investing

Why invest?

To enjoy a comfortable future, investing is absolutely essential for most people. Investing can provide you with another source of income, helping you in retirement or even getting you out of a financial jam tomorrow. Above all, investing helps you continue to grow your wealth, allowing you to meet your future financial goals and grow your purchasing power over time.

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What to consider

Risk tolerance and time horizon play big roles in deciding how to allocate your investments. Conservative investors or those near retirement may be more comfortable allocating a larger percentage of their portfolios to less-risky investments to minimize risk. These are also great for people saving for short term (about five years or fewer) or intermediate (around a decade) goals.

Those with stronger stomachs and workers still accumulating a retirement nest egg probably can fare better with riskier accounts, as long as they diversify. Be prepared to do your homework and shop around for the accounts that fit both your short- and long-term goals.

If you’re looking to minimize your portfolio’s risk, here are a few of the safest investments to consider:

#1: Certificates of deposit

Certificates of deposit, or CDs, are issued by banks and generally offer a higher interest rate than savings accounts.

These federally insured time deposits have specific maturity dates that can range from several weeks to several years. Because these are “time deposits,” you cannot withdraw the money for a specified period of time without penalty.

The financial institution pays you interest at regular intervals. Once the CD matures, you get your original principal back plus any accrued interest. Today you can earn as high as nearly 3 percent interest.

Risk: CDs are considered safe investments. However, they do carry reinvestment risk — the risk that when interest rates fall, investors will earn less when they reinvest principal and interest in new CDs with lower rates. The opposite risk is that rates will rise and investors won’t be able to take advantage because they’ve already locked their money into a CD.

Consider laddering CDs — investing money in CDs of varying terms — so that all your money isn’t tied up in one instrument for a long time. CD returns are inching up as interest rates are on the rise, but it’s important to note that inflation and taxes could significantly erode the purchasing power of your return.

Liquidity: CDs aren’t as liquid as savings accounts or money market accounts because you tie up your money until the CD reaches maturity — often for months or years. It’s possible to get at your money sooner, but generally you’ll pay a penalty.

#2: Money market accounts

A money market account is an FDIC-insured, interest-bearing deposit account.

Money market accounts typically earn higher interest than savings accounts and require higher minimum balances. Because they’re relatively liquid and earn high yields, money market accounts are a great option for your emergency savings.

In exchange for better interest earnings, consumers usually have to accept more restrictions on withdrawals, such as limits on how often you can access your money.

Risk: Inflation is the main threat. If inflation rates exceed the interest rate earned on the account, your purchasing power could be diminished. In addition, you could lose some or all of your principal if your account is not FDIC-insured (though the vast majority are) or if you have more than the $250,000 FDIC-insured maximum in any one account.

Liquidity: Money market accounts are considered liquid, especially because they come with the option to write checks from the account. However, federal regulations limit withdrawals to six per month (or statement cycle), of which no more than three can be check transactions.

#3: Treasury securities

The U.S. government issues various types of securities to raise money to pay for projects and pay its debts.

These are some of the safest investments to guarantee no loss on your principal.

T-bills technically are not interest-bearing. They are sold at a discount from their face value, but when they mature, the government pays you full face value. For example, if you buy a $1,000 T-bill for $980, you would earn $20 on your investment.

Treasury notes, or T-notes, are issued in terms of two, three, five, seven and 10 years. Holders earn fixed interest every six months and then face value upon maturity. The price of a T-note may be greater than, less than or equal to the face value of the note, depending on demand. If demand by investors is high, the notes will trade at a premium, which reduces investor return.

Treasury bonds, or T-bonds are issued with 30-year maturities, pay interest every six months and face value upon maturity. They are sold at auction throughout the year. The price and yield are determined at auction.

All three types of Treasury securities are offered in increments of $100.

Risk: Treasury securities are considered virtually risk-free because they are backed by the full faith and credit of the U.S. government. You can count on getting interest and your principal back at maturity. However, the value of securities fluctuates, depending on whether interest rates are up or down. In a rising rate environment, existing bonds lose their allure because investors can get a higher return from newly issued bonds. If you try to sell your bond before maturity, you may experience a capital loss.

Treasuries also are subject to inflation pressures. If the interest rate of the security is not as high as inflation, investors lose purchasing power.

Because they mature quickly, T-bills may be the safest treasury security investment, as the risk of holding them is not as great as with longer-term T-notes or T-bonds. Just remember, the shorter your investment, the less your securities will generally return.

Liquidity: All Treasury securities are very liquid, but if you sell prior to maturity you may experience gains or losses, depending on the interest rate environment.

#4: Government bond funds

Government bond funds are mutual funds that invest in debt securities issued by the U.S. government and its agencies.

The funds invest in debt instruments such as T-bills, T-notes, T-bonds and mortgage-backed securities issued by government-sponsored enterprises such as Fannie Mae and Freddie Mac.

These government bond funds are well-suited for the low-risk investor.

Risk: Funds that invest in government debt instruments are considered to be among the safest investments because the securities are backed by the full faith and credit of the U.S. government.

However, like other mutual funds, the fund itself is not government-backed and is subject to risks like interest rate fluctuations and inflation. If inflation rises, purchasing power can be diminished. If interest rates rise, prices of existing bonds decline, and if interest rates decline, prices of existing bonds rise. Interest rate risk is greater for long-term bonds.

Liquidity: Bond fund shares are highly liquid, but their values fluctuate depending on the interest rate environment.

#5: Municipal bond funds

Municipal bond funds invest in a number of different municipal bonds, or munis, issued by state and local governments.

Earned interest generally is free of federal income taxes and also may be exempt from state and local taxes.

According to the Financial Industry Regulatory Authority, muni bonds can be bought individually, through a mutual fund or and exchange-traded fund. You can consult with a financial adviser to find the right investment type for you, but you may want to stick with those in your state or locality for the best income tax rates.

Risk: Individual bonds carry the risk of default, meaning the issuer becomes unable to make further income or principal payments. Cities and states don’t go bankrupt often, but it can happen. Bonds also may be callable, meaning the issuer returns principal and retires the bond before the bond’s maturity date. This results in a loss of future interest payments to the investor.

Choosing a bond fund allows you to spread out potential default and prepayment risks by owning a large number of bonds, thus cushioning the blow of negative surprises from a small part of the portfolio.

Liquidity: You can buy or sell your fund shares every business day. In addition, you usually can reinvest income dividends and make additional investments at any time.

#6: Short-term corporate bond funds

Corporations sometimes raise money by issuing bonds to investors.

Small investors can get exposure by buying shares of short-term corporate bond funds. Short-term bonds have an average maturity of one to five years, which makes them less susceptible to interest rate fluctuations than intermediate or long-term.

Risk: As is the case with other bond funds, short-term corporate bond funds are not FDIC-insured. Investment-grade short-term bond funds can reward investors with higher returns than government and municipal bond funds.

But the greater rewards come with added risk. There is always the chance that companies will have their credit rating downgraded or run into financial trouble and default on the bonds. Make sure your fund is made up on high-quality corporate bonds.

Liquidity: You can buy or sell your fund shares every business day. In addition, you usually can reinvest income dividends and make additional investments at any time. Just keep in mind that capital losses are possible.

#7: Dividend-paying stocks

Even your stock market investments can become a little safer with stocks that pay dividends.

Dividends are portions of a company’s profit that they pay out to shareholders, usually quarterly. With a dividend stock, not only can you earn on your investment through long-term market appreciation, you’ll also earn cash in the short term.

Risk: As with any stock investments, dividend stocks come with risk. They’re generally considered safer than growth stocks or other non-dividend stocks, but you should choose your portfolio carefully. Make sure you invest in companies with a solid history of dividend increases rather than selecting those with the highest current yield. That could be a sign of trouble ahead.

Liquidity: Quarterly payouts, especially if the dividends are paid in cash, are relatively liquid. Still, to see the highest performance on your dividend stock investment, a long-term investment is key. You should reinvest your dividends for the best returns.

#8: High-yield savings account

Just like the savings account earning pennies at your brick-and-mortar bank, high-yield online savings accounts are accessible vehicles for your cash.

But at online banks with fewer overhead costs, you can earn much higher interest rates. Today, you can find accounts paying well above 2 percent.

Risk: The banks that offer these accounts are FDIC-insured, so you don’t have to worry about losing your deposit. While high-yield savings accounts are considered safe investments, like CDs, you do run the risk of earning less upon reinvestment due to inflation.

Liquidity: Savings accounts are about as liquid as your money gets. You can add or remove the funds at any time, but like money market accounts, federal regulations limit most transactions to six per month.

#9: Growth stocks

Growth stocks are one segment of the stock market that often do well over time.

These stocks are often of tech companies that are growing sales and profits very quickly.

Unlike dividend stocks, growth stocks rarely make any cash distribution, preferring to reinvest that cash in their business to grow even faster.

These stocks are some of the most popular for an obvious reason: The best of them can return 20 percent or more for many years. But you’ll have to analyze them yourself and figure out which ones are poised to do well.

Risk: Growth stocks are some of the highest-flying stocks in the market, but they’re also highly volatile. When investor sentiment turns – when the market declines, for example – growth stocks tend to fall even more than most stocks. Plus, unlike government-backed banking products, there’s no guarantee against losing your money. So if you pick the wrong stock, it could become worthless.

Liquidity: Growth stocks, like any stocks trading on a major U.S. exchange, are highly liquid, so you can buy or sell them on any day the stock market is open.

#10: Growth stock funds

For investors who don’t want the hassle of analyzing and selecting individual growth stocks, an alternative is buying a fund of growth stocks.

Investors can select an actively managed fund where professional fund managers select growth stocks to beat the market, or they can choose passively managed funds based on a pre-selected index of growth stocks.

Either way, funds allow investors to access a diversified set of growth stocks, reducing the risks of any single stock doing poorly and ruining their portfolio. The result is an average of the performance of all the stocks in the fund — and over time, that’s likely to be good.

Risk: Investing in a growth stock fund is less risky than selecting and owning a few individual growth stocks. With a fund, the professionals do all the stock selection and management, minimizing the risk that you might select the wrong investments. However, while diversification prevents any single stock hurting your portfolio much, if the market as a whole drops, the fund is going down, too. And stocks are well-known for their volatility.

Liquidity: Growth stock funds are highly liquid, much like the stocks they invest in. You’ll be able to move in and out of the investment on any day that the market is open.

#11: S&P 500 index fund

If you don’t want a growth stock fund but still want higher returns than more traditional bank products, a good alternative is an S&P 500 index fund.

The fund is based on the 500 largest American companies, meaning it comprises the most successful companies.

Like any fund, an S&P 500 index fund offers immediate diversification, allowing you to own a piece of all of those companies. The fund includes companies from every industry, making it more resilient than many investments. Over time, the index has returned about 10 percent annually. These funds can be purchased with very low expense ratios, and they’re some of the best index funds to buy.

Risk: An S&P 500 fund is about the least risky way to invest in stocks, because it has the market’s top companies. Of course, it still includes stocks, so it’s going to be more volatile than bonds or any bank products. And it’s not going to be insured by the government, so you can lose money. However, the index has done well over time.

Liquidity: An S&P 500 index fund is highly liquid, and investors will be able to buy or sell them on any day the market is open.

Saving versus investing: What’s more important and why

Savings and investing are both important, but they’re not the same thing. All of us should actively be doing both, but sometimes it’s hard to differentiate between the two because they seem similar.

For consumers, the main difference has to do with what’s known in investing as time horizon. Think of it like this: If the money needs to be there in the short-term, savings is probably more appropriate term. If it’s money earmarked for longer-term needs, such as retirement, then let’s call it investing. Here’s more on this.

What is saving?

Saving is the act of putting away money for a future expense or need. It usually is money that will potentially be used or at least be available to be used in the short to medium-term. Though it could be used to save for a long-term goal as well. When money is being saved, it is generally going to be in a low-risk account. With this low-risk account, you should get the highest annual percentage yield (APY) savings account that aligns with the minimum balance requirement in that account.

What is investing?

Investing could be a short or long-term event. Generally, investments are stocks, mutual funds or exchange-traded funds. But in most cases it should be a long-term activity as opposed to buying and selling stock in a very short time span, like daytraders. Investing is a long-term activity, because it often is associated with retirement or other longer-term life goal like buying a home. Investing also may involve the risk of loss – since some investments may have volatility or investment risks.

How are saving and investment similar?

They are similar because they accumulate money. Savings accounts will help you accumulate money with compound interest. Your account balance will grow at the rate stated in the APY.

“I think first and foremost, both involve putting money away for future reasons,” says Chris Hogan, financial expert with Ramsey Solutions and author of Retire Inspired.

Investing is money that you’re planning to leave alone, “to allow it to grow for your dreams and your future, later,” Hogan says.

Even if you have some debt, Hogan says try and start off by saving $1,000 in an emergency fund. That will give you at least a little cushion in case some type of unforeseen event happens. After debt is paid off, then Hogan says it’s time to fund your emergency savings account so that it contains three to six months of living expenses in it.

“So if you have an illness, a job loss or whatever, you don’t have to resort back to debt – you’ve got money you’ve intentionally set aside to be a cushion between you and life,” Hogan says.

How are savings and investing different?

When you think of saving, think of bank products such as savings accounts, money markets and CDs. And when you think of investing, think of stocks, ETFs and mutual funds, says Dan Keady, CFP, chief financial planning strategist at TIAA.

Also, when you think of saving, think stability and guaranteed returns. Investments are usually going to be associated with fluctuation, volatility and risk of losing principal.

For the most part, investments can gain or lose money and a savings account will only gain value. Generally, fees – such as maintenance fees or Regulation D violation fees when more than six certain transactions are made out of a savings account – are the only way a bank savings account at a Federal Deposit Insurance Corp. (FDIC) bank can lose value.

Investments, such as stocks or mutual funds, aren’t insured against loss. Savings and investing are different. Real-life examples are the best way to illustrate this, Keady says. For example, paying your child’s college tuition in a few months should be in savings – a savings account, money market account or a short-term CD or a CD that’s about to mature when it’s needed.

“When you use the word just saving and investing, people, really 90-some percent of people, think it’s exactly the same thing,” Keady says.

Money that has to be available at a certain time, needs to be in safe account – such as a savings account, money market account or a CD.

“Otherwise people will think, ‘Well, you know, I have a year and I’m buying a house or something, maybe I should invest in the stock market,” Keady says. “That’s really gambling at that point, as opposed to investing. Investing is where you have longer-term goals and you can hopefully take advantage of the general upward trends in stock prices over time.”

An easy way to differentiate the two is by looking at the time horizon – near-term goals are when you should save at a bank and investing is for long-term goals, Keady says.

Investing vs. Saving

Here are some pros of investing:

Save money now to live later on
When it comes to investing, you’re trying to grow your money for the future.
“With investing the world makes it more complicated than it really should be,” Hogan says. “All you’re doing is saving money for your dreams and you’re putting money away so you have it later. If we don’t invest, we won’t have anything to spend later on.”
Investing will help you keep up with inflation
Investing is your best defense against losing purchasing power. Currently, the inflation rate that the Federal Reserve uses is at 2.0 percent. If your return is below the inflation rate, you’re losing purchasing power over time.
Investing can help you save for retirement
Over time, your investments can help your money grow so that you have enough accumulated during retirement. Usually, the more time you have, the better it is for your account to grow.
Here are some cons of investing:
Investing may involve risk
Investments are usually not guaranteed. They generally involve risk of principal and or you could potentially lose all of your money in an investment. But at the same time, investments are ways to grow your portfolio at a rate of return not seen in savings accounts, money market accounts and in CDs.
Investing can be complex
If you’re not a professional, there’s the risk that you might not understand all the components – and potential risks – of an investment. Investing in single stocks isn’t recommended, Hogan says.
“So if someone’s beginning with investing, I would encourage them to really look at growth-stock mutual funds as a great starter way to get your foot in,” Hogan says. “And really start to understand what’s going on and how money can grow.

Investing may have fees

There may be fees associated with investments. These include expense ratios, commissions for trading or a commission on money that’s being managed by a brokerage. It could also be a fee paid to your financial adviser.

Here are some pros to saving:

Savings is secure

Safety is the main benefit to saving. As long as the savings account is with an FDIC bank, and meets the FDIC requirements, your money is protected. This gives you the confidence to know that your money will be there when you need it.

Emergency funds are vital

Savings is necessary as your first defense when an unexpected event happens. When you become a saver, you will no longer be relying on debt if an emergency occurs, Hogan says.

“We don’t want to rely on the credit card,” Hogan says. “We don’t want to call friends and family when we get in ourselves in bind.”

The power of compounding

Compound interest is a feature of savings accounts, money market accounts and CDs. This helps both your principal, current interest and previous interest grow at a faster pace – depending on the frequency of the compounding.

“You have two best friends of your money,” Hogan says. “I say time and compound interest. Those two things working together can make a couple hundred dollars a month start to turn into hundreds of thousands down the road.”

Here are some cons to saving:

Lower potential earnings

Generally, savings accounts may provide a lower rate of return than investments, which have potential risks.

It may be tough to stay ahead of long-term inflation

Savings accounts may not be able to keep up with long-term inflation as it rises. While this may not be the case in the long-term future, currently the APYs on the very top savings accounts and CDs are earning more than the current inflation rate.

Too much in savings should be avoided

Try to allot the right amount of short to middle-term money in a savings account. If you have too much of your long-term savings in a savings account, you may lose out on potential investment opportunities in the stock market.

Who should save vs. who should invest?

Everybody should be saving – or trying to save – no matter what point you’re at in your life. Investing gets a little trickier, because as you get older your risk tolerance changes. This means, generally, the older you are the more conservative your investments will probably be. The main reason for this is because when you’re older, you’re closer to that retirement finish line – so you’re ready to use the investments that you accumulated to potentially supplement your retirement income. Also, when you’re younger, if you’re in a higher-risk investment – and suffer a loss – you have time on your side to rebuild and recover. Time is one of your greatest assets as an investor.