Where is the Best Place to Invest New Money?
One of the most important decisions any investor will make is where to invest his money. What with IRAs, 401(k)s, taxable accounts, stocks, bonds, mutual funds, hedge funds, real estate, CDs and savings, there are an overwhelming number of choices. Fortunately, investors can narrow down their options by considering what they want to accomplish with their money, when they want to access their money, and what kind of returns they’d like to get on their money. These decisions lead to an asset allocation, which helps investors decide where to invest their new money.
Decide on an investment horizon. If you know you will need the money in a few years or less, investing it in the stock market could be very risky. Also, illiquid investments like real estate may not be a wise choice for short-term money. If you won’t need the money for 10 years or more, the stock market or real estate investments could be great options.
Assess your risk tolerance. If you can’t stomach the thought of losing so much as a penny of your principal, the stock market is not for you. Likewise, real estate is not a guaranteed investment. Those who are extremely risk-averse should stick to CDs, savings accounts and high-grade bonds that pay a guaranteed interest rate. You may not get great returns, but your principal will always be protected. Keep in mind, however, that inflation will take a toll on your savings. Big risk takers will want to look at the stock market and even hedge funds to maximize returns. Those in the middle will want a balanced portfolio containing some stocks and some less risky investments, to weather any storm. Risk tolerance calculators (like the one found in the Resource section below) can help you determine your individual risk tolerance.
Know why you’re investing. If you are investing for retirement, consider contributing to an IRA or 401(k) plan to maximize tax benefits, then use that money to purchase whatever long-term investments you desire. If you don’t have access to an IRA or 401(k), a taxable investment account will allow you to invest in stocks and bonds as well, just without tax advantages. If you are investing for a child’s college education, look into a 529 or Coverdell plan. If you have no specific plans for the money, a taxable investment account is your best bet – you will have complete control over the money, with no contribution limits or withdrawal rules.
Create an asset allocation. After answering the three questions above, you should have a good grasp on what the money is for, when you’ll need it, and how much risk you want to take with it. Based on those factors, choose a mix of small and large cap domestic stocks, small and large cap international stocks, bonds, cash savings and other investments that allows you to sleep at night. The articles at the Fund Advice may be helpful in deciding on an asset allocation. The classic “balanced” portfolio contains 60% stocks and 40% bonds, which some investors may find too conservative. Another rule of thumb is that your stock allocation should equal 110 minus your age, so if you’re 30, that means you would want to have 80% stocks and 20% bonds. If you want to be very hands-on with your investments, consider buying rental properties instead of (or in addition to) stocks and bonds–just remember that being a landlord can be a full-time job.
Once you have an asset allocation in place, the question of investing new money becomes very simple. When you have new money to invest, review your current holdings and see if they are in line with your desired asset allocation. For instance, your asset allocation calls for an 80% stock, 20% bond portfolio, but your stocks have risen in value and now comprise 90% of your portfolio. Put that new money into bonds to rebalance your portfolio. Rebalancing on a regular basis will help you keep track of your investments and reach your investing goals.