With the stock market going up and down like a bad roller coaster ride, many people wonder how to invest their money without getting killed.
I have good news! We're going to introduce you to the best investment opportunities for 2020 and beyond.
Volatility (dramatic moves up and down) in the stock market has always been here. Anyone investing in the market should understand that short term ups and downs are part of the package. Most investors understand that. It's the size of the gains and drops in the markets on a day to day basis that brings fear to investors.
In this year alone, we've seen the S & P 500 go down as much as 9% in one day. A 9% return in a year is a good one year return. Investors would be thrilled to have that as their average annual return. But 9% in one day? That's pretty unnerving.
Programmed (or computer-driven) trading is the culprit for these big market swings. If you're one who loves to trade stocks, volatility is your friend. Most of us aren't traders. Most of us are investing to help us plan for our retirement, pay for our kids' college, or other long term planning goals. Watching that money ride the roller coaster is not something we enjoy.
With that in mind, below are some options by category to help you find investment opportunities that you can use.
Investment Opportunities with Safety
If you're looking for safe investment opportunities, start with savings accounts at a bank. Most of us already have a checking account at a local bank. It's likely we also have savings accounts as well. But our local, regional, and national brick and mortar banks usually pay substantially less than most online banks.
The Federal Reserve, which controls interest rates, has lowered interest rates to near zero percent. Their latest statement on interest rates indicates they intend on keeping rates at near zero until the end of 2022.
With that said, if you're looking for a safe place to put your money with the added security of FDIC insurance, bank accounts may make sense for some of your money. Here are some banks that typically have higher savings account interest rates. Be sure to check current rates, minimum balances, and fees before opening your account.
These accounts are a great place to keep your emergency funds. Compare rates and fees from these online banks.
Certificates of Deposit (CDs)
CDs have fixed and variable rate accounts with a set maturity date. That date could be six months to one year or longer. They typically pay higher rates than savings accounts due to the longer time commitment.
If you want your money out before the agreed-upon time, you will pay a small penalty. That penalty comes out of interest, not principal. And again, you get the benefit of FDIC insurance of $250,000 per account title.
Here are some that offer higher rates.
Investments in bonds, like CDs, have a maturity date. The maturity dates on individual bonds range from as short as 9o-days to thirty years. Like any investment with a set maturity, the longer the term, the higher the interest rate paid. So, a ten-year bond will pay higher interest than a one year bond. The reason for that should be apparent.
If they ask you to leave the money with them for a more extended period, it takes away your ability to use that money. If interest rates go up during that time, you lose the ability to reinvest at the higher rate. Because of that, the entity issuing the longer-term bond must compensate you for that risk by paying a higher rate. That's the incentive for you to leave the money with them for the term.
Companies, federal, state, local governments, and government agencies all issue various types of bonds to investors. Unlike banks, there is no FDIC insurance to guarantee your money gets returned at maturity. Instead, the entity issuing the bonds is responsible for paying back your money, and the promised interest. It's essential to invest your money in financially secure entities.
Treasury securities, those issued by the federal government, are considered the safest type of bonds. They come with the backing of the “full faith and credit” of the federal government. I realize there is an argument as to whether that guarantee is still valid. But keep in mind, the Treasury department can refinance existing bonds by issuing new bonds to pay off the maturing obligations. They have an unlimited ability to issue new Treasury securities.
I'll leave the argument about whether that's a viable strategy for others. I will tell you that it's been that way since 1812 when the Treasury issued its first Treasury notes.
The Treasury issues three types of securities – bills, notes, and bonds. The kind of security depends on the length of maturity as follows.
- Bills – have maturities of less than one year.
- Notes – offer maturities of one to ten years.
- Bonds – have maturities of greater than ten years.
Corporate bonds are those issued by companies. When investing in corporate bonds, pay close attention to the finances of the company. The principal and interest are only as good as the company issuing the bonds. Like their Treasury counterparts, the longer the maturity, the higher the interest investors receive.
There is an additional factor that can increase or lower the interest investors receive – the quality of the company issuing the bonds. By quality, I mean the financial stability and credit rating of the issuing corporation. You can check those ratings at several rating agencies. These include Moody's, Standard and Poor's, and Fitch Group. We could make the argument that investors should do their own independent research on the issuing company.
One needs only to go back to the financial crisis of 2008 to see why. One of the biggest reasons cited for the meltdown was due to the inaccurate and, in some cases, fraudulent ratings on many of the securities issued that couldn't pay back investors. Since that time, the regulation makes it harder for these agencies to play that game.
Investors can get higher interest rates on bonds issued by companies with lower credit ratings. Remember, risk and return are related. The higher the risk of an investment, the great the expected return of that investment. Like the bond maturity, if the financial risk of a company is higher, investors can expect to get compensated for accepting that risk with a higher interest rate.
Be careful and do your due diligence on the companies before investing.
Investment Opportunities with Higher Expected Return
Let's review ways investors might achieve higher expected returns when investing. Here we'll look at the usual suspects – stocks, exchange-traded funds (ETFs), and mutual funds. Investment opportunities with higher expected returns come with higher risk.
Remember, the two are always related. Does that mean if you're risk-averse, you should avoid investing in these assets? Not necessarily. Properly diversifying your investments helps reduce the risk of investing in stocks.
Here is a brief summary of the three types of investment opportunities with higher expected returns.
Stocks are one of the most familiar riskier investments. For this discussion, I'm referring to common stocks. Investors can purchase these publicly-traded companies on stock exchanges (New York Stock Exchange, NASDAQ, etc.).
Investors can buy and sell stocks during a day, or they can buy and hold stocks for an extended period. Unless you are an active stock trader who has the time and personality to do your research, investing in stocks should be a long term strategy.
History shows that holding good companies' stocks for an extended time is the best way to build wealth. The chart below validates that statement.
Source: Dimensional Fund Advisors
If you're considering investing in individual company stock, be sure to check the financial stability of the company. Unlike bonds, investors can lose their entire investment in a company's stock if they go out of business.
As with bonds, the lower the rating, the higher the risk, and the higher the expected return. In general, smaller companies have a higher risk than their larger counterparts. There are a lot of things to consider when investing in individual stocks. Better options for most people to invest in stocks are to via mutual funds or ETFs.
By far, the most popular way to invest in stocks, bonds, and other types of securities is mutual funds. Fund managers pool your money with other investors and buy the stocks and bonds on the investors' behalf. Rather than owning shares of the stocks directly, you own shares in the mutual fund which represent ownership in the underlying securities the fund buys.
Mutual funds reduce the risk of owning individual stocks. When you invest in a fund, you may hold shares in hundreds, if not thousands of different companies. That reduces the risks of owning a few companies. Why? If you own a few individual stocks and one of those companies either goes out of business or drops in value substantially, that will have a much higher impact on your overall investments than if that stock was part of a mutual fund.
There are thousands of mutual funds with hundreds of different investment strategies. Like any investment, it's essential to do your due research to understand what the fund invests in, the risk of those investments, and whether it fits your goals. Here are some examples of the types of stocks mutual funds might buy:
- Large-cap stocks
- Mid-cap stocks
- Small-cap stocks
- Value stocks
- Growth stocks
You will find these categories in both U.S., international, and emerging market stock markets.
Active vs. Passive Mutual Funds
The next choice to make in mutual fund investing is whether you want an actively managed or passive fund.
In an actively managed fund, a fund manager or management team decides what stocks to by, when to buy them, in what industries, and when to sell them. They are actively managing the funds by making these decisions.
The alternative to actively managed funds is passive or index funds. Index investing doesn't have a manager picking and choosing stocks or bonds. Instead, they replicate an unmanaged index like the S & P 500, the Russell 3000, and many others. In an index fund, you get every company from the particular index and the same percentage as the index. For example, if Apple is 5% of an index, you will have 5% in Apple in the index fund.
Index fund investing is wildly popular and growing. Vanguard Funds are the most recognized and the largest index fund company out there. Index funds have the lowest fees and over both short and long term periods usually outperform their active fund counterparts.
If you want to simplify your investment choices and get returns that match the markets, index funds may be a good choice.
Like their mutual fund counterparts, ETFs offer investors a way to get exposure to many companies in many industries and market sectors. There are a couple of significant differences in ETFs and mutual funds.
Unlike mutual funds, ETFs trade on a stock exchange. Investors can buy and sell shares during the day. In contrast, mutual funds price their shares at the end of the day. ETFs offer real-time pricing. So, if you're an active trader, it is possible to buy and sell mutual funds during each day like stocks. My recommendation is the same. Don't do it. You'll be better served investing in the long term.
Many mutual funds have minimum investment amounts. ETFs have lower or no minimum investment requirements. Overall, ETFs may offer more funds with lower fees than many mutual funds. Because of their lower minimum investment, investors can build a more diversified portfolio for less money.
Both ETFs and mutual funds offer a way for investors to build a portfolio that matches their needs.
Investment Opportunities in Alternative Investments
Because the stock market is so volatile, many investors look for options outside the stock market. These alternative investments come in a variety of forms – hedge funds, managed futures, distressed debt, real estate investment trusts, and many others.
Alternative investments may offer a unique diversification opportunity for investors. The best alternative investments do not correlate with the stock market. In other words, when the stock market goes up or down, your alternative investments won't necessarily go up or down at the same time or at the same rate. That's the classical definition of diversification.
Alternative investments have risks of their own. One is liquidity. With REITs traded on stock exchanges, liquidity isn't an issue. Private REITs, however, are a different story. Many of these funds have holding periods of five years or more. Getting money out of them is not advisable and, if available at all, can be costly. In reality, if an investor needs money sooner, they probably shouldn't be investing in these types of investments in the first place.
Alternative investments are available to both accredited investors and nonaccredited investors. Nonaccredited investors can access these investments via mutual funds, ETFs, and crowdfunded investments.
Investment opportunities in 2020 and beyond are not that much different than they have been in the past. The main difference is in the form of alternative investments. There has been a concerted effort in the past few years to make these investments available to the smaller investor. These alternatives, especially real estate, have been the domain of the wealth for far too long.
The best investment strategy is one that incorporates some of each of these options, from the safest investments (savings accounts, CDs, and bonds) to the riskier investments (stocks, funds, and alternative investments). How you put those investments together in a portfolio is a personal decision. If you don't feel comfortable doing that on your own, consider hiring a financial advisor.
Take the time to review your situation. What are your goals? Why are you investing? For how long? For what purpose? Answer those questions before getting started. If you already have an investment portfolio, maybe it's time to review if how you're investing now matches your needs.
Once you get answers to those questions, build or modify your portfolio to include a mix of the investments described here. Good luck!