There are many different ways to invest your money. So how do you choose what's right for you? First, you must examine your own financial circumstances, your goals, and your individual personality. For instance, how much risk will you be able to tolerate before you're driven to walk the floors all night long worrying about your money? Along those same lines, the primary criterion for evaluating any investment is to weigh the potential profit against the risk that it will expose you to. Finding the proper match is crucial, not only to your financial success but to your psyche, as well. Use the list below as an at-a-glance comparison tool to help you sort through the general types of investment vehicles that are available.
Cash - Even today, with electronic methods of sending and receiving money globally, physical spendable cash still remains our basic medium of exchange. It has the advantage of complete liquidity – in other words, it can easily be converted into something else, such as goods or services. Cash, both paper and coins, is the criterion by which all other assets are measured. However, the value of paper money is solely a function of the general public's confidence in it, and their willingness to accept it as payment for goods and services rendered.
Advantages of Cash as an investment:
- Cash is readily accepted for goods and services.
- It's the standard of value used in our society.
- It's easily portable, so it can be efficiently used to purchase goods and services in lieu of bartering.
Disadvantages of Cash as an investment:
- Cash in itself earns no interest, and in periods of high inflation it can rapidly lose its value and capability to be exchanged for goods and services.
- It is subject to fire, theft, and other hazards.
- Large quantities of cash are cumbersome to handle and transport, and risky to carry. Most major transactions today are therefore completed by check or electronic funds transfer.
Savings Accounts - Insured savings accounts are the most liquid of all traditional investments, which means that they can be most easily converted to cash, which in turn can be used to buy goods and services. As opposed to cash on hand, savings accounts earn interest and are insured by the Federal Deposit Insurance Corporation (assuming, of course, that the bank is a member). For the purposes of this article, the term "savings account" also includes bank money market accounts and certificates of deposit.
Advantages of Savings Accounts as an investment:
- Savings accounts are the safest interest-bearing investment available. Your principal is usually protected by the FDIC as well as federal and state banking regulations.
- Due to the advent of electronic banking, money in savings accounts is readily accessible at any time of the day or night.
Disadvantages of Savings Accounts as an investment:
- Because of the generally low rates of interest that savings accounts earn, there's the potential for loss of your money's purchasing power due to inflation.
- The maximum FDIC insurance is $100,000 per depositor account. If the bank fails, it could take a while to receive your money while the FDIC audits and verifies balances.
- A significant financial penalty is imposed for cashing in a certificate of deposit before its maturity date.
Debt Instruments - Debt instruments, which are bonds and notes, are obligations of a government, a business, or other entity. Notes have an original life (or maturity) of less than ten years, while bonds have a maturity time of greater than ten years. Their safety (or lack of it) is a function of the financial strength of the issuer. In the United States, for example, the safest debt instruments are U. S. government bonds and notes, followed by state and municipal, corporate, and individual bonds and notes. The riskier the bond, the higher the interest rate it must pay.
Advantages of Debt Instruments as an investment:
- Bonds and notes pay higher rates of interest than savings accounts.
- Because of the fact that there's a trillion-dollar market for government and corporate bonds, they can generally be considered to be liquid investments.
- If you prefer not to liquidate them, they can be used as collateral for loans.
Disadvantages of Debt Instruments as an investment:
- Bonds and notes are less liquid than savings accounts.
- Their safety depends solely on the strength of the issuer.
- If interest rates increase, lower-paying bonds may temporarily drop in value until their maturity, when the bond or note becomes payable.
- During periods of inflation, the face value of bonds will be worth less than when they were first purchased.
Stocks - Because of their liquidity, stocks are subject to daily and short-term price fluctuations. Such ebbs and flows may be due to international, national, industrial, economic, or corporate events and circumstances – for example, new product introductions, corporate restructurings, interest rates, wars, hurricanes, etc. These price swings may actually be outside the long-term potential price range for the stock. Stocks have historically returned about 9 percent compounded annually for the last hundred years.
Advantages of Stocks as an investment:
- As a shareholder in a corporation, an investor actually owns a piece of the business, enabling him or her to benefit from the distribution of profits (or dividends) without incurring any personal liability for losses.
- During inflationary periods, the prices of the products or services that the corporation sells rise and the operation's profits increase, followed by a corresponding rise in share values.
- Stocks can easily be sold and converted into cash, thus providing a high degree of liquidity.
Disadvantages of Stocks as an investment:
- An important factor in stock prices is the ability of corporate management to run the company. If managers are effective the company will ideally grow, causing earnings to increase and thereby stock prices, as well. On the other hand, poor managers may hinder the organization's growth potential by making poor decisions.
- Stock prices are subject to general stock market conditions. If there's a temporary downturn in the market at a time in which you must sell for any reason, you could realize a substantial loss.
- Other people (the company's board of directors) are making decisions and handling your money for you.
Collectibles - These are objects that are difficult or impossible to duplicate and that have cultural, historical, or social value. Collectibles include, but are by no means limited to, artwork (including paintings and sculptures), antiques and relics, coins, stamps, rare books, dolls, automobiles, sports trading cards, and the like.
Advantages of Collectibles as an investment:
- By definition, rare collectibles (especially artwork) cannot be replaced, and are therefore more highly valued.
- They provide intangible benefits such as the enjoyment of accumulating a collection and the pride and pleasure of ownership.
- Recognized, appraisable collections can be used as collateral for loans. Although generally considered to be somewhat illiquid, they can in this manner still provide some measure of liquidity.
Disadvantages of Collectibles as an investment:
- Collectibles are not particularly liquid because there is not a ready, liquid market for them. In order to sell, you must find a dealer, an auction house, or a private buyer.
- They generate no interest income.
- The costs of preservation to prevent further aging and deterioration can often be prohibitive. Furthermore, the costs to insure collectibles against fire, theft, and other risks can also be quite high.
Precious Metals - Precious metals include gold, silver, and platinum, among others. Since ancient times, gold and other precious metals have been accepted as mediums of exchange worldwide. Today, many investors use precious metals, or their stocks, as a hedge against massive inflation. As the prices of the metals themselves rise, so do their stocks. Generally speaking, precious metal stocks have the same advantages and disadvantages as other stocks.
Advantages of Precious Metals as an investment:
- Precious metals are an excellent hedge against inflation. Historically, gold, silver, and platinum have been accepted as standards of value. During periods of hyperinflation, their prices rise accordingly to keep pace.
- Precious metal stocks, like other stocks, can be easily bought and sold on major stock exchanges, giving them a high measure of liquidity.
- Owning shares in a precious metal company is an easy way to invest in precious metals without having to physically buy and hold the actual commodities.
Disadvantages of Precious Metals as an investment:
- Like collectibles, precious metals do not earn interest.
- Precious metal prices are greatly influenced by the actions of governments. For example, if Russia (the world's major producer of platinum) were to decide to sell off its stockpiles of the metal in order to raise capital, the price of platinum worldwide would drop.
Real Estate - Real estate includes land and the improvements thereon. As an investment vehicle, it's important to note that real estate is virtually always purchased with the use of "other people's money," or OPM. This form of leverage allows real estate to earn significantly higher rates of return than most other investment instruments.
Advantages of Real Estate as an investment:
- There can be immediate income from the net cash flow of a well-chosen property after operating costs and debt service.
- The loan balance is amortized and reduced with each mortgage payment, thus increasing equity.
- Property depreciation can be deducted against property income for tax purposes.
- As long as replacement costs or inflation (or a combination of the two) exceed the rate of depreciation, the property will continue to appreciate in spite of depreciation.
Disadvantages of Real Estate as an investment:
- Real estate values, like stocks, are subject to the ups and downs of the economy as well as temporary value fluctuations. However, in both cases, if you hold the property long enough, overall growth in value will likely occur.
- Real estate is not a liquid investment, which is the reason that it should be done only with surplus funds and should be designated as a long-term investment program.
- Land does not become obsolete the way that buildings and equipment do. As such, only the depreciation of buildings and equipment may be deducted on your tax return. Therefore, in every real estate investment, you must allocate the purchase price between land and buildings in order to know how much is depreciable for income tax purposes.
- Real estate generally requires more hands-on management than stocks or other types of investments, but this disadvantage can actually reap additional tax benefits.