I Have Some Money, What’s Next?

Perhaps you inherited some money, you saved it, you earned it, you robbed a bank for it or you found it on the street.  However you came across it, it’s now yours and you want to start putting it to work.  This is the call to arms for every investor – “how can I take the money I currently have and use that money to earn more money?”.  Once you fully understand such a question and what it means you begin to grasp the concept of investing.  However, it is once your question changes to the more direct mutation of that question – “how can I take the money I currently have and use it to make the MOST money possible” that you begin to understand why millions of people and trillions of dollars are devoted to finding the solution.

But let’s take a step back and start with the basic question – “How can I make my money earn more money?”  Simply by going to the bank you’ll understand that a standard savings account will offer you an interest payment; a small percentage of your savings they pay to you for keeping your money with them.  But you’ll also notice that not all banks have the same interest payments.  The reason for this is marketing and competition.  Your own personal bank already has your money and they know for convenience you are probably going to want to keep everything in one place, whereas online banks and smaller banks know that in order to have any chance at getting your money they need to offer something better – it’s why most online and smaller banks charge very little or ZERO FEES at all.
 

When your money is earning interest in the bank or in a savings account it is earning RISK FREE interest.  That is to say that there is virtually no chance that your money will one day magically disappear, or that you’ll show up to the bank and find all the doors locked and someone peaking through the shutters telling you to go away.  Risk Free interest sets the bar for all other investments and is what’s known as the risk free rate of return.  This is an important benchmark because any investment that has any amount of risk greater than zero needs to provide a rate of return greater than the risk free rate of return for you to even consider it to be a viable investment.

Some examples of different types of investments and the potential rate of return.

As you can see, investing in your friends “next facebook” business carries by far the largest risk and yet has the potential (by far) to offer the largest reward.  But potential isn’t the same as having actual money in the bank.  Instead, you want to find the best combination of risk and reward possible that maximizes your return and yet keeps your risk minimal.

Below you can see these investments plotted out: 

It’s important when looking at the chart above to see that some investments are clearly very bad and some investments (if you could find them) would clearly be great.  In the example, used, hiding money under your bed and lending money to an untrustworthy friend are clearly bad investments.  For example, when you hide money under your bed, you earn zero interest and still have the very small chance of it getting stolen.  Lemonade stands are generally good ideas on hot summer days, but 10 lemonade stands offers a greater chance that the market will become saturated and there simply won’t be enough people to enjoy it.

Now let’s take our example and move it to the world of investing to see what the risk return rates of some common investment asset classes are.

Examples of Common Asset Classes 

As you can clearly see, international equity offers a higher degree of risk, while cash offers almost no risk and no reward.  Of course, life doesn’t always make things easy for us and most of the great investments get swamped with demand and lower the amount of return they offer making them no longer as fantastic an investment as they once were. 

What Investment Strategy Should I Use?

One of the most common questions asked by a financial advisor is “What sorts of investments are you interested in?”.  This is a stupid question.  It’s a stupid question because for the vast majority of investors they aren’t interested in any particular sector or industry, they are simply interested in making money.  The question is also a bit disingenuous – by having YOU, the investor be led to say something like “Well, I suppose I like green energy and banking”, the financial advisor takes the burden of choosing the right strategy from them on to you.

The truth is there is NO CORRECT INVESTMENT STRATEGY, there are only appropriate strategies, and inappropriate strategies for your asset allocation, and these are determined based on your income, the specifics of your situation related to how much risk you can take on, and what you’ll eventually be wanting to use the money for.

When it comes to picking an investment strategy the truth of the matter is most people are not able to beat the stock market in the long run – and if your investment advisor can’t do it, the chances of you being able to quadruple your investments while the market is losing money is relatively slim.  What you want is a strategy composed of assets that has a good enough mix to offer both growth and safety.  If you want to stay slightly more conservative, you’ll want to have a larger amount of money in safe bonds and cash, if you want a more aggressive strategy you’ll invest more in smaller, volatile stocks (like small technology stocks).

An Example of a Very Conservative Investment Strategy 

The chart above illustrates a very conservative investment strategy.  You can see by the over-allocation of bonds and cash that even in a very bad market this portfolio is unlikely to lose much money.  However, in a high growth market it will miss out on many of the large gains others are making.

An Example of a Moderate-Growth Investment Strategy

A moderate-growth strategy will be suitable for most investors.  It conserves cash in case the market dips while having enough exposure to take advantage of growth periods. 

An Example of a Speculative Investment Strategy

A speculative investment strategy is most suitable for younger, high income earners that have access to cash and no immediate plans for requiring it (this would NOT be the case if you are planning to get married and save for a house); portfolios like this can be up or down 10% in a single day, while gaining or losing almost 50% over a given year or more.

Why should I Invest In Bonds and International Stocks?

Throughout this article it’s been mentioned how proper diversification involves international equity and bonds.  What hasn’t been explained is ‘why’. 

By including asset categories with investment returns that move up and down under different market conditions within a portfolio, an investor can protect against significant losses. Historically, the returns of the three major asset categories have not moved up and down at the same time. Market conditions that cause one asset category to do well often cause another asset category to have average or poor returns. By investing in more than one asset category, you'll reduce the risk that you'll lose money and your portfolio's overall investment returns will have a smoother ride. If one asset category's investment return falls, you'll be in a position to counteract your losses in that asset category with better investment returns in another asset category.

In addition, asset allocation is important because it has major impact on whether you will meet your financial goals. If you don't include enough risk in your portfolio, your investments may not earn a large enough return to meet your goals or requirements for retirement. For example, if you are saving for a long-term goal, such as retirement or college, most financial experts agree that you will likely need to include at least some stock or stock mutual funds in your portfolio. On the other hand, if you include too much risk in your portfolio, the money for your goal may not be there when you need it. A portfolio heavily weighted in stock or stock mutual funds, for instance, would be inappropriate for a short-term goal, such as saving for a family's summer vacation. 

I Am Ready to Get Started Investing, Now What?

Now that you understand what you should be investing in, you need to understand HOW TO BEGIN INVESTING.  The process of investing is actually relatively straightforward, and you have several options.

The first and easiest option is to go online and begin investing by yourself.  Sites like actually make it really easy to invest in various mutual funds and help you track your asset allocation to make sure you’re investing right.

The second option is to simply walk into your bank and ask to speak with a financial advisor.  Most of the time they will be willing to explain everything to you but you want to make sure you communicate very carefully about the amount of risk you want to take on.  Using words like “moderate growth strategy” will help guide the financial advisor into making the right investment decisions for your future retirement as well as short term savings goals.

The third option is to find a financial advisor by yourself.  Our site has a registry of financial advisors if you’re looking for a referral, but you are also able to browse the websites of brokerage firms in your area.  Almost all of them will be willing to meet with you for a no obligation discussion.