You’ve paid off your credit card debt. You’ve cancelled subscriptions to services you don’t use. You’ve found others way to reduce your spending, and you now have more coming in than going out each month.
You’re saving money.
What are you going to do with all that money?
While the simplest option might be to simply to leave it in your checking account, inflation will eat away at its value. If you have $5,000 in your checking account and the inflation rate is two percent, you’ll pay $100 to keep the money in your account.
A much better idea is to move the money to somewhere it can work for you.
You can, through the bank, lend it to other people. Or you can buy an asset, such as a share of a company, that you expect to rise in value. When you’re ready, you can sell that asset for a profit. Both will give you a hedge against inflation, and should also enable your money to attract more money.
The Savings Principle
However you choose to invest your savings, a basic principle will apply:
Higher returns require higher risks and/or longer commitments.
To bring money into a high risk investment, the borrower will need to offer investors an incentive. That incentive comes in the form of a promise of greater rewards in the future. Venture capitalists expect a chunk of the company in return for their investment. They assume that most of those investments will fail but the one or two in ten that come good will more than make up for the losses.
If you want a borrower to give you back your money after a short period of time, you’ll have to give up on higher interest rates. In return for your agreement to commit your money for a longer period, a borrower will pay you more money.
That means that as you’re exploring different ways to save money, you’ll need to keep risk and commitment in mind.
You should also assume that any investment offer that promises you high returns with little or no risk is likely to be too good to be true!
To obtain high returns, you need to accept a high risk of losing your money and lock up your funds for a long time.
The simplest way to invest your savings is to move them out of the checking account and into your bank’s savings account. (These might also be called “money market” accounts, although money market accounts typically also allow check writing services.)
The savings in a savings account will be safe. The Federal Deposit Insurance Corporation (FDIC), a government body, insures your bank account holdings. As long as you have no more than a total of $250,000 in your deposit and savings accounts, you will always have that money. If the bank becomes bankrupt, the FDIC covers the balance.
You can also access your savings at any time. You don’t need to make a commitment. The bank might choose to levy a monthly fee if your balance falls below a certain level, but you can always spend your funds.
The cost of that no-risk, no-commitment option is a low interest rate. A typical savings account at the Bank of America now pays no more than 0.01 percent. Anything above half a percent—rates available from some “high yield savings accounts”—can look generous. Those interests rates will rise when the Fed increases its interest rate. But for now, putting your money in a savings account will deliver very little. You’ll be lucky to earn more than the rate of inflation.
Think of a traditional bank savings account as a no-risk, no-commitment option that gives you very low returns.
Bills, Notes, and Bonds
The reason that banks pay interest on your savings is that they take that money, and they lend it out. They lend it to businesses, fund mortgages, and cover overdrafts. They charge interest on those loans and they share a little—today, a very little—with savers.
But banks aren’t the only way to lend money and generate interest.
The government needs to borrow money too. And because the government can always pay back borrowers—by squeezing taxpayers—their risk level depends on the stability of the political infrastructure. An “I Own You” (IOU) from a government with a history of insolvency, such as Venezuela, would be worth much less than an IOU from the U.S. government.
Those IOUs take two forms.
A treasury bill or T-Bill, has a face value and a specific maturity date. It might agree to pay the holder of the bill $20,000 on August 1, 2025, for example. The treasure will sell that bill for less than its face value. You might pay $19,000 now to receive $20,000 in a few years.
The profit is called the discount rate, and takes the form of a percentage, such as five percent.
You don’t have to wait for the bill to mature before selling it, though. If you’ve bought a bill with a five-year maturity, for example, you could sell between before the maturity date for a portion of the profit.
A treasury note works in a similar way but instead of paying a fixed sum on maturity, it pays a fixed rate of interest every six months. Maturities can be as short as two years.
You can buy both treasury bills and notes from the Treasury website or through your bank. But again, the rates will be very low. Bill rates are currently as low as 0.09 percent for a year. If you’re willing to lock your funds up for 30 years, you’ll get 2.16 percent.
Both treasury bills and treasury notes are ways for the government to borrow money. But both governments and companies can issue bonds. Again, these are IOUs. You lend money to the borrower—whether it’s a company or a government—and receive in return a chit promising to return a set amount at the end of the loan period.
Like any other IOU, you can sell that chit for less than its face-value. That lets you receive some of your funds early. So if you bought a bond for $1,000 that pays $1,100 in three years’ time, you might be able to sell it after eighteen months for $1,050.
Bonds come in various degrees of risks. Government bonds are usually low-risk and therefore pay the lowest dividend. Companies can more easily fall into bankruptcy so their bonds are higher risk and pay higher dividends.
In practice, though, retail investors often buy a basket of bonds—a bond fund or an exchange-traded fund (ETF). Instead of putting all of their funds into a single loan, they purchase a collection of bonds from multiple companies. If one of those companies fails, they won’t lose all of the loan. The dividend will be an average of the basket’s returns.
The advantage of bonds is that they’re relatively reliable. Purchase bonds in strong companies with a good track record and you can expect to see that investment pay off. The disadvantage is that bonds often have low yields, especially when interest rates in general are low.
In general, the reliability of bonds usually makes them one essential element in an investment portfolio. They ensure that whatever happens in the rest of the financial market, some of your savings will be safe and will come back to you with interest.
Stocks and Shares
Bonds are the relatively safe part of an investment strategy for your savings. Choose reliable companies or ETFs and you should be able to rest easy. Those companies and governments will pay you your money back with interest.
Stocks and shares are higher risk. (The two terms are largely interchangeable. “Stocks” refers generally to parts of multiple companies, while “shares” usually refers to parts of a single company.) When you own a share, you own part of the company. Buy a share in Amazon, for example, and it will cost you more than $3,400. That price will give you one share out of the more than 504 million that the company has released. But you’ll be one of the owners of Amazon.
Ownership of that share can give you three benefits.
It might give you voting rights. In general, shares divide between those that provide voting rights, allowing owners to take part in company decisions, and those that don’t. The rights are important for large commercial investors who want to retain some control over the companies they’re buying on behalf of their clients. But they’re less relevant for retail investors who own too few shares for their votes to have much influence.
More importantly, a share can deliver a dividend. Not all shares pay dividends but those that do pay the owner a portion of the company’s profits. Each quarter you’ll receive a notification informing you that you’ve received a payment.
If you own enough dividend-paying shares—and if the companies you own continue to make profits—you could find that you’re be able to live on the income generated by those companies. You’ll have to invest a lot. If the dividend yield is three percent, a million dollar investment would still only give you $30,000 a year. But at the very least, those dividends can be useful bursts of extra income that your savings generate.
The easiest way to use share ownership to grow your savings though, is by buying shares of companies that continue to grow. As the companies grow, the value of the shares will rise. The value of the profits that you receive when you sell those shares will grow too.
Share Ownership Strategy
While there’s no shortage of investment strategies that use shares, savers generally have two strategies. They can invest for the short term; and they can invest for the long-term.
Short-term investors have to watch the markets. They buy low, sell high, and try to profit from small movements in share prices. It’s risky and requires expertise. Most day traders lose money. Short term stock investments aren’t a savings plan.
A savings plan requires a long-term strategy. That means balancing your investments across companies and across industrial sectors. You won’t get all of the benefits that come with a sudden leap in one industry but you will limit your losses if the sector falls. The daily, weekly, and monthly ups and downs in the market don’t bother you. You don’t sweat when you see some of your portfolio fall into the red because you know that over years, the value of the market usually grows. You might lose in the short-term but by the time you come to crack open your savings, you should be back in profit.
Saving with Mutual Funds
One way to make that investment balance easier to build is by buying mutual funds. Gathering a collection of different shares and bonds from different companies and lenders would require some research. You’d need to be able to assess risk and do it constantly. If one company starts to look riskier, you’d want to swap it out for a safer one in order to maintain the same level of risk.
Mutual funds do the work for you.
These are pools of securities that can include stocks, bonds, and other assets. Professional money managers choose them and maintain them according to set criteria. You can choose a fund based on its risk level or specialization. Some funds, for example, might include a basket of tech stocks. Index funds are a kind of mutual fund that tries to replicate the movement of an index such as the Dow Jones.
As an investor, you’ll always be able to see what’s in the fund and check its performance. Mutual funds give individual investors easy access to professionally managed investment portfolios.
But they come with a price. There’s an annual fee and there may be a commission as well. When you check the performance of a mutual fund, be sure to check how much it charges too. You might be able to get the same basket of shares and the same results for a lower fee from a different mutual fund.
Investing in Real Estate
Shares carry a higher risk than bonds. With that higher risk, of course, comes higher returns but using your savings to buy parts of a company can be confusing. You can look at the previous performance of a company or fund. But previous performance is a limited guide to future performance. With so many companies and funds to choose from, how do you pick the safest ones, and the ones with the highest returns?
And having poured your savings into bonds and shares, it’s hard to see where your money has gone. You can look at your money account and see columns of figures and initials, but you can’t see what you own. Nor is it always easy to understand what’s causing the prices of the assets to rise and fall.
Investing in real estate can feel more straightforward. Instead of buying names on a page, you’re buying bricks and mortar. You can travel to a building, and say: “I own that.” You know what your savings have bought you. You can touch it and feel it.
There are multiple ways to put your savings into real estate but none of them are as easy or straightforward as they sound.
Buy to Rent
One option is buying a property to rent it out. Instead of putting your savings into a bank account or in stocks and shares, you put them into bricks and mortar. When you find people who want to live in those bricks and mortar, they pay you rent. So your savings generate an income stream. Better yet, they also cover the mortgage so you don’t need to save all of the price of the property in order to invest. You just need to save enough to make the down payment.
The result should be that tenants pay the mortgage on your property and give you a little extra income. Once the mortgage is paid, you’ll be able to take all of the rental income. And because real estate tends to rise in value, you’ll win a third income too.
In practice, it’s not that easy. Finding and maintaining a property is a job, as is checking and servicing tenants. The rate of return on your investment will depend on your location, the nature of the property, and so on. There are maintenance costs and taxes. There may be periods in which the property is empty. You’ll still need to pay local taxes and the mortgage. Your rate of return might be no better than you could have found in the financial markets with none of the maintenance and servicing work.
Buying properties in order to rent them out is a long-term investment. The aim is often to hold on to the property until the rent has paid off the mortgage. The income then jumps and the property will have increased in value.
But you have regular building maintenance. You need to find tenants and cope with their complaints. It’s work, which is why many property owners outsource the property management to service companies. But that eats into income, lowering returns.
One alternative is to flip properties.
The goal is to buy a property for a low price, add value, then sell it for a profit. That usually means buying a run-down property in need of renovation or buying a property in good condition then renovating it.
Either approach requires using just enough savings to obtain a mortgage and take possession of the property.
The advantage is that your savings aren’t tied up for a long time. You only need to put them in the property for as long as it takes to sell it. Once you’ve found a buyer, you get your savings back, and with a profit.
You also don’t have to deal with tenants or property management.
But you will have to invest work and more finances in renovating the property. If you can’t sell it quickly, you can quickly run into trouble. You’ll still need to make the mortgage payments so you could find yourself with an extra property to pay for.
And you’ll need a good understanding of your local property market. You can’t tell whether a property has a good price if you don’t know how much a local property should sell for.
Real Estate Investment Trusts (REITs)
Both buying to rent and house flipping involve buying properties. You’ll need to view the properties, assess them, and put in the work needed to generate a profit from them. There is an easier way to make money from real estate.
Real estate investment trusts, or REITs, work like mutual funds. You lend money to a corporation or trust that collects money from multiple investors. The corporation or trust then uses that money to build a real estate portfolio. Investors receive a return on their investment in that portfolio.
Unlike mutual funds, REITs have to pay 90 percent of their taxable profits as dividends. So you can expect a good income stream. They’re easier to buy than a home, and they can include commercial property that retail investors tend to avoid.
You can also cash out easily. Because REITs are exchange-traded, you should always be able to find a buyer for your investment. So your savings aren’t locked up in the way they would be if you buy to rent.
You can think of REITs as a kind of stock. It pays dividends by holding for the long term real estate assets that generate revenue.
The downside is that you can expect to pay a fee to the manager of the REIT. You also can’t borrow against your REIT holdings in the way that you can borrow against your property. And you don’t get the thrill that comes from driving to your property, and saying: “I own that.” You’ll still feel that you’re investing in paper rather than in something solid and real.
There are plenty of other, more complex ways of investing in real estate. You can join real estate investment groups, invest in wholesaling, NNN leasing, tax liens, and more. But while real estate can be a good place to put your savings, like any other form of investment it also comes with risk. Real estate can drop in value, as well as rise. Tenants don’t always pay. Property can suffer damage. Mortgage rates can change. Make sure that you’re prepared for both the risk and the work involved in putting your savings into real estate.