You've decided to start saving and take control of your financial future, now what?
After you make the commitment to begin saving, the next question that arises is what do you do with your nest egg? How do you harness the power of compound interest. Most savings accounts give you an abysmal savings rate like .05% a year! If you were to have $1000 in an account like this each year you would be making 50 CENTS per year. I had to do the math three times because that number just seems impossibly low. You need a plan of what to do with your money that is intentional and works to build your wealth, not just keeps it stagnant if you want to harness the power of compound interest. You need to become an investor.
An investor is a person who uses their financial resources intentionally in ways that produce monetary gains. There are many different ways to do this, that all offer unique benefits and risks that we will evaluate later.
The first thing we need to discuss before you become an investor is RISK TOLERANCE. Risk tolerance is a common financial term that refers to an individuals ability to maintain their peace of mind, while taking calculated risks to reach financial goals. If you are extremely risk adverse, you will find yourself drawn to safe investments where you will earn less money but can trust it to be consistent. If you have a more positive relationship with risk, you will find yourself drawn towards investments that are more risky but also offer greater financial returns.
When thinking about risk tolerance, it’s important to consider your age, how long you plan to invest the money, and your ability to maintain a level head and stick to your investment strategy despite what's going on in the news.
Once you figure out your risk tolerance (this can be a fluid declaration that changes are your experience and priorities change), it’s time to think about ASSET ALLOCATION. Asset allocation is your investment strategy, it is a guideline for where and how you are going to invest your money. It is your plan to avoid the chaos you here the news and follow a plan despite whats going on in the world. In order to talk about asset allocation, we need to go over the various types of assets you can choose to invest in.
Savings Accounts - A savings account is essentially keeping your money in cash at the bank.You are lending your money to a financial institution for an undefined period of time, and they use this money to make loans to other individuals or in various types of investments. It is the safest investment and offers the lowest interest rate. It is a great place to keep an emergency fund or money you are going to need to access in the near future.
Bonds - Bonds are loans you make to a business or a government that get paid back to you over a period of years with interest. The company or government you loan the money to can use it for a variety of projects, and depending on what you invest in you can have some say in this. It is slightly higher risk than putting your money in a savings account and it makes your money less fluid because you can only access it when the set time period has passed.
Precious Metals - Everybody loves silver and gold! Precious metals are similar to saving accounts and bonds in that it is a fairly safe investment and the annual return isn’t typically very high. It is different in that when you invest in precious metals you are owning something that increases in value over the years, instead of lending money to a bank, government, or business.
Real Estate - Real estate is a riskier investment option that takes a few different forms. You can flip houses, rent property, or invest in a Real Estate Investment Trust (REIT). A REIT is a low cost way to invest in real estate. When you flip houses or rent apartments you take all the risk and you get all the pay out. With an REIT you lend money to a trust who uses that money to invest in rental properties with many other investors so your risk is mitigated and so is the pay out.
Stocks - stocks are the investment opportunity we hear the most about in the news. When you buy stock, you are buying a small percentage of the company. You become an owner and as an owner you receive money when the company does well but it is high risk. There are a variety of ways to invest in the stock market and if offers the highest returns. Young people are typically recommended to keep most of their money here.