Say you’ve come into $5,000, but aren’t sure what to do with it. The first thing you probably want to do is decide what the best way to invest $5,000 is. It might not seem like a lot of money, but you should consider that some millionaires and billionaires started out investing small. The decisions you make today on a small amount of money could chart the course for greater financial success, so don’t minimize its importance.
Whether you’re investing $5,000 or $500,000, the same proven investment principles apply. It starts with knowing what you want your money to do for you in the future.
Short-Term Needs vs. Long-Term Goals
Your investment decisions should be based on your objectives and your time horizon for achieving them. If you have short-term needs or goals, such as saving for a down payment on a house, you will want to invest differently than if you’re saving for a longer-term goal, such as retirement. The longer your time horizon, the more risk you might be willing to assume in order to earn a higher return.
The stock market has returned about 10 percent a year on average over the last 50 years, but that occurred through up and down markets. If you have a long time horizon, you can allow the stock market to work for you in the same way as long as you are able and willing to deal with market fluctuation.
To see how much you could earn on your investments over time, check out our Interest Savings Calculator.
Best Short-Term Investing Idea
If your investing timeframe is less than five years, consider options that can generate the best possible returns with the lowest possible risk.
High Yield Savings Account
If you need access to your money in a few years or less, it’s best to make sure it is safe and liquid. Traditionally, the best option was a bank savings account. But today’s low interest rate environment only yields about 0.07 percent, which is next to nothing.
Instead, let your mouse do the clicking to find a high yield savings account offered by online-only banks. The yields available through these digital savings accounts often exceed 1.2 percent. That’s still not a high return, but it’s better than keeping your money in a mattress. The accounts are liquid and safe – backed by the FDIC.
Best Long-Term Investing Options
If you have a longer investment timeframe, you can allow your money to work harder for you by investing in the stock market. You can expect your average long-term return to exceed 8 percent if you allow for the inevitable ups and downs in the market.
Invest with a Robo-Advisor
If you want guidance on your investment decisions without paying big fees or commissions for an investment adviser, you can use a robo-advisor. Robo-advisors apply sound investment principles in helping you allocate your investments according to your specific objectives and risk tolerance. Instead of a human making investment decisions, robo-advisors utilize proven, sophisticated algorithms to come up with your investment strategy.
Most robo-advisors will invest your money in low-cost exchange-trade funds (ETFs), which are like index funds but they are traded on the stock exchange. After you complete a questionnaire, a robo-advisor will choose from the vast universe of ETFs to create a diversified portfolio that matches your investment profile.
Betterment even offers human interaction and customer support from financial advisers. You’ll receive monthly updates on your account and annual recommendations for adjusting your allocation based on the changing circumstances of your account and the market.
Mutual funds are advertised as great investment choices for small investors because they offer instant diversification, which is important for minimizing your risk. They pool your money with thousands of other investors’ money to invest in a portfolio of stocks or bonds. You can invest in a mutual fund that matches your investment objective, preferences, and risk tolerance.
The problem is most mutual funds are actively managed, which means they charge management fees and they can eat into your investment performance. Plus, the vast majority of active fund managers don’t have a very good record of being able to outperform the market – so why pay them a management fee?
That’s where index funds come in. Index funds are similar to mutual funds in that your money is part of a pool of investors. but instead of actively managing the portfolio, index funds invest in a static portfolio that mirrors one of the stock indexes. The result is that the portfolio can be expected to perform as well as the market.
Over the last couple of decades, the average index fund has outperformed the majority of actively managed mutual funds. The best part, however, is that the fees you pay are typically a fraction of what actively managed funds charge. There are thousands of index funds from which to choose.