Understanding Surplus Funds Investment Strategies And Benefits

Investing surplus funds is a great way to make your money work for you. While storing extra money in a savings account is a good start, it may not be the most efficient way to grow your wealth over time. With inflation eating into the value of your savings, it's important to explore other options that offer higher returns. This includes investing in stocks, mutual funds, or even gold. Each of these investment avenues has its own set of advantages and considerations, catering to different risk appetites and financial goals. By choosing the right investment strategy, you can make the most of your surplus funds, securing a more prosperous future for yourself and your loved ones.

Stocks: Investing in stocks can grow your money over time

Investing in stocks is a great way to grow your money over time. Here's how:

Time in the Market

One of the most important things to remember when investing in stocks is that time in the market beats timing the market. This means that rather than trying to predict the best time to buy or sell stocks, it's often more beneficial to adopt a buy-and-hold strategy, where you hold onto stocks for a long time instead of engaging in frequent trading. The stock market has returned 9.9% annually to those who remained fully invested, but investors who missed the best 30 days during that period actually saw an average loss of -0.4% annually. Therefore, it's crucial to stay invested for the long haul to capture the best and worst days of the stock market.

Opt for Funds Over Individual Stocks

Diversification is a key strategy to reduce risk and boost returns. Instead of investing in individual stocks, consider investing in stock funds such as mutual funds or exchange-traded funds (ETFs). Funds allow you to buy exposure to a diverse range of individual investments with a single share, providing automatic diversification. While it may be tempting to invest in the next big company, most investors, even professionals, don't have a strong track record of predicting which companies will deliver outstanding returns.

Reinvest Your Dividends

Many companies pay shareholders dividends, which are periodic payments based on the company's earnings. While these payments may seem small at first, they are responsible for a large portion of the stock market's historic growth. From 1921 to 2021, the average annual return of the S&P 500 was 6.7%, but when dividends were reinvested, that percentage jumped to almost 11%. Reinvesting dividends allows you to compound your earnings faster, and financial advisors often recommend this strategy for long-term investors.

Choose the Right Investment Account

The type of investment account you choose is crucial, as it can offer different tax advantages. Traditional retirement accounts offer tax deductions now, while Roth accounts offer tax-free withdrawals in retirement. These accounts also allow your investments to grow tax-free until you withdraw them. However, there are usually penalties for early withdrawals before a certain age. Taxable investment accounts, on the other hand, don't offer tax incentives but provide more flexibility for withdrawing your money whenever you want.

By following these strategies and practicing patience, investing in stocks can be a powerful way to grow your money over time and build long-term wealth.

Gold ETFs: Gold exchange-traded funds are more profitable than physical gold

Investing in gold is a common strategy for portfolio diversification and market risk management. There are various ways to invest in gold, with physical gold and gold exchange-traded funds (ETFs) being two of the most popular choices.

Gold ETFs are investment vehicles traded on a stock market. They invest in a diverse range of gold or gold-related assets, such as futures contracts, to track the development of the gold price. Investors who invest in gold ETFs buy shares of the fund, which are traded on the stock market and whose value is based on the price of gold.

Gold ETFs offer several advantages over physical gold. Firstly, they provide higher liquidity, allowing investors to buy and sell shares quickly through financial markets without the logistical challenges of physical gold transactions. This makes gold ETFs a more liquid and tradeable investment alternative. Secondly, gold ETFs have lower costs over time compared to physical gold. Physical gold incurs costs related to storage and insurance, and potentially higher dealer markups, while gold ETFs have lower management fees. Thirdly, gold ETFs offer greater diversification than physical gold. They can spread risk across various gold-related investments, whereas physical gold only provides exposure to the price of gold.

While gold ETFs have benefits, there are also some considerations. One potential downside is the possibility that the fund may not properly track the price of gold, leading to minor tracking errors. Additionally, there may be annual fees associated with gold ETFs, and investors do not physically own the gold.

In summary, gold ETFs offer a more profitable investment option than physical gold due to their higher liquidity, lower costs, and greater diversification. However, it is essential to consider the potential downsides, such as tracking errors and annual fees. A well-diversified portfolio can benefit from including gold investments, and investors should carefully evaluate the distinctions between physical gold and gold ETFs to make a wise investment choice.

Mutual Funds: A passive form of investing, pooling money to invest in securities

Passive investing is a long-term strategy for building wealth by purchasing securities that mirror stock market indexes and holding them for extended periods. It is a passive approach because it does not require the investor to actively research and select individual stocks. Instead, they rely on a pre-defined index, such as the S&P 500 or Dow Jones Industrial Average (DJIA), to determine their investments. This strategy aims to reduce costs by minimising the buying and selling of securities and taking advantage of the diversification offered by investing in a variety of asset classes and industries.

Mutual funds are a type of investment vehicle that pools money from many investors to purchase a diverse range of assets, such as stocks, bonds, and other securities. They are a common way to implement passive investing strategies. There are two main types of mutual funds used in passive investing: index funds and exchange-traded funds (ETFs).

Index funds are mutual funds that aim to replicate the performance of a specific market index, such as the S&P 500. When the index adds or removes a company, the index fund automatically adjusts its holdings accordingly. This type of fund is typically bought and sold at set prices after the market closes and the net asset value is announced. While index funds offer a simple way to invest in a broad range of securities, they may require periodic rebalancing due to changes in the underlying index.

ETFs are another type of mutual fund that trades on an exchange like a stock. They also track an index but can be traded during market hours, providing more flexibility for investors. ETFs are often cheaper to buy than index funds and offer similar diversification benefits.

Passive investing through mutual funds offers several advantages, including lower fees, tax efficiency, and reduced risk due to diversification. However, it may result in limited investment options and smaller potential returns compared to active investing. Additionally, passive investors rely on fund managers to make investment decisions and are locked into a specific set of investments defined by the index.

In contrast, active investing involves regularly buying and selling individual stocks or other investments based on their performance or expected performance. It requires a more hands-on approach and can be more expensive due to higher transaction costs and analyst team salaries. Active investing aims to beat the market's average returns and take advantage of short-term price fluctuations.

While active investing offers more flexibility and the potential for higher returns, passive investing through mutual funds can be a more cost-effective and less time-consuming strategy for investors seeking long-term wealth accumulation.

Savings Accounts: A great start for surplus money, but low returns

Savings accounts are a great way to start saving any surplus money. They are easy to open, often requiring no branch visits or paperwork, and can be done entirely online. They are also a safe, low-risk investment option, offering modest returns without the possibility of losing your money.

One of the biggest advantages of a savings account is that it helps you earn interest on the deposited amount. Banks often offer higher interest rates to attract new customers, and these rates depend on the bank, with the national average being about 0.09%, and high-yield interest rates going up to 2.05%. Online-only savings accounts may offer even higher rates, sometimes 10 times higher than traditional accounts. Your money is also protected, as savings accounts at banks that are members of the Federal Deposit Insurance Corporation (FDIC) are insured for up to $250,000.

However, savings accounts also have their drawbacks. The interest rates offered are variable and can change, and are often lower than those of other accounts or investments. The money in your savings account is also easily accessible, which can be a good thing, but it may make long-term saving difficult as you are more tempted to spend. Most savings accounts also have minimum balance requirements, and if your account falls below this, the bank will deduct fees from your account.

Overall, a savings account is a great place to start for anyone looking to put aside money for the future, but it may not offer the highest returns.

Direct Equity: Requires time, patience, and sound market knowledge

Investing in stocks or direct equity can be a great strategy to grow your surplus funds over time. When you invest in the stocks of a company, you are essentially becoming a partial owner of that company. As the company grows, so does your money.

Direct equity investments can offer excellent returns over a long investment horizon. This makes them ideal for young investors who are looking for long-term investment options. However, investing in direct equity is not a quick or easy process. It requires time, patience, and a good understanding of the market. As an investor, you need to be prepared to actively make all the buying and selling decisions yourself. Therefore, sound market knowledge is crucial.

Before investing in direct equity, it is important to assess your risk appetite. This will help guide your investment decisions and determine the types of companies you should invest in. For example, you might consider investing in large, mid, or small-cap companies depending on your goals and how much risk you are willing to take.

Direct equity investments can be an attractive option for those with the time and knowledge to actively manage their investments. However, it is important to remember that, as with any investment, there are risks involved and your money is not guaranteed to grow.

Frequently asked questions