There are lots of ways to invest and some are good for your financial health. But others can represent pretty poor investments. With this post we’ll talk about ways to invest in the three essential investments we’ve already been discussing: cash, bonds, and stocks.
A quick note before we begin: I’ll mention a bunch of different products in this post. I’m not recommending anything in specific! But I am pointing out areas that might benefit from. Are you interested in anything here? You can either contact me here for a free 30-minute consultation or use these ideas to kick off your own research.
Ways to Invest in Cash
Remember when you used to take your money to the bank down the street? You could open a savings or checking account and they gave you a toaster? Yeah, I don’t remember that either. Heck, I ain’t that old! But saving and investing cash used to be a lot easier and now you have to be a savvy consumer. We’ll call this section cash and cash equivalents.
- If your savings and checking accounts pay you little interest at your local bank, see if a Certificate of Deposit (CD) or a money market account can pay you a higher rate. But understand the limitations of these products before you use them. Especially for CDs which tie up your money for some period of time.
- Try an online bank. Since they don’t have to pay for brick and mortar infrastructure, their interest rates are often very competitive. I’ll have an online bank review in the future.
- Look at your local credit union. These are local co-op financial institutions chartered to serve their members (in a credit union you’re a member, not a customer). Credit unions do have membership requirements but it’s easy to find one that fits your situation. I’m a fan of credit unions and I’m a member. This isn’t true at every credit union, but shop around. I’ve found their products to be innovative and their interest rates to be competitive.
- If you have cash within an investing account, carefully consider alternatives to the “cash sweep” tied to your account. Cash sweeps generally pay you very little interest and there are alternatives. Look at things like brokered CDs which are CDs available through a brokerage account. Another alternative is an Ultra short-term bond fund. Unlike a savings account, you can lose money in these funds. But in one of my accounts, the cash sweep pays .06% interest while the ultra-short bond fund I use pays 1.21%. That’s 20 times the interest! As we talked about previously: know your risk tolerance!
Ways to Invest in Stocks and Bonds
You can invest in individual stocks (like Ford, 3M or Disney for example) and bonds directly. This is either through brokerage firms, through the United States Treasury (for U.S. government bonds), or some companies offer direct buying of their stock through a program called a Dividend Reinvestment Program (DRIP).
In a mutual fund you pool your money with a lot of other investors, and that money is used to buy assets on your behalf. They usually (but not always) provide broad diversification which means that instead of buying shares in one or two companies or bonds, you can invest a proportional amount in many different stocks or bonds. It’s like an investment club where everyone pools their money, but it’s run by investment companies, banks, and so on. Some things to be aware of:
- Mutual funds sometimes require minimum investments and this varies by mutual fund. Stay tuned for a future post on this!
- Mutual funds charge a variety of management fees to you as an investor in their fund. We’ll talk a whole bunch about fees soon because it’s one of the most important factors in investing. But for now: in general, the lower your fees the better for you as an investor!
- You can typically buy shares in a mutual fund any day the Wall Street markets are open. But the price you invest for any share of the fund is determined at the end of the trading day (usually 4 PM Eastern time). So, if there are big ups or downs in the market you may miss whatever these ups or downs are. Some investors use Exchange Traded Funds, (ETFs) to have more control over how they trade their investments during the course of the day.
- Mutual funds are typically considered to be either actively managed or passively managed. In active management, a fund manager tries to find investments they think will go up in value. Passively managed funds, in contrast, seek to track an index (they are usually referred to as “index funds”, or funds that passively follow the stocks or bonds in a given index like the S&P 500 for instance). Like fees, active versus passive management is a huge issue in investing. We’ll devote a lot of time to this. Soon! I promise!
Exchange Traded Funds (ETFs)
ETFs are a lot like passively managed index funds: they generally work to track the performance of some type of investment index. The difference is you can buy shares of an ETF throughout the day. So, unlike a mutual fund where you can only get the price of the mutual fund at the end of the trading day, with an ETF you can get the price where the ETF is trading at any given time. Depending on your perspective, this may either be a great thing, or a horrible one.
The positive perspective is that if the market is volatile you can sell shares before your losses are too large. On the other hand, if you’re prone to buying during a downturn you can buy shares when the market is down. Similarly, if the market is going up, the positive perspective is that you can either buy shares, or sell them, based on what your feelings are for the market.
The negative perspective is that investing should have a long-term time-horizon. If this is true, there should be no reason to buy or sell that urgently during the day. Other facts about ETFs:
- ETFs can have very low management fees, but fees can vary between investment companies. Like mutual funds, if you find two ETFs with exactly the same strategy and following exactly the same index, the lower-cost ETF should be the better-performing for you over the long term.
- Since ETFs trade like stocks, they can have brokerage commissions depending on the type of account you have, or where you have it. If you’re paying commissions, these can eat away at your returns over time especially if you’re buying and selling ETFs frequently. There are some situations where you can avoid these brokerage commissions. But we’ll save that for a later post!
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