Savings Strategies: Where To Invest

People invest their savings into a variety of different things, depending on their financial goals and risk tolerance. Some common options include savings accounts, certificates of deposit (CDs), money market funds, stocks, bonds, and property. Savings accounts are considered low-risk, as they are federally insured and offer flexible access to funds, but they typically provide lower interest rates than other options. For those seeking higher returns, investing in stocks, property, or shares in a fund can be more lucrative but also carries greater risk. It's important to understand the level of risk and potential returns associated with each investment option before making a decision.

Savings accounts

There are several types of savings accounts to choose from, each with its own features, benefits, and drawbacks. Here are some of the most common types:

• Traditional or Regular Savings Account: These accounts are typically found at traditional banks or credit unions and allow you to earn interest on your money, although usually at a lower rate compared to other savings products. They often have low minimum deposit requirements and offer easy access to your funds, including online and mobile banking options. However, monthly maintenance fees may offset interest earnings, and additional fees may apply for excess withdrawals.
• High-Yield Savings Account: Offered primarily by online banks, neobanks, and online credit unions, these accounts provide a higher annual percentage yield (APY) than regular savings accounts. They often have lower minimum deposit requirements, fewer fees, and better interest rates. However, you may not have branch banking access for cash deposits, and transferring funds between accounts at different banks can take several days.
• Money Market Accounts (MMAs): These accounts combine features of both savings and checking accounts. They are offered by traditional banks, online banks, and credit unions. MMAs usually offer better interest rates than regular savings accounts and may provide check-writing and ATM/debit card access. However, they often require a higher minimum deposit, and interest rates may be tiered, requiring a higher balance to earn the best rates. Banks may also charge monthly fees for these accounts.
• Certificates of Deposit (CDs): CDs are time deposits where you agree to keep your money in the account for a set period, known as the "term." During this time, your money earns interest, and you cannot access it without paying a penalty. When the CD matures, you can withdraw your savings or roll them into a new CD. CDs typically offer higher interest rates than regular savings accounts, and longer terms usually have higher rates. However, withdrawing money before the maturity date may result in an early withdrawal penalty.
• Cash Management Account: These accounts are different from traditional savings accounts as they are not specifically designed for saving. Instead, they are offered by investment firms or robo-advisor platforms and are meant to hold cash that you plan to invest in a brokerage or retirement account. Cash management accounts often earn interest at a higher rate than traditional bank accounts, and some offer checking account features like check-writing and bill payment. However, they may not always be covered by FDIC insurance.
• Specialty Savings Account: Specialty savings accounts are tailored to specific savings goals or types of individuals. Examples include kids' savings accounts, student savings accounts, education savings accounts (such as 529 plans and Coverdell Savings Accounts), retirement savings accounts (such as IRAs and IRA CDs), and healthcare savings accounts (such as Flexible Spending Accounts and Health Savings Accounts). These accounts can help you save for specific financial goals and often earn interest. However, some accounts, like IRAs and 529s, have strict tax rules for withdrawals.

When choosing a savings account, it's important to consider your financial goals and needs. You may decide to open multiple accounts to maximize the benefits and meet your short-term and long-term savings objectives.

Stocks

There are two main kinds of stocks: common stock and preferred stock. Common stock entitles owners to vote at shareholder meetings and receive dividends. Preferred stockholders usually don’t have voting rights but they receive dividend payments before common stockholders do, and have priority over common stockholders if the company goes bankrupt and its assets are liquidated.

There are several categories of stocks:

• Growth stocks have earnings growing at a faster rate than the market average. They rarely pay dividends and investors buy them in the hope of capital appreciation. A start-up technology company is likely to be a growth stock.
• Income stocks pay dividends consistently. Investors buy them for the income they generate. An established utility company is likely to be an income stock.
• Value stocks have a low price-to-earnings (PE) ratio, meaning they are cheaper to buy than stocks with a higher PE.
• Blue-chip stocks are shares in large, well-known companies with a solid history of growth. They generally pay dividends.

There are also large-cap, mid-cap, small-cap, and microcap stocks, which refer to the size of the company as shown in its market capitalization.

The benefits of stocks include the ability to influence the company through voting shares, capital appreciation, and dividend payments. However, there are risks to investing in stocks. Stock prices can be affected by factors inside the company, such as a faulty product, or by events beyond the company's control, such as political or market events. If a company goes bankrupt, common stockholders are the last in line to share in the proceeds.

To invest in stocks, most people use an online brokerage account. You can also purchase funds, which hold many different stocks within one investment. You can buy and sell stocks through a dividend reinvestment plan, a discount or full-service broker, or direct stock plans.

Before investing in stocks, it's important to set clear investment goals, determine how much you can afford to invest, decide how much risk you can tolerate, and choose the type of account that's right for you.

Property

Benefits of Property Investment

• Property is considered a stable and lower-risk investment.
• Property often increases in value over time (capital growth).
• Opportunity to generate income by renting the property to tenants.
• Potential tax benefits, such as tax deductions for certain expenses and negative gearing.
• Investing in "bricks and mortar" is seen as more reliable and desirable as it is a tangible asset.
• Property is traditionally less volatile than some other investments.
• Opportunity to increase the value of the investment through renovations and other works.

Considerations

• Risk of investing in a property that doesn't deliver a return or losing money.
• High-value entry point compared to other investments.
• Need to have the time and funds to manage the investment property, including ongoing expenses and unexpected costs.
• Need to be able to cover the costs of the loan, even if the property doesn't generate adequate rental income.

There are three key areas of potential: capital growth, rental income, and tax benefits.

Capital Growth

Capital growth is the increase in the value of the investment property over time. While capital growth is never guaranteed, some investors choose to purchase property in areas known for reliable capital growth, even if the rental income is not adequate to cover the costs.

Rental Yield and Income

Rental yield is a calculation to estimate the potential income from an investment and compare properties. Gross rental yield is a simple calculation based on the annual rental income against the market value of the property. Net rental yield provides a more accurate assessment by factoring in costs such as council rates, property management fees, insurance, maintenance, and repairs.

Tax Benefits

There are potential tax benefits to property investment, such as negative gearing, where losses from the property can be offset against other income. However, tax rules change constantly, so it is important to seek expert advice.

Getting an Investment Home Loan

When considering an investment home loan, it is important to understand your budget and how much you can afford to spend. You will typically need a 20% deposit to avoid paying lender's mortgage insurance. You may also need to factor in other upfront costs such as stamp duty and legal fees.

If you already own a property, you may be able to borrow against the equity in your existing property to help fund the investment. Usable equity is the equity in your home that you can borrow against, calculated as 80% of the property's current value minus the remaining balance on the mortgage.

Finding the Right Property

When choosing a location for your investment property, it is important to do your research. Consider growth areas, future developments, lifestyle amenities, and proximity to schools, transport, and hospitals. Compare different properties in the area, taking note of rental prices and potential rental yield.

Managing a Rental Property

Managing a rental property can be time-consuming, especially if you don't live close by. You may want to engage a property manager or real estate agent to handle tasks such as advertising, screening tenants, maintenance, and repairs, but this will involve property management fees.

Tips for Buying an Investment Property

• Is capital growth trending up?
• What is the rental demand and potential yield?
• Do your research on the location and compare different properties.
• Consider the type of property you want to own (apartment, house, etc.) and how it will impact rental income and yield.
• Be aware of the ongoing costs associated with owning an investment property.

Shares in a fund

There are several benefits to investing in mutual funds:

• Professional Management: Fund managers research and monitor the performance of the securities, so you don't have to.
• Diversification: Mutual funds typically invest in a range of companies and industries, reducing your risk if one company fails.
• Affordability: Most mutual funds have a relatively low dollar amount for initial investment and subsequent purchases.
• Liquidity: Mutual fund investors can easily redeem their shares at any time for the current net asset value (NAV) plus any redemption fees.

There are four main categories of mutual funds:

• Money Market Funds: These funds have relatively low risks and can only invest in certain high-quality, short-term investments issued by U.S. corporations and governments.
• Bond Funds: These funds have higher risks than money market funds as they aim for higher returns. The different types of bonds mean that the risks and rewards can vary.
• Stock Funds: These funds invest in corporate stocks and can be further divided into categories such as growth funds and income funds.
• Target Date Funds: These funds hold a mix of stocks, bonds, and other investments, and the mix gradually shifts according to the fund's strategy. They are designed for individuals with specific retirement dates in mind.

Mutual funds offer three ways to earn money:

• Dividend Payments: The fund may earn income from dividends on stocks or interest on bonds, which is then paid out to shareholders.
• Capital Gains Distributions: If the price of the securities in the fund increases, the fund makes a capital gain when it sells those securities. These capital gains are then distributed to investors at the end of the year.
• Increased NAV: If the market value of the fund's portfolio increases, the value of the fund and its shares also increases, reflecting the higher value of your investment.

It's important to remember that mutual funds carry some level of risk. The securities held by the fund can decrease in value, and dividends or interest payments may change as market conditions change. Additionally, fees and expenses can impact the overall returns of your investment.

Bonds

There are three main types of bonds: corporate bonds, municipal bonds, and treasury bonds. Corporate bonds are issued by private and public companies to raise capital for initiatives like expansion and research and development. Municipal bonds, or "munis", are issued by states, cities, counties, and other government entities to fund public projects such as schools, roads, and hospitals. Treasury bonds, also known as T-bonds, are issued by the US government and are considered risk-free due to their backing by the full faith and credit of the government.

When investing in bonds, it is important to consider factors such as the maturity date, the bond's rating, the issuer's track record, and your own risk tolerance. Bonds are typically considered less risky than stocks, but they do carry certain risks, including interest rate risk, inflation risk, credit risk, liquidity risk, and call risk.

Overall, bonds can play a vital role in an investment portfolio by providing income, diversification, and risk management benefits. They are a good option for investors seeking predictable returns and capital preservation.

Frequently asked questions