful additional income source generated by your savings.
However, the simplest way to increase savings through share ownership is to buy shares of growing companies. As the company grows, the value of the shares will rise. The profit value you gain when you sell these shares will also increase.
While there are countless strategies for investing in stocks, savers typically have only two strategies: short-term investing and long-term investing.
Short-term investors must closely monitor the market. They buy low and sell high, trying to profit from small fluctuations in stock prices. This method is high risk and requires expertise. Most day traders lose money. Short-term stock trading is not a savings plan.
Savings plans require long-term strategies. This means diversifying investments across different companies and industries. You cannot benefit from all gains resulting from a sudden surge in one industry but if that industry falls, your losses will be limited. Daily, weekly, and monthly market fluctuations will not trouble you. When you see losses in parts of your investment portfolio, you won’t panic because you know that, from a multi-year perspective, the market value usually increases. You may incur losses in the short term, but when it comes time to actually tap into your savings, you should have returned to a profitable state.
One way to keep your investment portfolio balanced is to purchase mutual funds. Creating a collection of securities from different companies and borrowers for your investment requires extensive research. You need to continually assess risks. If a company appears riskier, you should replace it with a safer one to maintain the same risk level.
Mutual funds handle these tasks for you.
They are collections of securities that may include stocks, bonds, and other assets. Professional fund managers select and maintain these assets according to an established standard. You can choose funds based on risk level or expertise area. For example, some funds may contain a basket of tech stocks. Index funds attempt to replicate the performance of an index (like the Dow Jones Index).
As an investor, you can always see what assets are included in a fund and check its performance. Mutual funds provide individual investors with an opportunity to professionally manage investment portfolios easily.
However, they come with costs. There are annual management fees and possibly commissions. When viewing a mutual fund’s performance, always consider its fees. You may find that another fund can offer the same stock portfolio and similar results at a lower cost.
Stocks carry higher risks than bonds. Of course, higher risk comes with higher returns, but investing savings in company shares can be confusing. While you can review a company’s or fund’s past performance, past performance has limited guidance for the future. Among many companies and funds, how do you choose the safest and most profitable ones?
Moreover, when you invest savings in bonds and stocks, it is challenging to intuitively see where your money is going. You can see rows of numbers and abbreviations in your account, but you do not see what you truly own. The reasons for the rise and fall of asset prices are not always easy to understand.
Investing in real estate feels more intuitive. You are not buying a name on a piece of paper; you are buying bricks and mortar. You can see a building in person and say, “That’s mine.” You know what your savings have bought. You can touch it, feel it.
There are various ways to earn money from real estate investments. Buying a property and renting it out is one option. Instead of keeping savings in a bank account or stocks, you invest in bricks and mortar. When someone wants to live in these bricks and mortar, they pay you rent. Thus, your savings generate income. What’s more, this rent can cover the mortgage, so you need not save the entire property price to invest. You only need the down payment.
The result should be that the tenants repay your mortgage and bring you some extra income. Once the mortgage is paid off, you can take away all the rental income. Additionally, as real estate typically appreciates, you will also gain a third benefit.
In reality, things are not so simple. Searching for and maintaining properties itself is a job, as is selecting and managing tenants. Your return on investment depends on factors like location, property type, and more. There are maintenance costs and taxes. Properties may also be vacant. Even without tenants, you still need to pay property taxes and the mortgage. Your return rate may not be higher than in financial markets, and you must put in maintenance and management work.
Buying properties for rent is a long-term investment, usually aimed at holding the property until the mortgage is repaid. At that time, your income will increase significantly, and the property’s value will have risen.
Yet, regular building maintenance is necessary. You need to find tenants and address their complaints. This is a job, so many landlords outsource property management to service companies. However, this will erode income and reduce returns.
Another option is flipping properties.
The goal is to buy distressed properties at a low price, increase their value, and then sell them for a profit. This often involves purchasing a dilapidated property requiring renovation or buying a well-maintained property and renovating it.
Whichever way you choose requires sufficient savings to get a mortgage and acquire the property.
The advantage is that your savings are not locked for the long term. You only need to keep the money in the property until you sell it. Once you find a buyer, you can retrieve your savings and earn a profit.
You need to put in labor and more funds for property renovation. If you can’t sell quickly, problems may arise. You still need to pay the mortgage, so you might find yourself with an extra property that requires payment.
Moreover, you need a thorough understanding of the local real estate market to determine if a property’s price is appropriate.
Whether buying properties for rent or flipping properties, direct property purchase is involved. You need to view, assess, and put in the work to profit. However, there is a simpler way to make money from real estate.
Real estate investment trusts (REITs) operate similarly to mutual funds. You lend money to a company or trust that raises funds from multiple investors. This company or trust then builds a real estate investment portfolio using these funds. Investors receive returns from this portfolio.
Unlike mutual funds, REITs must pay out 90% of taxable profits as dividends. Therefore, you can expect a decent income source. They are easier than buying properties and can include commercial real estate types that individual investors usually avoid.
You can quickly liquidate your investment. Since REITs trade on exchanges, you can usually find a buyer. Hence, your savings are not locked in like they would be with buying properties for rent.
You can think of REITs as a type of stock. They generate income by owning real estate assets that can produce income over the long term.
The downside is that you need to pay fees to the REIT’s management. You cannot use the property held by REITs as collateral like you could with properties you own. Additionally, you may not get the same excitement as saying “this is mine” when investing in paper assets rather than physical ones.
There are many other, more complex real estate investment options. You could join a real estate investment group, invest in wholesale transactions, triple net leasing, tax lien certificates, and more. However, while real estate can be a good place for savings, it also comes with risks, much like any other investment form. Real estate prices can rise and fall. Tenants may not pay rent on time. Properties may incur damage. Mortgage rates may fluctuate. Make sure you are ready to face the risks and workload involved in investing your funds in real estate.
In this series of articles, we also discussed
why you should save money
,
how to save money
,
track your expenses
, and retirement funds.
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The Ultimate Guide To Saving Money, Part 4: The Right Place to Put Your Savings
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