Many people lost their appetite for investing in the aftermath of the great market meltdown of 2008 caused by Alan Greenspan mainly and we know Barney Frank destroyed Fannie Mae and Freddie Mac.
However and moreover, you should not let history hold you back from making an all-important nest egg for yourself even when you only have $5,000 to start with.
Investing is not speculation or gambling. It is important that you do not indulge in speculative trades in the stock markets with little information or experience. Your goal should be choose a safe investment strategy after a careful deliberation.
As a first step, you should set aside a portion of your $5,000 as emergency fund while investing the rest. You can play with different options here. You could invest a small part into a high-risk, high-return fund while placing the rest in a steady and more secure investment.
Here are a few good options to get you started on your investment journey:
Saving with Online Banks
These banks are known to offer more interest than traditional brick-and-mortar banks. It is important that you build an emergency fund to fall back upon before you start investing in riskier options. The right emergency fund should have enough to let you live off easily for 3 to 4 months until you find your bearings.
Online banks offer multiple attractive options to novice investors to start out with savings. You can easily create a liquid ‘rainy day’ fund in any of the various online bank options available.
The only downside to online banks is that they do not have physical locations. This makes the whole transaction somewhat impersonal. It gets even trickier when you want to speak with a human being face to face to understand the various terms and policies.
However, this small drawback is easily offset by the highly lucrative rates offered by online banks. For instance, EverBank offers a 0.91% interest rate on your savings.
A Roth IRA is a proven way to begin investing. It gives you the option to pay up your taxes on $5,000 even before you invest the amount. You do not have to worry about the fluctuating tax rates by the time you retire simply because you would have already paid up your taxes in full.
Roth is a great investment vehicle aiding amateur investors to start saving money. These are long-term accounts in which you pay up the taxes on your investment amount ($5,000 here). These are effective tax-planning tools for the future. You can start by saving 30% of your $5,000 and any income moving forward in a retirement account.
Money Market Accounts and Certificate of Deposits
If you think you are going to need the money in the next 5 years, then it is best to park it in a short-term commitment. Both CDs and Money market accounts offer 5 year terms.
The prime difference between CDs and Money market accounts boil down to liquidity. Once you commit to certificate of deposits for 5 years, there is no going back. Money market accounts on the other hand offer more options as a liquid savings account.
It is important that you do not confuse money market accounts with money market funds. The funds are offered by investment banks whereas the money market accounts are federally insured deposit accounts.
There is a wide selection of funds out there from equity and bond funds to target date funds and investing in emerging international markets. The key is to spread your money through a series of high and low risk returns.
This is where an actively managed mutual fund option comes in useful. You can invest a major portion of your $5,000 in a well-researched mutual fund if you are young and have time on your side.
Actively managed mutual funds do not require any investment of time or efforts on your part. The fund manager studies changing market trends to invest in the most worthwhile options.
However, nothing is completely free of risks. You should take the time to study quarterly performance reports. Also, actively managed funds come with a fee that can eat up your savings.
Most financial advisors recommend an expense ratio below 1%. You can find this information on the fund’s prospectus or website.
Exchange Traded Funds
These are similar to mutual funds except you are the active manager. You buy a small slice of the investment holding when you purchase a share of an exchange traded fund (ETF).
The major benefit of ETFs over mutual funds is in saving the management fee. The downside of this is that you need to do all the work. You need to rebalance your portfolio at least once a year.
Another benefit of ETF over mutual funds is that there are no lower costs associated. They are also treated as stock transactions on your tax return as opposed to index and mutual fund investments.
Index funds are for people who want the best of all worlds. They want to invest in stock markets without spending time on researching stock options or paying the fee accrued in actively managed mutual funds.
You could consider investing in popular Indices such as S&P 500, DJIA, or Nasdaq. Index works the same way as mutual funds. You simply get the ball rolling and sit back to watch your money grow.
Index funds do not accrue heavy management fee and you get to enjoy the same benefits as you would in a mutual fund.
If you have the time and a penchant for stock trading, then there is no better way to invest than in stocks of reputable companies. You could read up about people like Warren Buffet and understand how they have been investing in stocks for the past several decades.
There are various online investment platforms such as Covestor, Charles Schwab, and E*Trade that can make investing easier for you. Individual stock investments, if done right, can give you returns in the range of 15% or even more. You should invest for the long-term and grow your portfolio gradually as you gain more insights about stock investing.
No Risk, No Reward
No matter how safe you play it, there is always some risk associated in investing. You need to come up with a strategic investment plan where you take an appropriate amount of risk that boosts your returns.
A well-diversified investment portfolio can work well to reduce your long-term risk burden and grow your money way beyond your initial investment amount of $5,000.