I received the following email from a reader, Justin, asking me where I would invest in the current market given all the turmoil. Here is part of the discussion that formed the basis for this post, and my thoughts on investing for the year ahead:
Original Email from Justin: I’m a new reader of your blog and I just wanted to say that I am very thankful for people like yourself that take their time to help people such as me. I have learned a lot reading your blog today and I really enjoy it. Keep up the great work. I do have one question for you though. My job is pretty questionable as far as whether it will be here as the economy gets worse. Luckily I have a good amount of money saved up to live off of but I also have an expensive car payment. I am very concerned on whether I should put that money towards my car loan or investing it into gold bullion so i do not lose so much money when the dollar crashes.
My Response was: What interest is your car loan at? If it is around the standard 7%, I would pay off your car loan first because in effect you are getting an after tax 7% return (equal to about 10% for those in higher tax brackets). The dollar is not going to crash anytime soon, in fact it will probably go up as it is seen as a safe haven currency. Not being a big gold investor myself, I am always cautious about investing in bullion. It is okay for a small part of your portfolio, but should not be your total investment. For now keep the money in cash in a high yield savings account or Vanguard money market fund. When the markets stabilize, consider an ETF or fund that invests in big American companies (which are very cheap right now).
Justin’s follow up email: My interest rate is actually above 8% unfortunately. So I guess that’s what I will do is pay it off. As for the dollar crashing, I’ve heard rumors of it happening very soon but maybe it won’t, I hope not. Well, with that being said, I’m going to reconsider my decision on the gold and look into some investments. Can I ask you, do you think with $50,000, I can make a good amount of profits with a stock investment? I have never done stocks so I’m nervous. I also have no idea what type of profits to expect from 50k or less.
The last question on where to invest $50,000 is what I delve into now
$50,000 is a lot of money and much more than most first time investors have to start with. However the principles for first time investing and the 5 broad choices I present here are valid for investors with as little as $1,000 to invest, to those with much more than Justin. The advice I provide here is general in nature because everyone has their own circumstances and preferences. Each investment choice/class I present below is not mutually exclusive and in fact for diversification purposes having exposure across various investment classes is a prudent approach. The best allocation is based on various factors like time of investment, risk profile, need for cash, age and interest rates. Where relevant I have included links back to more detailed articles on the investment choice.
1. Cash, High Interest Savings or Money Market Funds: The current mantra, thanks to the extreme stock market volatility, is Cash is King. I have to agree, because having liquidity now gives you financial security and the ability to invest at the right time. The only problem is that with saving (interest) rates at record lows due to the Federal reserve supporting the economy (low interest rates promote borrowing and spending, which leads to economic growth), leaving your money sitting in a regular savings account is actually costing you money in real terms. However this is still a safer choice in the short term, while you wait for the markets and economy to stabilize. The best thing to do with your cash (in order of importance) is to: 1) setup an emergency fund to cover 6 or more months of living costs; 2) pay off any credit card or other high interest rate debt. If you are paying 14% on credit card debt, paying off the balance will mean a 14% risk-free return, which you cannot get elsewhere. 3) Put your money in a high yielding savings account; 4) If you have more risk tolerance go for a money market type mutual fund that invests in high grade municipal or corporate bonds.
2. Stocks, ETF and Mutual Funds: In the current market, the best bet for newer investors interested in stock related investments is to use a Mutual or Exchange Traded Fund (ETF) to invest in a basket of stocks (diversification) so as to minimize the risk of failure in a single stock.Go for a broad based, diversified ETF or low cost mutual fund that tracks an index or sector (eg QQQQ, XLK for Nasdaq or XLF for financials). Also ensure you get the lowest cost broker when buying and selling shares, to avoid excessive transaction costs. For diversified mutual funds the best fund managers, because of their ultra low management fees and broad offerings, are Vanguard and Fidelity. Before you make any purchases, track your potential investments for a while, do a lot of research and only buy when you feel comfortable. With the current market volatility, you will get plenty of buying opportunities so don’t rush in to the first investment you like.
3. Real Estate: As the last decade or two has shown, one’s home is not the rock solid appreciating asset that everyone thought it was. Real estate in general is probably going to be a tough investment next year as well, despite record low borrowing rates. If you want to invest in real estate, don’t pursue a “flip-that-house” type of strategy. Instead go through a well diversified, high yielding REIT (real estate investment trust). These are just like ETF’s and Mutual funds, except that they invest primarily in real estate. If you already have a house, it could be a good time to refinance or find a better loan and use the $50,000 to cover some of the associated costs. You may also want to consider value-adding home improvements, because major appliances and materials are quite cheap in the current retail market.
4. Gold, Oil and other Commodities: Many people are saying to put all your money in gold because of it’s safe-haven status in times of crisis or a falling US dollar. Gold prices have moved up strongly last year despite one of the toughest economic and market conditions we have experienced. High prices makes me reluctant further to invest in gold, because in itself it is not an income producing asset and when things improve, it will get hit hard. For other commodities and metals, whose prices have taken a beating in the last few months, it is best to invest in them through a commodity-specific fund or a large and diversified resource based company. However, I would watch things for a while before making any investments in this sector due to expectations of ongoing volatility. Going back to Point 1, rather than investing in a specific stock you could go for an ETF like XME which invests in various metals and mining stocks, or OIH for the oil services industry. If you do want to go for a pure play gold investment (without buying actual gold bars), go with the GLD fund, which aims to reflect the performance of the price of gold bullion.
5.Roth IRA: If you haven’t already got one, I definitely recommend you open a Roth IRA (Individual Retirement Account). This is a post-tax long term (retirement) investment vehicle whose best feature is that all your returns enjoy tax free growth. Make sure you take advantage of this investment if your income levels permit. Just go through one of the big fund managers (like Vanguard or Fidelity) to open up one of these accounts.
So Justin (and other investors), I hope the above has given you some guidance in choosing where to invest. $50,000 is a lot of money and if invested well it can generate some excellent profits and ongoing (passive) income for you. I am not a finance expert or professional planner and urge you to do your own research before investing. Also, try and see an accredited investment advisor to get a long term investment plan put in place. Above all, make sure you understand what you are investing in, start small and don’t be afraid of making mistakes.