Investments: Spend, Save, Or Grow?

People invest their money in a variety of ways, including stocks, bonds, real estate, mutual funds, exchange-traded funds (ETFs), commodities, and alternative investments such as private equity, venture capital, cryptocurrency, art, or collectibles. The basic principle behind investing is to put money into something that will generate income or increase in value over time. This can include spending money to improve your own life or the lives of others, but it usually refers to the purchase of securities, real estate, and other items of value.

Different types of investments carry different levels of risk and potential reward. For example, stocks are generally considered riskier than bonds, but they also offer the potential for higher returns. People who invest are known as investors, and they can be individuals or entities such as firms or mutual funds.

Diversifying investments to reduce risk

Diversification is a risk management strategy that involves spreading investments across a range of assets to reduce investment risk. The idea is that by holding a variety of investments, the poor performance of one investment can be offset by the better performance of another, leading to a more consistent overall return.

Diversify Across Asset Classes

The three main general asset classes are stocks, bonds, and cash. Stocks offer the highest long-term gains but are volatile, especially in a cooling economy. Bonds pay interest and are income generators with modest returns, but they are usually weaker during an expanding economy. Cash is low on risk and returns. There are also other asset classes such as real estate, commodities, and alternative investments, which can aid in diversification as they often have a lower correlation to the stock market.

Diversify Within Asset Classes

You can further diversify by breaking these categories down. For example, within stocks, you can diversify by industry, company size, and geography. Within bonds, you can diversify by creditworthiness, bond issuer, and term length.

Diversify Geographically

International diversification can provide returns that are differentiated from those of domestic markets and benefit from economies that may be on a different growth path. It can also provide a cushion of protection against losses during a downturn in your home country's economy.

Diversify by Company Stage and Size

Diversifying by the corporate lifecycle stage can also help reduce risk. For example, growth companies are newer, fast-growing companies with higher valuations, while value companies are more established firms with slower growth and lower valuations.

Diversify with Mutual Funds, Index Funds, or ETFs

Mutual funds, index funds, and exchange-traded funds (ETFs) are an easy way to achieve diversification without having to research and select individual stocks or bonds. These funds typically hold a variety of investments, providing instant diversification.

Diversify with Robo-Advisors

Robo-Advisors are another option for achieving diversification. They can structure a diversified portfolio to meet a specific goal or target date, taking into account factors such as your risk tolerance and investment horizon.

Diversify with a Target-Date Fund

A target-date fund automatically adjusts your asset allocation over time, typically shifting from higher-return, more volatile assets to lower-risk assets as you approach your target date, usually retirement.

By implementing these diversification strategies, you can "smooth" the performance of your investment portfolio, reducing the impact of any single investment and improving the consistency of your returns over time.

Investing in stocks

Set Clear Investment Goals

Be specific about your objectives. For example, instead of saying "save for retirement", set a target like "accumulate $500,000 in my retirement fund by age 50". Determine your investment horizon by assessing how long you have to achieve each goal. Also, evaluate your finances and rank your goals based on urgency and importance.

Determine How Much You Can Afford To Invest

Review your income sources and establish an emergency fund. Pay off any high-interest debts and create a budget to decide how much money you can comfortably invest in stocks.

Determine Your Tolerance for Risk

Ask yourself if you are willing to accept higher risks for potentially greater returns, or if you prefer stability. Your risk tolerance depends on your investment timeline and financial cushion.

Determine Your Investing Style

You can take a DIY approach by using a brokerage account to access various investments and trade independently. Alternatively, you can seek professional guidance from a broker or financial advisor, who will tailor their advice to your goals and life experiences.

Choose an Investment Account

You can choose from regular brokerage accounts, retirement accounts, managed accounts, or special accounts for education and health savings. Consider the tax implications of each account type and evaluate the fees, commissions, and minimums involved.

Fund Your Stock Account

You can fund your stock account through a bank transfer, check deposit, or transfer from another brokerage. Set up automatic contributions to invest a fixed amount of money at regular intervals.

Pick Your Stocks

Look for stability, a strong track record, and the potential for steady growth. Examples of stocks that are considered solid bets for beginners include blue-chip stocks, dividend stocks, defensive stocks, and ETFs.

Learn, Monitor, and Review

Stay informed about the global economy, industry trends, and the companies you invest in. Use stock simulators to practice trading risk-free, and learn about diversification to spread your investments across diverse asset classes. Regularly review your goals and adjust your investment strategy as needed.

Investing in bonds

There are several types of bonds to choose from, including:

• Federal government bonds: These are considered among the safest investments, although they offer a very low-interest rate.
• Municipal bonds: Issued by state and local governments, these bonds are among the lowest-yielding but are non-taxable, which can make them attractive to investors in high-tax states.
• Investment-grade corporate bonds: Issued by companies with good to excellent credit ratings, these bonds are safer than other corporate bonds but offer a lower interest rate.
• High-yield bonds: Formerly known as junk bonds, these offer a larger payout but are riskier.

When investing in bonds, it's important to consider the maturity date, the bond's rating, the issuer's track record, your tolerance for risk, and any associated fees and commissions. It's also crucial to understand the risks associated with investing in bonds, such as interest rate risk, inflation risk, credit risk, and liquidity risk.

Bonds can be purchased directly from the U.S. government or through a broker, and they can be held until maturity or sold on the secondary market. Investing in bond funds, which are managed by professionals and include a variety of bond types, is another option that offers higher interest rates than bank accounts.

Overall, investing in bonds can be a great way to preserve capital, generate income, diversify your portfolio, and manage risk.

Investing in real estate

Rental Properties

This option is ideal for those with DIY skills, patience, and time to manage tenants and the property. It requires substantial cash upfront for maintenance and to cover periods of vacancy. However, once the property starts generating income, you can leverage it to acquire more properties and build multiple income streams.

Real Estate Investment Groups (REIGs)

REIGs are ideal for those with some capital who want to own rental real estate without the hassle of managing it. They are similar to mutual funds, pooling money from multiple investors to invest in rental properties. A company operating the REIG handles maintenance, advertising, and tenant interviews, taking a percentage of the rent in exchange.

House Flipping

House flipping involves buying undervalued properties and selling them quickly for a profit. It requires significant experience in real estate valuation, marketing, and renovation, as well as the ability to accurately estimate repair costs. Flippers often aim to sell properties within six months to avoid long-term mortgages.

Real Estate Investment Trusts (REITs)

REITs are ideal for investors seeking portfolio exposure to real estate without traditional transactions. They are corporations or trusts that use investors' money to purchase and operate income-producing properties. REITs are bought and sold on major exchanges like stocks, and they must pay out 90% of their taxable profits as dividends to maintain their status.

Online Real Estate Platforms

Online real estate investing platforms, also known as real estate crowdfunding, allow investors to pool their resources for larger commercial or residential deals. They provide an opportunity to diversify into real estate with a relatively modest investment. However, these platforms often require investors' money to be locked up for several years, making them illiquid.

Investing in mutual funds

• Decide on your mutual fund investment goals: Are you investing for a long-term goal, like retirement, or a shorter-term goal, like buying a home?
• Pick the right mutual fund strategy: If you're investing for the long term, your mutual fund allocation should probably be mostly in stock-based mutual funds. If investing heavily in stocks makes you nervous, you can opt for balanced mutual funds that invest in both bonds and stocks.
• Research potential mutual funds: Use tools like the Mutual Fund Observer and Maxfunds to research different mutual funds. Consider factors such as past performance, expense ratios and load fees when making your decision.
• Open an investment account: You can invest in mutual funds through an employer-sponsored retirement plan, such as a 401(k) or 403(b). If you don't have access to these, you can open a brokerage account and invest through individual retirement accounts (IRAs), taxable brokerage accounts or education savings accounts.
• Purchase shares of mutual funds: Make sure you have enough money deposited in your investment account. Keep in mind that mutual funds may have higher investment minimums than other asset classes.
• Set up a plan to keep investing regularly: Decide how much you want to invest and how often. Your brokerage trading platform can help you set up recurring investments.
• Consider your exit strategy: Eventually, you'll want to sell your mutual fund shares to pay for your financial goals. If you bought mutual funds with backend loads, you'll have to pay a fee to your broker when you cash out. You'll also probably owe taxes on any capital gains your investments made.

There are several ways to invest in mutual funds, including through a mutual fund distributor, direct investment with an Asset Management Company (AMC), Registered Investment Advisors (RIA), Registrars and Transfer Agents (RTAs), online investment, stockbrokers, bank-enabled mutual fund investment, and mobile apps.

Frequently asked questions