For most of this year, interest rates have remained at a historic low. In practical terms these low rates are going to hurt your savings as any money you may have set aside in your bank account is not going to be working as hard for you as would have liked. As such you might be tempted to invest your money instead of saving it and doing so certainly makes a lot of sense.
The sheer variety and volume of investment options and financial products on offer can overwhelm new investors and can be rather daunting. After all, once you commit your money you have no guarantees and a bad decision could end up costing you your savings. That said, in spite of this it is actually much simpler than you may initially think. If you want to start investing with low-risk investments, read on to find out everything you need to know in my guide to low risk investments US.
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Why should I save or invest?
Usually, any money you have left over, once you have paid all your monthly expenses and budgeted for groceries, you have two options. Either you can put the extra into a savings account, or you can invest it on the stock market.
Recently though with interest rates at record lows the value of a savings account has come under question. Simply put the savings account is now a loss-maker and is one of the worst things you could do, assuming you want to grow your wealth. This has been especially true since the start of the coronavirus pandemic when the Fed lowered its base rate to historic lows.
Low interest rates mean that your wealth won’t grow by very much while resting in your savings accounts, even if you leave it with the bank for a long time. For example, if you deposited $1,000 into a savings account with an annual interest rate of 0.1%, at the end of the year you would only have gained $1 in interest. Nothing to write home about.
How does inflation affect my savings?
While your wealth is still technically growing in a savings account, with the low rates of interest and rising inflation rates the purchasing power of your dollars will decline. You won’t be losing money but the actual value of your dollars will be falling to the wayside.
A good way to see this is with the US inflation calculator, which can show you how much impact it has on your money’s buying power over time.
For example, if you had $10,000 in 1990 then you would be able to buy goods and services worth that amount. However, in 2020 you would need $22,671.08 to buy the same goods due to an average annual rate of inflation of 3.9% in that period.
So, while it is true that your money is typically safe from stock market disruption should you deposit it in a savings account, it is also unlikely to be growing enough to outpace the rate of inflation. This means your money’s buying power is being diminished over time, and you are literally getting less bang for your buck.
Should I keep any of my wealth in cash?
While inflation does slowly erode the true value of your cash in your savings account, it can be useful to keep some this way to act as an emergency fund.
For most cases its recommended that you keep enough cash to cover at least three months’ worth of expenses, in case you were ever to lose your income. Of course, you may want to keep a larger fund if you are self-employed or work in a field that is particularly at risk from stock market downturns.
Keeping an emergency fund can be very useful as it means that when the unexpected happens, you are less likely to be significantly affected by a financial shock. This can be particularly useful for younger people, who are typically more financially vulnerable as they have not had as long to build up their wealth.
If you don’t already have a fund in place, you may want to use any spare money to set one up before you start investing in the stock markets, as it can be handy for staying on top of your bills should something unforeseen happen.
If your financial situation is precarious, or if you are unsure as to the immediate future then putting money away into your savings accounts, rather than investing it, can be the wiser option. With the money on hand and readily available you will be able to access it, should you need, and at the same time earn modest interest for your continued good financial health.
What are the benefits of investing?
The main benefit of investing your wealth is that, depending on how and where you choose to invest, the returns are typically greater than the rate of inflation. This means that you can grow your wealth in the long term and in this way attain your financial goals.
Whether these goals are enjoying a comfortable retirement, building up enough wealth to purchase a home or growing your financial wealth, is down to you.
However, when investing it’s also important to bear in mind that doing so comes with some amount of risk. Unlike with saving, when you invest your wealth, there is always a chance of losing money. Because of this, it’s important to think carefully about how you invest, to minimize the chance of this happening.
What are investment horizons and how do they affect me?
When it comes to investing, it can be important to have a clear idea of how long you want to invest for. This goal is called your investment horizon.
Simply put, an investment horizon is how long you’re willing to hold your portfolio for before selling it. You may want to stop when you have earned a certain amount of money, when you reach retirement or after a certain amount of time passes.
Whatever your reason to invest, one important rule to bear in mind is that, typically, the longer you invest, the lower the chance of you losing money. As the old Wall St. adage goes, “it’s time in the market, not timing the market”.
Typically, most investment professionals will recommend that you look to invest for as long as possible, in order to reduce the impact of short-term stock market volatility on your investments.
If you want to avoid the effect of short-term disruptions, you should consider investing for at least five years.
What is diversification?
Another important thing to bear in mind when you start investing is that you should try and diversify your portfolio, if you can.
The purpose of diversification is to spread your investment into different sectors, thereby lowering your investment risk. In essence what you are trying to do is ensure that you are not putting all your eggs in one basket.
Having a diversified portfolio means that you invest in different asset classes with different levels of risk. It can also mean investing across a range of different industries and sectors, in both the US and also abroad.
The main benefit of portfolio diversification is that it lessens the impact of a potential stock market crash. If there is a fall in one area, whether that’s a region, an industry, or an asset class, it is hopefully offset by better performance in another.
If you think you may benefit from this, read my article about how to create a diverse portfolio for more information about how it can benefit you.
What are investing charges?
Many investment products, although not all, typically come with some sort of charge or fee attached to them. For example, if you invest in an actively managed mutual fund then you may need to pay fees for the services of a fund manager.
If you want to grow your wealth in the most effective way, it is important to shop around for the best deal.
When comparing fees, it can be easy to think that the difference of a few per cent is negligible. However, this isn’t the case as over the long term, even small percentages can add up and eat into your returns. Nickel and diming has been the key to wealth ever since money was invented, after all it all adds up.
That’s why, before you start to invest your hard-earned money, you should take some time to do some stock market research to find the best investments for you.
What are my main options for investing?
Choosing where to invest your money can be difficult, which is why it’s important to think carefully about your options. There are a wide variety of stock markets and assets to choose from, depending on your attitude to risk.
For example, if you are willing to take more risks, you may be tempted to invest in commercial property or companies that mine precious metals. However, while these can be lucrative, they may also expose you to too much risk, as stock market downturns can severely affect their profitability.
If you’re looking for low-risk investments, here are some of the most popular choices:
- Stocks and shares
- Corporate bonds
- Treasury bonds
It’s important to bear in mind that all assets have their own pros and cons, so it’s important to be able to make an informed decision before investing money in them.
One of the most common ways of investing is to buy stocks and shares in companies.
Simply put, a share is a ‘unit’ of the value of the company. For example, if a large company is worth $100 million and there are 50 million shares in that company, each share is worth $2.
The value of shares can go up or down in value for a variety of reasons, but often because the value of the company increases. For example, the share value of many pharmaceutical companies rose during 2020, as the Covid pandemic meant that there was increased demand for their services and products.
Any buying or selling of shares is done via a stock exchange. In the US, the New York Stock Exchange (NYSE) is the most famous example and is known worldwide. In fact, many companies from abroad want to go public on the NYSE simply due to its sheer size and prestige. In any case it is on the NYSE that companies and shareholders can sell to investors, agreeing on prices and quantities.
Typically, there are two ways that you can profit from buying shares: capital gains or dividends.
One of the main ways that people make money from investing in company shares is through capital gains. Essentially, this involves buying a share and selling it once it has increased in value.
For example, let’s say again that there’s a company worth $100 million with 50 million shares. You decide to invest, so you buy one share of the company worth $2 and then wait.
In the following year, the company experiences strong economic growth and the value of the company doubles from $100 million to $200 million.
At the end of this year, since the company’s value has doubled, the value of your share may have doubled to $4. This means that should you decide to sell your share at this point you will have made a profit of $2.
Another way that you can benefit from buying stocks and shares is through dividends. These are essentially bonuses paid to shareholders, usually monthly, quarterly, or annually, from company profits or reserves.
You can either take dividends as income or reinvest them through the purchase of new shares. If you choose to reinvest them, you could benefit from compound growth as you may receive even more dividends in the next year.
It’s also important to note that the dividend is calculated based on the number of shares you hold, rather than the overall value of your holding. This means that, even if a share has reduced in value, you will still typically benefit from a dividend return.
One of the main benefits of dividends is that they can be a good way of making a passive income. Of course, not all companies pay dividends, so it’s important to do some research before you invest money.
What are bonds?
A good way to understand corporate bonds is that you’re essentially giving a loan to a company, which they will pay back with interest. Businesses usually issue bonds when they need to raise money.
Like dividends, buying a bond will give you a passive income stream, as you’ll benefit from period interest payments, usually twice a year. They can also be less risky than buying shares in a company.
However, unlike when you buy shares, owning a bond gives you no ownership rights so you don’t necessarily benefit if the company grows. Of course, the flipside of this is that you also won’t be as impacted if the company struggles financially – as long as they are able to meet their loan obligations.
If you buy a bond, you can simply collect the regular interest payments and wait for the bond to mature, which is when the company will repay you.
However, one alternative that you could consider is selling the bond. Once corporate bonds are issued, their value tends to fluctuate, as company shares would. If you want to simply hold the bond until it matures, these fluctuations won’t matter, as its face value and interest payments won’t change.
If the bond increases in price since you originally bought it, you could consider it selling it on as you may be able to make a profit. Of course, you’d have to weigh up the value of the decision, since you would no longer be receiving interest payments.
U.S. Treasury bonds
The final low-risk investment that you may want to consider are Treasury bonds. As the name would suggest, these bonds are issued by the US government and are essentially very similar to corporate bonds.
Like regular bonds, these government bonds allow you to earn interest while you wait for the bond to mature, giving you a passive income stream.
Since there is a negligible risk of the government collapsing and being unable to meet its debt obligations, gilts are typically considered the epitome of a low-risk investment. However, the flipside of this is that they often have low interest rates, meaning that your investment may not grow by a significant amount.
Also consider: Your Comprehensive Guide to US Treasury Bonds
What are my options to start investing?
If you want to grow your wealth, there is more than one way to invest. Some of the most common ways to get started are:
Of course, these options aren’t mutually exclusive since each of these options has its own benefits, and you may want to invest your money in more than one. Of course, before you act, it’s important to know a bit more about how they work.
What are IRAs?
An Individual Retirement Account (IRA) is a tax-efficient way to grow your wealth and can be a great way to start investing.
One of the main benefits of an IRA is that they come with different tax perks, depending on the product you pick. Some for example let you make withdrawals and earn interest tax free and others let you make tax free contributions. All of which can help you to build your wealth faster.
Each tax year you have an annual contribution limit for 2019, 2020, 2021, and 2022 is $6,000, or $7,000 if you’re age 50 or older. The annual contribution limit for 2015, 2016, 2017 and 2018 is $5,500, or $6,500 if you’re age 50 or older.
An IRA can consist of almost any investment product, including stocks, bonds, mutual funds, annuities, unit investment trusts (UITs), exchange-traded funds (ETFs), and even real estate.
What is the benefit of investing in a pension?
If the goal of investing is to build up your wealth in preparation for retirement, one useful option can be to invest money into a pension scheme.
Whether this pension scheme is one via your employer or a private on you have selected any contributions you make will be managed by a pension fund manager on your behalf.
As well as investment returns, the other main benefit of investing money via your pension is that it should provide a secure source of funds to help you enjoy your retirement. That said you should check the tax burden on your pension fund as they will vary from state to state and will also depend on the product you have chosen.
Just be aware that your pension, whilst usually tax incentivized, is not tax free!
What are funds?
Investing in funds can be an easy way of investing, as much of the difficult parts, like building your own portfolio, are done for you.
Essentially, a fund is an investment that pools money together from many different investors. Typically, a fund manager then invests that money on their behalf. Each investor is issued units, which represent a portion of the assets being held by the fund.
There are two main benefits to investing in this way. The first is that, as you may have read in my previous article about mutual funds, since many of them are run by fund managers on your behalf, you don’t have to spend time researching good potential investments yourself. Instead, you can simply benefit from the expertise of the manager and their team.
A second benefit of investing in funds is that your money will be spread across several different asset classes and market sectors. This means that your investment portfolio is diversified for you, which can significantly lower how much risk you are exposed to.
What types of funds are available?
There are a variety of funds to choose from, such as:
Mutual funds – A mutual fund is a classic type of fund, allowing you to pool your money with other investors. They typically come in two main types: “actively managed funds” and “passive funds”.
Multi-asset funds – A multi-asset fund typically invests in a wide variety of assets to maximize its diversity and lower risk for the investor.
Index funds – Also known as “tracker funds”, an index fund aims to match or track a particular market index, such as the performance of the FTSE 100.
Are there any tax issues I need to know about?
When it comes to investing, there are two main taxes that you need to be aware of.
Capital Gains Tax
The first tax you should be aware of is Capital Gains Tax (CGT).
This is the tax you have to pay when you sell an asset for more than you bought it for. It’s important to bear in mind that you only need to pay tax on the profit from the sale.
So for example, if you bought shares for $1,000 and they rose to be worth $1,100, you’d only potentially owe tax on the 4100 gain.
Individuals do not have to pay any capital gains tax if their total taxable income is $40,400 or below. However, they’ll pay 15 percent on capital gains if their income is $40,401 to $445,850.
The other tax to be aware of is the Dividends Tax. As the name implies, this is a tax on the income that you receive from dividends.
Each tax year you have a Dividend Allowance for how much you can earn from dividends without having to pay tax on them. In the 2021/22 tax year, this stands at $1,500.
As you can see, there can be a lot of potential tax pitfalls to be aware of. If you’re concerned about running into one, you may benefit from seeking financial advice.
What are the benefits of working with a financial advisor?
As you probably already know, investing carries an inherent risk as any money invested can be lost. If you want to avoid this prospect, it’s important to be able to make properly informed decisions with your wealth. This is where it can be important to seek financial advice.
When you work with a professional, they can help you to find the right investments for your risk level. This can help you to grow your wealth while still having peace of mind to know that there’s a low chance of losing money. This can help to give you a sense of confidence in your investing.
Working with a financial adviser can also be useful to give you more peace of mind and reassurance if there’s ever a fall in stock markets. When there is a market downturn, it can be tempting to panic-sell, but this isn’t always the best decision. A professional can help to act as a sounding board, ensuring that you make sensible decisions.
Furthermore, they can also help you to avoid any potential tax issues, helping you to grow your wealth with confidence.
The value of your investments (and any income from them) can go down as well as up and you may not get back the full amount you invested. Past performance is not a reliable indicator of future performance. Investments should be considered over the longer term and should fit in with your overall attitude to risk and financial circumstances.