There are more than 20,000 U.S.-listed stocks available to investors. You don’t need to buy all of them, but to build a diversified portfolio, you need exposure to a lot of them.
If you don’t want to spend hundreds of hours researching individual stocks, another option is to buy index funds — baskets of stocks that track broad-market indexes like the S&P 500.
Below, we’re looking at some of the best index funds that track the S&P 500 and Nasdaq-100 indexes.
5 of the best index funds tracking the S&P 500
Index funds work by tracking specific market indices. So you’ll need to know which market index you want your index fund to track before you start investing.
Here are some of the best index funds pegged to the S&P 500.
Index fund
Minimum investment
Expense ratio
Vanguard 500 Index Fund – Admiral Shares (VFIAX)
Schwab S&P 500 Index Fund (SWPPX)
No minimum.
Fidelity 500 Index Fund (FXAIX)
No minimum.
Fidelity Zero Large Cap Index (FNILX)
No minimum.
T. Rowe Price Equity Index 500 Fund (PREIX)
Data current as of market close on January 31, 2024. For informational purposes only.
Vanguard 500 Index Fund Admiral Shares (VFIAX)
This fund is also known as the Vanguard S&P 500 Index fund. It was founded in 1976 and is the granddaddy of all index funds. Like the other S&P 500 funds on this list, this fund gives exposure to 500 of the largest U.S. companies, which make up about 75% of the U.S. stock market’s total value.
Schwab S&P 500 Index Fund (SWPPX)
As research firm Morningstar notes, this is one of the cheapest S&P 500-tracking funds out there. Launched in 1997, this Schwab fund charges a scant 0.02% expense ratio and requires no minimum investment. That makes it attractive for investors concerned about costs.
Fidelity 500 Index Fund (FXAIX)
Founded in 1988 (formerly known as Institutional Premium Class fund), Fidelity removed this fund’s investment minimum so investors with any budget size can get into the low-cost index fund action.
Fidelity Zero Large Cap Index (FNILX)
In the race for the lowest of the low-cost index funds, this Fidelity fund made news by being among the first to charge no annual expenses. That means investors can keep all their cash invested for the long run.
T. Rowe Price Equity Index 500 Fund (PREIX)
Founded in 1990, the fund’s expense ratio is competitive with other providers. However, the $2,500 minimum may be steep for beginning investors.
Top 3 index funds for the Nasdaq-100
Here are some of the best index funds pegged to the Nasdaq-100 index.
Index fund
Minimum investment
Expense ratio
Invesco NASDAQ 100 ETF (QQQM)
No minimum
Invesco QQQ (QQQ)
No minimum
Fidelity NASDAQ Composite Index Fund (FNCMX)
No minimum
Data current as of Feb. 9, 2024. For informational purposes only.
Invesco NASDAQ 100 ETF (QQQM)
QQQM includes 100 of the biggest nonfinancial companies listed on the Nasdaq. It also includes at least 90% of the assets on the NASDAQ-100 index and is rebalanced quarterly.
QQQM has an expense ratio of 0.15%. For every $1,000 invested, you’d pay a $1.50 fee annually.
Invesco QQQ (QQQ)
QQQ holds 101 companies, tracks the NASDAQ-100, and has $151.51 billion in assets under management.
QQQ has an expense ratio of 0.20%. For every $1,000 invested, you’d pay a $2 fee annually.
Fidelity NASDAQ Composite Index Fund (FNCMX)
FNCMX aims to mirror the performance of the Nasdaq Composite index. The fund usually holds 80% of stocks included in the index. In addition to the typical sectors represented by a Nasdaq index fund (such as IT, consumer services and health care), FNCMX also includes the real estate and material sectors.
FNCMX has an expense ratio of 0.37%. For every $1,000 invested, you’d pay a $3.70 fee annually.
Frequently asked questions
What are some of the advantages of index funds?
Exposure to hundreds of stocks with a single purchase.
You can build a balanced, diversified portfolio with just a few index funds.
May be cheaper to buy and easier to research than individual stocks.
What are some of the disadvantages of index funds?
Distributions may generate income tax liability.
Some index mutual funds have large investment minimums.
Index funds can’t beat the market — they deliver the market return.
The author owned shares of Invesco QQQ at the time of publication.
Timing the market, as it relates to trading and investing, requires a whole lot of luck. In effect, it means waiting for ideal market conditions, and then making a move to try and capitalize on the best market outcome. But nobody can predict the future, and it’s a high-risk strategy.
When seeing stock market charts and business news headlines, it can be tempting to imagine striking it rich by timing investments perfectly. In reality, figuring out when to buy or sell stocks is extremely difficult. Both professional and at-home investors make serious mistakes when trying to time their market entrance or exit.
Why Timing the Stock Market Doesn’t Work
Waiting to start investing could cost an individual thousands of dollars over their lifetime. It’s also important to know that by leaving money in a checking or savings account, a person is not protecting their money from inflation risk. That’s because the value of that cash in a checking or savings account erodes if the prices of goods and services increase.
Meanwhile, stock market timing is incredibly complex. Stock prices can be influenced by global macroeconomic events, political events in a country, developments in specific industries or companies, as well as the sentiment of investors as a collective.
Even professional investors struggle to “beat the market,” which often means simplifying trying to outperform a benchmark stock index. In fact, most investors can’t beat the market, and are likely better off sticking to index investing.
Fear and Greed in Investing
When investing, it’s also important not to let two key emotions – fear and greed – drive decisions. That means if the stock market is plummeting, investors may be fearful, but they can’t let those feelings push them toward a decision to sell. That could cause them to “lock in” losses. There’s even a Fear and Greed Index that investors sometimes use to make contrarian decisions.
Take for instance what happened during the 2008 financial crisis. After Lehman Brothers Holdings Inc. filed for bankruptcy in September 2008, the stock market entered a tumultuous stretch. The S&P 500 finally bottomed on March 9, 2009. However, the index eventually regained all its losses in the course of roughly the next four years. Investors who had hung on likely may have recovered their losses.
Meanwhile, greed can cause investors to make poor decisions as well. For instance, during the dotcom bubble, investors bought into many newly public Internet companies without always doing the research. Some of these stocks weren’t even turning a profit, making their businesses vulnerable to going belly up. Ultimately, many at-home investors suffered losses when the dot-com bubble burst.
Of course there are no guarantees when it comes to investing. There’s always risk and volatility involved. However, one of the most tried and true methods for building wealth has been a buy-and-hold strategy when it comes to stock investing.
💡 Quick Tip: When people talk about investment risk, they mean the risk of losing money. Some investments are higher risk, some are lower. Be sure to bear this in mind when investing online.
Why It May Be a Good Idea to Invest Immediately
One of the most important predictors of your returns is the length of time you’ve invested in the stock market. While it’s difficult to predict what the market will do in the near future, an investor can get a better sense over the long term.
When an investor lets their money grow, it has the chance to weather short-term ups and downs and grow over time. On average, the S&P 500, often used as a market benchmark, has grown 7% a year after adjusting for inflation. That doesn’t mean a person can predict what will happen this year, or even in the next 10 years, but looking at long term trends can give them a better sense of market dynamics.
An individual might put off investing because they want to pay off all debts first or achieve other goals, like buying a house. In some cases, that might be true, like paying off high-interest credit cards or saving for a short-term goal, such as a three to six-month emergency fund.
But once a person has an emergency fund and is out of credit card debt, they should consider investing, even if they have a mortgage or student loan debt. Even if they’re only investing for retirement, it’s a good idea to start as soon as possible.
💡 Quick Tip: How to manage potential risk factors in a self-directed investment account? Doing your research and employing strategies like dollar-cost averaging and diversification may help mitigate financial risk when trading stocks.
Consider Investing as Early as Possible
The younger you are when you invest, the better the chances are that you’ll reach your financial goals. For example, imagine Person A invests $200 a month in a retirement account starting at age 25.
Person B invests the same amount starting at age 35. They both continue to add $200 a month to their account. When they both retire at age 65, Person A will have almost twice as much as Person B: $306,689, compared to $167,550, assuming a 6% rate of return, 2% inflation rate, and 15% tax rate.
That’s true even though Person A only contributed 33% more to her account. This is how compound interest grows investments, or the power of how earnings from one’s investments can continue to build wealth.
Percentage of Retail Investors in Stock Market
As mentioned, after the 2008 financial crisis, many people were reluctant to invest in the stock market. But in recent years, that’s changed. Retail investor participation in the U.S. stock market increased considerably in 2020 and 2021, for a variety of reasons.
As of 2023, retail inventors comprise about a quarter of all total trading volume in the stock market. That may change in the future, too, as younger investors – with quicker, easier access to investing tools, in many cases – look at getting into the markets.
The Takeaway
Timing the market is difficult, if not impossible, and involves trying to “time” trading or investing moves to coincide with an increase or decrease in the stock market. Nobody can tell what the future holds, so it’s generally hard to accurately pick the right investments at the right time. That’s not to say that some investors don’t get it right from time to time, but as an overall strategy, it’s likely not advisable.
If an individual is skittish about investing, their anxiety makes sense in light of the dramatic market ups and downs many have witnessed in the past two decades. But trying to time the market doesn’t work. Instead, investing in a diversified portfolio can be a good step toward building individual wealth.
Ready to invest in your goals? It’s easy to get started when you open an investment account with SoFi Invest. You can invest in stocks, exchange-traded funds (ETFs), and more. SoFi doesn’t charge commissions, but other fees apply (full fee disclosure here).
For a limited time, opening and funding an Active Invest account gives you the opportunity to get up to $1,000 in the stock of your choice.
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Neither the Investment Advisor Representatives of SoFi Wealth, nor the Registered Representatives of SoFi Securities are compensated for the sale of any product or service sold through any SoFi Invest platform. Information related to lending products contained herein should not be construed as an offer or prequalification for any loan product offered by SoFi Bank, N.A.
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Investment Risk: Diversification can help reduce some investment risk. It cannot guarantee profit, or fully protect in a down market.
Looking to build wealth with the best income-generating assets? As you set out on the path to financial freedom, understanding the different types of income-generating assets can truly change your life. This is because you can invest in assets that will generate you income, earning you more passive income. Today’s article will introduce you to…
Looking to build wealth with the best income-generating assets?
As you set out on the path to financial freedom, understanding the different types of income-generating assets can truly change your life.
This is because you can invest in assets that will generate you income, earning you more passive income.
Today’s article will introduce you to a range of assets that reliably bring in cash, giving you peace of mind and the freedom to live life on your own terms.
From traditional investments like stocks and bonds to more creative options like peer-to-peer lending or real estate, income-generating assets give you the power to diversify your portfolio and build wealth over time.
Related content:
What are income generating assets?
Before we begin, I want to talk about the basics on income-generating assets, in case you are new to the subject or if you want a background first.
Income-generating assets are investments that, as the name suggests, generate income for you. These are assets that provide you with a steady cash flow, allowing you to earn passive income and build your wealth over time.
Examples include rental real estate and dividend-paying stocks (we will go over 17 different types of income-generating assets below in more detail).
There are several benefits of the best income-generating assets such as:
Passive income: You earn money without actively working, and this can provide financial freedom and the ability to focus on other things in life. You can earn money in your sleep, while on vacation, making dinner, and more.
Diversification: You can diversify your investments so that all of your income is not coming from just one source.
Wealth building: Earning income and generating a steady cash flow can help you build your wealth over time.
Note: Please keep in mind that there is no one-size-fits-all approach when investing in any of these income-producing assets. Everyone is different and while one asset may work great for someone, it may not be the right asset for you. I recommend doing as much research as you can if you are interested in one of the asset investments I talk about below.
Types Of Income Generating Assets
There are many types of income-generating assets. Some may be more traditional such as dividend-paying stocks, and others may be more alternative income-generating assets, such as selling stock photos, and even renting out your driveway.
Today, I will talk about 17 different types of income-generating assets, but this is not a full list of the best income-producing assets. There are many, many more!
The different types of income-generating assets that I will talk about today include:
1. Dividend-paying stocks
One of the best assets to invest in are dividend-paying stocks.
Dividends are simply a payment in cash or stock that public companies distribute to their shareholders.
The amount of a dividend is determined by a company’s board of directors, and they are given as a way to reward those who have stock in their company. Both private and public companies pay dividends, but not all companies pay dividends.
How do dividends work? If you own shares of a dividend-paying stock, then a dividend is paid per share of that stock. So, if you have 10 shares in Company ABC, and they pay $5 in cash dividends each year, then you will get $50 in dividends that year. While dividends can be paid on a monthly, quarterly, or yearly basis, they are most commonly paid out quarterly — so, four times a year. In this example, the $5 in cash dividends the company pays each year will most likely be distributed as $1.25 per quarter for each share of stock.
The most common type of dividends are cash dividends. Shareholders may choose to get this deposited right into their brokerage account. Stock dividends are another common type of dividend. In this case, shareholders get extra shares of stock instead of cash.
Both cash dividends and stock dividends are great income-generating assets that will earn more money for you.
As a shareholder, you can earn income when companies distribute profits to their shareholders. Look for stocks with a history of consistent dividend payouts and a high dividend yield. Keep in mind that dividend stocks are still subject to market fluctuations, and just because a company has paid a dividend in the past does not mean that they always will in the future.
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2. High-yield savings accounts and CDs
High-yield savings accounts and CDs are a great way to grow your savings, but most people have their money in accounts with low rates. Unfortunately, that means many of you are losing out on some easy money.
Savings accounts at brick-and-mortar banks are known for having really low interest rates. That’s because they have a much higher overhead — paying for the building, paying the tellers to help you in person at the bank, etc.
High-yield savings accounts offer an easy option for earning interest on your cash. Online banks often offer higher interest rates than traditional banks. As of the writing of this blog post, you can easily find high-yield savings accounts that can earn you above 4.00%.
Certificates of Deposit (CDs), another form of income-generating assets, are FDIC insured and provide a guaranteed interest rate over a specific term. Remember that access to your money is limited during the term of the CD. You will agree upon the term before putting your money in the CD. The terms typically vary in length from around 3 months to 5 years.
Money market accounts are also offered by banks and often with a higher yield than other types of savings accounts.
3. Real estate
Real estate is one of the most common income-generating assets that people think of.
Investing in rental properties is a popular way to generate steady cash flow. You can earn rental income from tenants, and properties typically appreciate in value over time.
Location and property management are important factors that can impact your return on investment.
By investing in real estate, you may be investing in residential properties, commercial real estate, short-term rentals, REITs, and more.
Recommended reading: How This Woman In Her 30s Owns 7 Rental Homes
4. Real estate investment trusts (REITs)
An REIT is a company that owns and manages income-producing real estate. They then sell shares to investors like stock.
By investing in REITs, you can make money in the real estate market without actually owning real estate.
So, if you don’t want to be a landlord, then this may be something for you to look into. This makes it much more passive than actually owning real estate and having to manage it.
You can even diversify your income stream with REITs by investing in different property types, such as residential homes, commercial office space, industrial, and retail store properties.
5. Bonds
Bonds are fixed-income investments that are issued by governments and companies. If you own a bond, you receive interest payments from borrowers on a regular basis.
An easy way to explain this is: When you buy a bond, you are giving someone a loan and they are agreeing to pay you back with interest.
Bonds with higher credit ratings are generally a safer investment but may offer lower interest rates.
6. Mutual funds
Mutual funds gather funds from investors to invest in stocks, bonds, or other securities. Basically, the funds are pooled together and there’s a fund manager who chooses the best investments.
Income-generating assets like this have multiple types of mutual funds available for multiple types of investors. Some of these fund types include bond funds, stock funds, balanced funds, and index funds.
Mutual funds typically have higher fees because they have fund managers who are actively trying to beat the market.
With a mutual fund, you get diversification because the fund manager mixes the assets in it.
7. Index funds and exchange-traded funds (ETFs)
ETFs and index funds are popular options for those who are looking to diversify their portfolio of income-generating assets.
This is because index funds and ETFs track a specific market index and invest in a wide range of stocks or other assets, instead of picking and choosing stocks in an attempt to beat the market. This is what makes them different from mutual funds.
They often have lower fees and higher diversification compared to actively managed funds.
8. Annuities
Annuities are long-term investments offered by insurance companies that give you a guaranteed income stream to build wealth. In exchange for a lump-sum payment or periodic contributions (such as monthly or annually), you’ll receive steady payments in the future.
The way it works is you pay premiums into the annuity for a set amount of time. Later, you stop paying premiums, and the annuity starts sending regular payments to you. Some are even set up to pay you back with a lump sum.
Annuities can be fixed or variable. A fixed annuity offers a guaranteed payment amount — which means a predictable income for you. As for a variable annuity, the payment amount does vary, depending on how the market is doing.
9. Websites and blogs
Starting a website can generate income through the money-making assets of advertising, affiliate marketing, or the sale of products and services.
Since I started Making Sense of Cents, I have earned over $5,000,000 from my blog through affiliate marketing, sponsored partnerships, display advertising, and online courses. These income-generating assets make sense for building wealth.
Blogging allows me to travel as much as I want, have a flexible schedule — and I earn a great income doing it.
Now, it’s not entirely passive, but I do earn semi-passive income from my blog.
You can learn how to start a blog in my How To Start a Blog FREE Course.
Here’s a quick outline of what you will learn:
Day 1: Why you should start a blog
Day 2: How to decide what to write about (your blog niche!)
Day 3: How to create your blog (in this lesson, you will learn how to start a blog on WordPress)
Day 4: The different ways to make money with your blog
Day 5: My advice for making passive income with your blog
Day 6: How to get pageviews
Day 7: Other blogging tips to help you see success
Recommended reading: The 25 Most-Asked Blogging Questions To Get You Started Today
10. Royalties and intellectual property
Intellectual property, such as patents, copyrights, and trademarks, can generate income through licensing fees or royalties. This particular option is good for creative professionals, such as authors, musicians, and inventors, who are looking for income-generating assets.
Royalties are a way to earn income from your creative work or intellectual property. By granting others permission to use or distribute your intellectual property, you can receive ongoing payments known as royalties.
Whether you’re a musician, author, inventor, or artist, royalties offer a passive income stream as your creations continue to generate revenue over time.
Royalties can be paid out periodically or as a lump sum on these passive income assets, depending on your agreement with the licensee.
11. Stock photos
If you have a talent for photography, you can monetize your skills by selling stock photos on platforms such as Shutterstock or Adobe Stock. The more high-quality images you upload, the more potential passive income you can generate.
With stock photography, you simply upload photos that you have taken to a platform such as DepositPhotos, turning your pictures into income-generating assets. Then, you will receive a commission whenever someone buys one of your stock photos.
Stock photos are used for all sorts of reasons by websites, companies, blogs, and more. Businesses need stock photos because they are not usually in the business of taking photos of everything that they need. Instead, they can use stock photos to make their content, website, or business more visually appealing.
Some examples of stock photography include pictures of:
Travel, vacations, landmarks, outdoor adventures
Family members, such as parents, children, family gatherings
Food and drink
Cars, boats, RVs
Businesses, pictures of people in meetings, in an office.
Sports, professional events
Animals, such as household pets or wildlife
The photo possibilities are almost endless for this type of income-generating asset.
Recommended reading: 18 Ways You Can Get Paid To Take Pictures
12. Crowdfunding and peer-to-peer lending
Crowdfunding platforms enable you to invest in real estate deals with a smaller amount of money than buying real estate up front, giving you a passive income through rental income or even a property increasing in value.
Peer-to-peer lending platforms allow you to lend money directly to borrowers. Typically you can earn higher returns than traditional savings accounts, though there’s always the risk of a borrower not paying you back.
Both of these types of assets — crowdfunding and peer-to-peer lending — use technology to connect investors with those looking for funding.
13. Renting out storage space
If you own unused land or unused space in your home, renting it out for storage can be a simple way to generate passive income.
You can offer storage solutions for vehicles or boats. If you have a smaller space, then offer it to store personal belongings. You can rent out your driveway, closet, basement, attic, and more. You can even rent out a shelf.
A website where you can list your storage space is Neighbor. You can earn $100 to $400+ each month on this platform. This depends on the demand in your area and the type of income-generating assets you are renting out. And, you can choose who, what, and when — who to rent to, what things are stored, and when it will happen.
You can learn more at Neighbor Review: Make Money Renting Your Storage Space.
14. Short-term rentals
Short-term rentals can be a lucrative income-generating asset if you own properties in popular tourist destinations or business hubs.
Websites like Airbnb provide a platform to rent out your property to travelers for short periods, potentially generating higher returns than traditional long-term leases.
Furnished Finder is another website for short-term rentals. This is a way to connect with travel nurses in need of short-term housing.
Keep in mind that rental income can be affected by local regulations, potential vacancies, or seasonal fluctuations.
15. Car rentals
Car rental platforms like Turo allow you to rent out your car when you’re not using it. Assets that generate cash flow include your own wheels, and that means no significant initial investment besides the cost of the car you already own.
Be mindful of risks such as wear and tear, insurance, and potential damage caused by renters.
It’s an affordable alternative to traditional rental car companies for customers, and it’s a good way to make money if you’re already working from home and don’t need your car, or are a two-car household.
Turo is one of a few different places to rent out your car, turning your vehicle into one of your income-generating assets. Your car is covered by Turo with up to a $1 million insurance policy. You can also pick the dates for when your car is available and set your rates.
Turo says you can earn an average of $706 per month by listing your car on their site.
16. RV rentals
Similarly to car rentals, RV rentals can provide additional income by renting out your recreational vehicle when you’re not using it. Your RV could easily become one of your income-generating assets.
You may be able to earn $100 to $300 a day, or even more, by renting out your RV on RVShare.
If you have an RV that is just sitting there and not being used, then you may be able to earn an income with it by renting it out to others who are interested in RVing. Cash flow-generating assets like RVs are a win-win for both you and the renter who wants to experience life in a recreational vehicle.
You can learn more at How To Make Extra Money By Renting Out Your RV.
17. Vending machines
With a vending machine business, you can generate income by selling a variety of products, from food to fishing supplies, beauty products to baby items, and more.
You may be able to earn $1,000+ a month by running a vending machine business. That’s enough reason to take a closer look at income-producing assets like this.
You can learn more at How To Start A Vending Machine Business – How I Make $7,000 Monthly.
Questions about income generating assets
Here are common questions that you may have about income-generating assets:
How do I start passive income from nothing?
Starting passive income from nothing requires creativity and resourcefulness. You can begin by identifying skills you possess or interests that can be turned into income-generating opportunities.
What are the assets that generate income?
The assets I talked about above include:
Dividend-paying stocks and stock market investing
High-yield savings accounts and CDs
Real estate
Bonds
Mutual funds
Index funds and exchange-traded funds
Annuities
Websites and online businesses
Royalties and intellectual property
Stock photos
Crowdfunding and peer-to-peer lending
Renting out your storage space
Car rentals
RV rentals
Vending machines
How do I start buying income generating assets?
There are traditional investments or more creative options. Do as much research as you can before deciding which option fits you best.
What are good assets to buy?
After deciding if you want to purchase traditional investments or more creative options, choose an asset that you can afford and best fits your lifestyle.
What are the best assets to buy for beginners?
For beginners seeking income-generating assets, you may want to look into:
Dividend-paying stocks for your investment portfolio
Crowdfunded real estate investing: Platforms like Fundrise allow smaller investments with lower risk exposure.
ETFs and index funds: They provide diversification and passive income through dividends.
What is income generating real estate?
Income-generating real estate refers to properties that produce regular rental income, such as apartments, commercial properties, or short-term vacation rentals.
How do I start passive income in real estate?
There are a few ways that you can earn passive income from real estate, including:
Buying a property, such as an apartment building or duplex, and renting it out to tenants
Using real estate crowdfunding platforms
Investing in REITs
How to make passive income with real estate without owning property?
You don’t need to actually own property in order to make money with real estate. Instead, you can earn passive income from real estate by investing in REITs and using real estate crowdfunding platforms.
This is an option for those who want to be diversified with their income-generating assets but don’t want to spend all of their money or time on a single piece of real estate.
How to make $1,000 a day in passive income?
Making $1,000 a day in passive income with assets that produce income will not be easy. If it were easy, then everyone would be doing it, after all.
Making $1,000 a day in passive income may require a large amount of money up front, diversifying into different assets mentioned above, and lots of patience from you because it will take time to make that kind of money.
You may want to start off by focusing on building multiple income streams and reinvesting your profits as you earn them.
What to think about before investing in income producing assets?
There are many different things to think about when it comes to income-generating assets. You want to find the best assets to invest your money in that will also be the best fit for you.
Remember, as I said at the beginning of this article, not everything will be applicable to everyone. Everyone is different! You may prefer to create a stock photo portfolio and hate real estate, whereas someone else may really enjoy being a real estate investor — or it may even be the other way around.
Here are some of my tips if you are interested in income-generating assets:
Do your research and talk to experts —I recommend researching as much as you can on the asset you are interested in. And, if you still have questions, don’t be afraid to talk to an expert.
Diversify — One of the important parts of building a successful income-generating portfolio is finding ways to be diversified.
Think about the risks —When making money, there’s usually some sort of risk. I recommend evaluating the risks and seeing what you are comfortable with.
What are the best books on income generating assets?
Some highly recommended books on income-generating assets include:
The Simple Path to Wealth by JL Collins
The Millionaire Real Estate Investor by Gary Keller
The Little Book of Common Sense Investing by John C. Bogle
Income Generating Assets — Summary
I hope you enjoyed this article on the best income-generating assets. As you learned, there are many different types of assets that you can invest in so that you can earn an income.
The best income-producing assets, if they’re right for you, can truly change your life.
With these assets, you can build wealth through a reliable passive income, giving you peace of mind and freedom to live life on your own terms.
Are you looking to build income-generating assets? What are your favorite ways?
Market cap represents the total market value of a company’s outstanding shares. A company’s market capitalization, or market cap, provides a good measure of its size and value versus revenue or sales figures.
Knowing what the market cap is for a given company can help investors compare it to other companies of a similar size.
Note the market cap (the value of a company’s total equity) is different than a company’s market value, which is a more complex calculation based on various metrics, including return-on-equity, price-to-earnings, and more.
Recommended: What Is Market Value?
How to Calculate Market Cap
To figure out a company’s market cap, simply multiply the number of outstanding shares by the current price per share. If a company has 10 million outstanding shares of stock selling for $30 per share, the company’s market cap is $300 million.
Share prices fluctuate constantly, and as a result, so does market cap. You should be able to find the number of outstanding shares listed on a company’s balance sheet, where it’s referred to as “capital stock.” Companies update this number on their quarterly filings with the Securities and Exchange Commission (SEC).
Market Cap Formula
The formula for determining a company’s market cap is fairly simple:
Current price per share x Total # of outstanding shares = Market capitalization
Remember that the share price doesn’t determine the size of the company or vice versa. When measuring market cap you always have to look at the share price multiplied by the number of outstanding shares.
• Company A could be worth $100 per share, and have 50,000 shares outstanding, for a total market cap of $5 million.
• Company B could be worth $25 per share, and have 20 million shares outstanding, for a total market cap of $500 million.
Market Cap and Number of Shares
In some cases, market cap can change if the number of stocks increases or decreases. For example, a company may issue new stock or even buy back stock. When a company issues new shares, the stock price may dip as investors worry about dilution.
Stock splits do not increase market share, because the price of the stock is also split proportionally.
Changes to the number of shares are relatively rare, however. More commonly, investors will notice that changes in share price have the most frequent impact on changing market cap. 💡 Quick Tip: If you’re opening a brokerage account for the first time, consider starting with an amount of money you’re prepared to lose. Investing always includes the risk of loss, and until you’ve gained some experience, it’s probably wise to start small.
Market Cap Versus Stock Price
If you’re new to investing, you may assume a company’s share price is the clearest indicator of how large a company is. You may even assume it’s as important in choosing a stock as market cap.
While the share price of a company tells you how much it costs to own a piece of the company, it doesn’t really give you any hints as to the size of the company or how much the company is worth.
Market cap, on the other hand, might give you some hints about how a particular stock might behave. For example, large companies may be more stable and experience less volatility than their smaller counterparts.
Recommended: Intrinsic Value vs. Market Value
Market-Cap Categories
Analysts, as well as index and exchange-traded fund (ETF) providers commonly sort stocks into small-, mid-, and large-cap stocks, though some include a broader range that goes from micro or nano-cap stocks all the way to mega cap on the large end.
The size limits of these categories can change depending on market conditions but here are some rough parameters.
Nano-cap and Micro-cap Stocks
Nano- and micro-cap companies are those with a total market capitalization under $300 million. Some define nano-cap stocks as those under $50 million, and micro-cap stocks as those between $50 million and $300 million.
These smaller companies can be riskier than large-cap companies (though not always). Many microcap stocks trade over-the-counter (OTC). Over-the-counter stocks are not traded on a public exchange like the New York Stock Exchange (NYSE) or Nasdaq. Instead, these stocks are traded through a broker-dealer network.
As a result there may be less information available about these companies, which can make them difficult to assess.
Small-cap Stocks
Small-cap companies are considered to be in the $300 million to $2 billion range. They are generally younger and faster-growing than large-cap stocks. Investors often look to small-caps for growth opportunities.
While small-cap companies have historically outperformed large-caps, these stocks can also be more risky, and may require more due diligence from would-be investors.
Mid-cap
Mid-cap companies lie between small- and large-cap companies, with market caps of $2 billion to $10 billion.
Some investors may find mid-cap stocks attractive because they can offer some of the growth potential of small-caps with some of the maturity of large-caps. But mid-cap stocks likewise can share some of the downsides of those two categories, being somewhat vulnerable to competition in some cases, or lacking the impetus to expand in others.
Large-cap
Large-cap stocks are those valued between $10 billion and $200 billion, roughly. Large-cap companies tend not to offer the same kind of growth as small- and mid-cap companies. But what they may lack in performance they can deliver in terms of stability.
These are the companies that tend to be more well established, less vulnerable to sudden market shocks (and less likely to collapse). Some investors use large-cap stocks as a hedge against riskier investments.
Mega-cap
Mega cap describes the largest publicly traded companies based on their market capitalization. Mega cap stocks typically include industry-leading companies with highly recognizable brands with valuations above $200 billion.
Recommended: Investing 101 Guide
Evaluate Stocks Using Market Cap
Understanding the market cap of a company can help investors evaluate the company in the context of other companies of similar size.
For instance, as noted above market cap can clue investors into stocks’ potential risk and reward, in part because the size of a company can be related to where that company is in its business development. Investors can also evaluate how a company is doing by comparing its performance to an index that tracks other companies of a similar size, a process known as benchmarking.
• The S&P 500, a common benchmark, is a market-cap weighted index of the 500 largest publicly traded U.S. companies.
• The S&P MidCap 400, for example, is a market-cap weighted index that tracks mid-cap stocks.
• The Russell 2000 is a common benchmark index for small cap stocks.
Within this system, companies with higher market cap make up a greater proportion of the index. You may often hear the S&P 500 used as a proxy for how the stock market is doing on the whole. 💡 Quick Tip: Look for an online brokerage with low trading commissions as well as no account minimum. Higher fees can cut into investment returns over time.
What Market Cap Can Tell You
Here are some characteristics of larger market-cap companies versus smaller-cap stocks:
Volatility: Larger companies, also often dubbed blue-chip stocks, tend to be less volatile than smaller stocks and tend to offer steady returns. What’s more, compared to larger companies, they have relatively few resources, such as access to cheaper credit and access to liquidity.
Revenue: Larger stocks tend to have more international exposure when it comes to their sales and revenue streams. Meanwhile, smaller stocks can be more oriented to the domestic economy.
Growth: Smaller companies tend to have better odds of offering faster growth.
Valuation: Larger stocks tend to be more expensive than smaller ones and have higher valuations when it comes to metrics like price-to-earnings ratios.
Dividends: Many investors are also drawn to large cap stocks because companies of this size frequently pay out dividends. When reinvested, these dividends can be a powerful driver of growth inside investor portfolios.
Market Cap and Diversification
So how do you use market cap to help build a portfolio? Market cap can help you choose stocks that could help you diversify.
Building a diversified portfolio made up of a broad mix of investments is a strategy that can help mitigate risk.
That’s because different types of investments perform differently over time and depending on market conditions. This idea applies to stock from companies of varying sizes, as well. Depending on market conditions, small, medium, and large cap companies could each beat the market or trail behind.
Because large-cap companies tend to have more international exposure, they might be doing well when the global economy is showing signs of strength. On the flip side, because small-cap companies tend to have greater domestic exposure, they might do well when the U.S. economy is expected to be robust.
Recommended: Guide to Investing in International Stocks
Meanwhile, larger-cap companies could also be outperforming when there’s a downturn, because they may have more cash at hand and prove to be resilient. In recent years, the biggest companies in the U.S. have been linked to the technology. Therefore, picking by market cap can have an impact on what kind of sectors are in an investor’s portfolio as well.
What Is Free-Float Market Cap?
Float is the number of outstanding shares that are available for trading by the public. Therefore, free-float market cap is calculating market cap but excluding locked-in shares, typically those held by company executives.
For example, it’s common for companies to provide employees with stock options or restricted stock units as part of their compensation package. These become available to employees according to a vesting schedule. Before vesting, employees typically don’t have access to these shares and can’t sell them on the open market.
The free-float method of calculating market cap excludes shares that are not available on the open market, such as those that were awarded as part of compensation packages. As a result, the free-float calculation can be much smaller than the full market cap calculation.
However, this method could be considered to be a better way to understand market cap because it provides a more accurate representation of the movement of stocks that are currently in play. Many of the major indexes, such as the S&P 500 and the MSCI indices, use the free-float method.
Market Cap vs Enterprise Value
While market cap is the total value of shares outstanding, enterprise value includes any debt that the company has. Enterprise value also looks at the whole value of a company, rather than just the equity value.
Here is the formula for enterprise value (EV):
Market cap + market value of debt – cash and equivalents.
A more extended version of EV is here:
Common shares + preferred shares + market value of debt + minority interest – cash and equivalents.
The Takeaway
Market capitalization is a common way that analysts and investors describe the value and size of different companies. Market cap is simply the price per share multiplied by the number of outstanding shares. Given that prices fluctuate constantly, so does the market cap of each company, but the parameters are broad enough that investors generally know whether a company is a small cap vs. a mid cap vs. a large or mega cap.
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FAQ
What is the maximum market cap?
In theory there is no cap on market cap; i.e. there is no maximum size a company can be. As of Aug. 21, 2023, the top five biggest companies by market cap, according to Forbes, are: Apple ($2.744 trillion), Microsoft ($2.353 trillion), Saudi Aramco ($2.224 trillion), Alphabet (Google) ($1.624 trillion), Amazon ($1.336 trillion).
How does market cap go up?
A company’s market cap can grow if the share price goes up.
Are large-cap stocks good?
The market cap of any company is neither good nor bad; it’s simply a way to measure the company’s size and value relative to other companies in the same sector or industry. You can have mega cap companies that underperform and micro-cap companies that outperform.
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If you find yourself with $100,000 to invest your first job is to decide what you need from this money – income or growth. You will also need to determine your risk tolerance, time horizon, and the level of involvement you want to have with your investment.
If you want long-term growth with little to no involvement, then index funds or mutual funds might be your speed.
If you are looking for income then you might consider bonds or real estate, depending on how much involvement you want to have.
But no matter what you decide, make sure that your financial house is in order before you start and ensure that you are well diversified as you invest.
Before You Start Investing
If you’ve received a $100,000 windfall you’ll want to make sure your financial house is in order before you begin investing it. First, ensure that you have an emergency fund in place. The last thing you want is to invest this money and then need to sell an investment because you have an emergency. Next, you’ll want to consider paying off any debts you have.
Emergency Fund
Having an emergency fund is an important part of a solid financial plan. It can provide a safety net during difficult times and help you stay on track to achieve your long-term financial goals. If you don’t already, you’ll want to have six months of living expenses saved up. Having to dip into your investments unexpectedly can disrupt your plans to save for the future and may result in penalties, taxes, or just poor investment timing.
You’ll want this money in a safe and easy-to-access place. A high interest savings account is likely your best option.
Here are our favorite high yield savings accounts.
Pay off debt
Before you start investing consider paying off your debts. The interest rates on most consumer debts, such as credit cards and personal loans, are typically higher than the returns you can expect to earn from most investments. By paying off high-interest debt first, you are effectively earning a guaranteed return on your money equal to the interest rate on the debt.
Paying off debt also reduces risk and frees up cash flow, which can put you in a better position to invest for the long term, as it makes it less likely you will need to access your investments for emergencies.
Determine Your Investment Needs and Risk Tolerance
The best way for you to invest $100k will be different than how someone else should invest $100k. What you want to use the money for, how soon you’ll need it, and your risk tolerance are all factors in determining the best way to invest.
What are Your Investment Goals
You’ll first want to determine your investment goals. Ask yourself what you want to achieve with your investments. For example, do you want to save for retirement, build a college fund for your children, or save for a down payment on a house?
Each of these goals would require different investment vehicles. Also, keep in mind that you don’t need to use all the money for one thing. You can work towards several goals at once.
If your goal is to use the money to provide income, you would consider different investments than you would if your goal was to grow the balance of the account.
What is Your Risk Tolerance?
How much risk you are willing to take? This really means – how comfortable are you with the potential for losing money.
In general, the more risk you are willing to take the more potential growth there is. For example, if you have a very high risk tolerance you could consider investing in emerging markets. If your tolerance for risk is low, you’ll want to consider more stable investments such as bonds or real estate.
The longer your time horizon the more risk you can take since you will have longer for the markets to recover before you need the money. This is why you’ll want to have a robust emergency fund – so you don’t need to access the funds before it’s time.
When Will You Need the Money?
Consider the time frame you have to achieve your financial goals. Are they short-term goals that you want to achieve within the next few years, or are they long-term goals that you want to achieve over the next several decades?
If you are investing for the long term (over 5 years) then depending on your risk tolerance you can afford to be more aggressive, consider a portfolio of well-diversified stocks and bonds. If you are saving for retirement you’ll want to consider a tax-advantaged account such as an IRA.
If you are saving for a short-term goal (less than 5 years) such as a down payment on a house, you’ll want something with less risk and easier access, such as a CD.
How to Invest $100k
Stocks
If you have $100,000 to invest, stocks will likely be a part of your portfolio. You have several options on how to buy stocks.
Index funds
If you are new to investing in stocks, or just don’t have a lot of time to research and manage a portfolio, then index funds, mutual funds, and ETFs are great options. These investments are mostly hands-off, yet allow you to get access to a diversified portfolio.
Index funds aim to match a particular index that tracks the market. For example, you could invest in a fund that tracks the S&P500 or the Dow. You could even buy a fund that tracks the stock market as a whole.
The benefits of index funds are that it’s easy to get a lot of diversification and they often have very low fees as they require very minimal human research and management.
The drawbacks of index funds are that they aim to match the returns of the index they track, so you will never outperform the index – however, they also aren’t likely to underperform.
Also, with index funds you can become over-invested in a particular sector without realizing it as there can be an overlap of companies across different indices.
Mutual funds
Mutual funds are similar to index funds in that they pool together funds from multiple investors to buy a collection of stocks. The difference is that they are run by professional managers who follow the investment objectives of the fund, rather than following a specific index.
The benefits of mutual funds are good diversification and professional management. Unlike index funds, mutual funds are not limited to a set selection of investments. As long as the investments follow the stated objectives of the fund the manager is allowed to invest as she thinks best based on her knowledge of the markets and investment experience.
The drawbacks of mutual funds are fees and the possibility of underperformance. Since mutual funds are managed by a real person they have higher expenses than index funds, which are managed by a computer. This will reduce your returns.
Mutual funds also have the potential to underperform the market. While index funds aim to track a sector of the market they typically won’t under or overperform. Mutual funds have a lot more flexibility, so while they may overperform some years, they also risk underperforming as well.
ETFs
Exchange-Traded Funds, are a type of investment vehicle that allows investors to buy and sell a diversified portfolio of stocks or bonds in a single transaction, similar to an index fund. However, ETFs are traded on stock exchanges like individual stocks, and their prices fluctuate throughout the day as investors buy and sell shares.
ETFs are designed to track the performance of a specific index or benchmark, such as the S&P 500, and their holdings are usually disclosed on a daily basis. This allows investors to gain exposure to a broad market or sector with a single investment.
The benefits of ETFs are low expenses and diversification. Because they are managed by computers, like index funds, they tend to have very low expense ratios. They also allow you access to a broad range of investments.
The drawbacks of exchange traded funds are trading costs and the potential for underperformance. ETFs have the potential to be actively traded – if you partake in this activity you will likely have fees when you buy and sell shares. Also, if you actively trade shares you have the potential to underperform (or overperform if you are luck) the market.
Individual Stocks
Rather than buy collections of stocks via a mutual fund or ETF you could invest in individual stocks, if you have the time, knowledge, and inclination to do so.
Investing in individual stocks has more risks due to the fact that it’s difficult to build a diversified portfolio. Plus, you are also limited by your own knowledge and research abilities.
However, some people love to research stocks and investing strategies. If that’s you, and your risk tolerance is high enough you may find a lot of satisfaction in choosing your own investments. You could potentially beat the market – although you could also underperform the market as well.
Even if this appeals to you, I recommend investing in individual stocks with only a small percentage of your portfolio, while the bulk of your money remains in index funds or mutual funds.
Here are our favorite stock trading apps.
Dividend Stocks
If income is your goal you may want to consider dividend stocks. These are stocks that pay out a portion of their earnings to shareholders in the form of dividends. Dividends are typically paid out quarterly, and the amount of the dividend can vary depending on the company’s earnings and dividend policy.
Dividend stocks are typically issued by established, mature companies that have a history of stable earnings and strong cash flow. These companies may not offer high growth potential, but they are often viewed as more stable and less volatile than growth stocks.
The benefits are that they can provide investors with a regular stream of income and lower volatility than growth stocks.
The drawbacks are they have limited growth potential and can make dividend cuts at any time.
Here is how to find the best dividend paying stocks.
Real Estate
If you are looking to invest $100k you’ve probably thought of real estate. You have a lot of options when it comes to owning property. You could buy an individual property to rent or you could be more hands off with REITs or crowdfunding.
Buying Rental Property
Buying individual rental properties can be an attractive investment option for individuals seeking to generate passive income and build long-term wealth through real estate.
The benefits of real estate is passive income and appreciation potential. When you have a rental property you get rent each month from your tenants and the value of the property will likely go up over time. If the rent is high enough to cover all your expenses you could have a fairly passive income stream.
The drawbacks of real estate are that there are high upfront costs as well as ongoing costs. There is also market risk and tenant risk.
Plus, real estate is illiquid. If you want to sell it will take weeks, even in a strong market. If the market is weak at the time of the sale it could potentially take years to find a buyer and make a sale.
REITs
REIT stands for Real Estate Investment Trust, which is a company that owns or operates income-producing real estate properties, such as apartments, shopping centers, office buildings, hotels, and warehouses.
REITs allow individual investors to invest in real estate without having to purchase, manage, or finance the properties themselves. Instead, investors can buy shares of a REIT, which represent ownership in the underlying real estate portfolio.
This eliminates many of the drawbacks of individual real estate. You can participate in the rental income and price appreciation of a property without having to deal with tenants or broken hot water heaters.
They are also more liquid than individual properties. Shares of Real Estate Investment Trusts are traded like stocks, so if you want to sell a portion of your holdings you can easily do so.
REITs are the only way to get in and out of real estate quickly.
Real Estate Crowdfunding
Real estate crowdfunding is a relatively new form of investment that allows multiple real estate investors to pool their money together to invest in real estate projects. Crowdfunding platforms provide a digital marketplace where investors can browse and select from a range of real estate investment opportunities, typically offered by developers, sponsors, or real estate companies.
Crowdfunding is like a cross between buying an individual property and REITs. Like REITs, it allows you to invest in real estate for a lower entry amount and avoid having to be a landlord.
However, unlike REITs (and more like owning an individual property) your money is invested in a particular property, rather than in a fund that has multiple properties. The rent you receive and property appreciation is linked to your specific property.
Also, crowdfunding is typically not very liquid. Crowdfunding platforms usually have a set amount of time, often five years or more, before you are allowed to draw your funds out of the investment.
Here’s more information on real estate crowdfunding.
Bonds
Bonds are a type of fixed-income security that represents a loan made by an investor to a government, corporation, or other entity. In essence, an investor who buys a bond is lending money to the bond issuer in exchange for regular interest payments and the promise of a the return of their principal investment at the bond’s maturity date.
If your goal is to generate income, then bonds are worth considering. They can provide a regular stream of income in the form of interest payments, which can be particularly attractive for investors who are looking for steady, predictable income.
Bonds can provide diversification in an investment portfolio, as they tend to have a lower correlation with stocks and other assets. This can help to reduce overall portfolio risk and volatility.
However, bond prices and yields are inversely related, meaning that when interest rates rise, bond prices tend to fall. This can result in capital losses for bond investors. Also, bond issuers may default on their payments, which can result in capital losses for investors. You can lessen credit risk by only buying bonds from governments and large stable companies.
Here’s how to invest in bonds.
Certificates of Deposit
Certificates of Deposit similar to a savings account except that your money is locked away for a set period of time in exchange for a higher interest rate. They are good investments when your primary goal is safety of principal but don’t need access to the money for a fixed period of time.
The benefits of CDs are that they are very low risk. Your money is insured and not invested in any market so you have no risk of losing your principal. They also offer CDs offer a fixed rate of return, which is nice if you are looking for a predictable source of income.
However, they also have fairly low returns. Depending on the interest rate environment the returns may not even keep up with inflation – so you may even be actually losing purchasing power over the long term.
Here are the best CD rates.
Taxes
Investing means dealing with taxes – even investing in a retirement account will have some sort of tax implications.
Capital Gains Tax
If you are investing outside of retirement accounts you will want to consider capital gains taxes. Capital gains occur anytime you sell an investment for more than you paid. If you’ve held the asset for less than a year when you sell, then you will be taxed at your ordinary income tax rate.
However, if you’ve held the asset for more than year you will be taxed at your capital gains rate, which is likely 15% (and likely lower than your ordinary income tax rate).
Capital losses can also occur. If you sell at a loss you can use your losses to offset any other capital gains you had that year. If your losses exceed your gains you can carry them over indefinitely.
Income
If you are receiving income from your investments, for example, rent, dividends, or interest payments you will likely pay your ordinary income tax rate on this income.
An exception is some dividends are tax advantaged. Dividends can be “qualified” or “non-qualified” which will affect their tax status. Here is some information from the TurboTax on this.
Also income from government issued bonds may be tax advantaged as well. Income payments from municipal bonds are exempt from federal taxes and state taxes if the issuing state is also the state where you live.
Income from federal bonds are exempt from state taxes and local taxes.
Retirement Accounts
If you are investing for retirement then using a tax advantaged retirement account is your best bet.
Common accounts are Traditional and Roth IRAs. Both are individual retirement accounts but they are taxed differently.
Traditional IRAs give you a tax break when you contribute to the account but withdrawals in retirement are considered taxable income and you’ll pay taxes as your ordinary income tax rate.
Roth IRAs do not receive a tax break when you contribute but withdrawals in retirement are tax free. Meaning the growth is actually never taxed.
IRAs have annual contribution limits. You can find out more about that here.
Diversify
As you start investing, keep in mind that you don’t have to invest your money all in one place. If you like the idea of long-term growth but feel nervous about putting it all in the stock market, that’s ok. You can split it up between an index fund and a real estate investment trust.
Maybe you sock most away in a well-diversified index fund but want to keep a little bit set aside to trade in individual stocks and try your hand at individual stocks.
It’s your money and ultimately you get to decide what to do.
Hire a Financial Advisor
If you don’t feel confident enough to invest $100k on your own you can always ask for help from a financial advisor. They typically have expertise in various areas of finance, such as investments, retirement planning, tax planning, and estate planning.
Financial advisors get paid in a few different ways:
Commission-based: Some earn commissions on the products they sell, such as mutual funds, insurance policies, or annuities. This model can create a conflict of interest, as advisors may be incentivized to recommend products that may not be in the client’s best interest.
Fee-only: Fee-only advisors charge clients a fee for their services, typically based on a percentage of the assets they manage. This model eliminates the potential conflict of interest associated with commissions, as advisors are not incentivized to recommend specific products.
Fee-based: Fee-based advisors charge both a fee for their services and may also receive commissions for the products they sell. This model can also create a conflict of interest, as advisors may be incentivized to recommend products that generate higher commissions.
Hourly or project-based: Some financial advisors charge clients an hourly rate or a flat fee for specific projects or services, such as creating a financial plan or reviewing investment portfolios.
It’s essential to understand how a financial planner is compensated before working with them, as their compensation structure can influence the advice they provide. Fee-only financial advisors are often considered the most transparent and unbiased, as they are not incentivized to recommend specific products.
It’s important to find an investment advisor that you trust. They will be helping you make some of the most important financial decisions of your life.
How to find a financial advisor.
Summary of How to Invest $100k
Investing $100,000 can be an overwhelming task, but with the right approach and mindset, it can be a fruitful one. The first step is to create an emergency fund/ savings account and pay off high-interest debt to ensure financial stability.
Ultimately, the key to successful investing is to develop a diversified portfolio that aligns with your investment goals, risk tolerance, and financial objectives. With the right strategy and mindset, investing $100,000 can be a smart move towards securing a better financial future.
Rule #1 by Phil Town is not a general personal finance book, and it’s not a book for beginning investors — it turns a lot of conventional investment wisdom on its ear. The book explores a philosophy ascribed to Columbia University’s Benjamin Graham (author of The Intelligent Investor), and popularized by Graham’s student, Warren Buffet (perhaps the most successful investor of all time).
What is The Rule? “There are only two rules of investing: Rule #1: Don’t lose money […] and Rule #2: Don’t forget Rule #1.” Town writes: “Most Americans are trapped in mutual funds that, at best, ride the waves of the market.” He believes that his method can help investors break free from these cycles.
At its heart, Town’s philosophy is simply “buy low, sell high”. He’s not pushing a get-rich-quick scheme (though at times, especially early in the book, that’s exactly how it comes across). But he’s certainly encouraging his readers to abandon traditional “get rich slowly (and surely)” techniques.
Town argues that there are three myths of investing:
You have to be an expert to manage money.
You can’t beat the market.
The best way to minimize risk is to diversify and hold for the long term.
Dollar-cost averaging will not protect you, he says. These statements may make some nervous about Town’s philosophy. In the recent Wall Street Journal article about personal finance books, one expert cautioned:
“Any book that suggests it has a new way to riches should probably be a little suspect,” says Prof. Kenneth Froewiss, a finance professor at New York University Stern School of Business. A good book about personal finance, he says, always elaborates on three simple themes: Save early, know your risk tolerance, and diversify.
Town says that “knowing you will make money comes from buying a wonderful business at an attractive price”. If you can find a wonderful business, know what it’s worth as a business, and then buy it at a discount, you will become rich. If you repeat these steps, you will become very rich. “The price of a thing is not always equal to its value,” he says, arguing against Efficient Market Theory. He points to the recent Tech Bubble as an example. (As you might expect, Town doesn’t care for A Random Walk Down Wall Street.)
Rule #1 describes how to evaluate the investment potential of a business. You want:
A company that means something to you (you know its inner workings because you’re passionate about it).
A company that has a wide moat, or protective buffer (whether this is a competitive advantage, a huge cash reserve, or an exclusive license).
A company with excellent management.
A company with a margin of safety (that is, a company priced so low that even if you miscalculate its target price, you’re not going to lose money).
Using Town’s method, an investor creates a watch list of companies that meet each of these four criteria. Each company’s financials are checked against five measures of fiscal health (return on investment, revenue growth rate, earnings-per-share growth rate, equity growth rate, and free-cash-flow growth rate) over periods of one, five, and ten years. If a company’s numbers look good, the investor develops a target price for it.
And then the waiting begins.
When the market price reaches 50% below what the calculations show it ought to be, the investor fully commits himself. Sort of. Ideally, says Town, you would hold a company’s stock forever. In reality, he argues that there are a couple of times to sell:
When a company has ceased to be wonderful.
When the market price is above the sticker price.
It is here that the Rule #1 system begins to resemble day trading. When you’ve found your ideal business, and when it passes the Rule #1 criteria and is selling at half-off the sticker price, you begin buying and selling the stock based on market conditions. You use a set of tools to make your decisions, constantly moving in and out of the stock. You’re committed to the stock for the long haul, it’s true, but you’re attempting to use market timing to maximize your returns. (Town stresses that these tools should not be used to find and value stocks, but only to time the re-purchase (or sale) of a stock to which you’re already committed.)
The book jacket incorrectly touts this as a “fifteen-minute-a-week” system (which makes it sound even more like a get-rich-quick scheme). The author, though, is clear that more time is needed to make this work. He admits that constructing a watch list takes several hours per company. It’s only after the watch list is created that the time investment declines.
I can’t recommend this book, but that’s because it’s beyond my ken. I don’t hate it. In fact, I find the ideas fascinating, even plausible, but I lack both the experience and the expertise to evaluate Town’s system. It seems to be made of equal parts sound advice and gimmicks. I’d love to read a review from somebody more firmly rooted in investment theory.
One saving grace — and it’s a big one — is that the system includes a built-in escape hatch. By using the “margin of safety”, you are buying heavily discounted stocks of good companies. It’s unlikely that they could fall further. (But not impossible.)
For more information on Rule #1, check the following web sites:
Rule One Investor is the book’s official site. It includes additional information, including handy calculators. (Which is good, because much of this system requires number-crunching.) Free registration required.
The Rule #1 Blog is author Phil Town’s personal site where he answers questions and provides additional insight. I like the fact that Town makes himself publically available. This, too, makes me less inclined to classify this as a “get rich quick” scheme.
A review of the book at Fat Pitch Financials also seems ambivalent about the system. The author writes “I really wish Phil would have shared more information about his past performance using his investment techniques.” I agree.
For 35 years, Bay Area finance revolutionaries have been pushing a personal investing strategy that brokers despise and hope you ignore. [This is] the story of a rebellion that’s slowly but surely putting money into the pockets of millions of Americans, winning powerful converts, and making money managers from California Street to Wall Street squirm.
So writes Mark Dowie in a recent issue of San Francisco magazine. Dowie describes how Google prepared for its IPO in 2004. Aware that hundreds of young employees would soon be millionaires, the company brought in a series of financial experts to teach them to make smart investment choices.
Stanford University’s Bill Sharpe, winner of the 1990 Nobel Prize in economics said, “Don’t try to beat the market.” He advised the Google employees to put their money into indexed mutual funds.
Burton Malkiel, author of the classic A Random Walk Down Wall Street (in which he posits that a “blindfolded monkey” could pick stocks as well as a professional money manager) and former dean of the Yale School of Management said much the same thing. “Don’t try to beat the market … and don’t believe anyone who tells you they can — not a stock broker, a friend with a hot stock tip, or a financial magazine article touting the latest mutual fund.”
Jack Bogle is the founder and retired chairman of The Vanguard Group. What did this expert on mutual funds advise? The same as the others. “Brokers and financial advisors … are there for one reason and one reason only — to take your money through exorbitant fees and transaction costs, many of which will be hidden from your view.”
These experts, and many like them, recommend the same thing: take the slow, sure path to wealth. Invest your money in index funds. Index funds are low-maintenance, low-cost mutual funds designed to follow the price fluctuations of a broader index, such as the Dow Jones Industrials or the S&P 500. They are boring investments. But they work.
Related >> How to Invest in Index Funds
Jack Bogle’s common-sense approach has inspired a loyal following among savvy investors, many of whom participate in the Vanguard Diehards discussion forum.
[This] forum is characterized by its contributors’ commitment to low cost — primarily index — mutual fund investing, its unusually civil tone, and the thoughtful replies to almost all who post a question, no matter what their level of investing knowledge.
Some of these diehards call themselves Bogleheads in tribute to their muse. Three of them recently published The Bogleheads’ Guide to Investing, which is an excellent guide to smart investment choices. In the book, the Bogleheads stress their philosophy: Make index funds the core — or all — of your portfolio.
But not everyone believes that index funds the best choice for personal investors. A week ago I shared a brief conversation about money with Sparky, a friend to whom I often go for investment advice — he reads widely on the subject, and is well-informed. He doesn’t like index funds. Also last week, Jim at Blueprint for Financial Prosperity urged his readers, “Don’t just buy index funds.” Another blogger is worried that even index funds may be getting too complicated.
Even some professionals prefer other stock investment strategies. For example, Lowell Miller wrote a well-regarded book entitled The Single Best Investment: Creating Wealth with Dividend Growth in which he touts high-quality, moderate-growth, dividend-producing stocks as the best choice. In The Only Investment Guide You’ll Ever Need, Andrew Tobias admits the virtues of index funds, noting that over time they beat the returns on nearly every other sort of investment. But he notes:
For the prudent, thoughtful investor there is now the possibility of the ultimate fund. The one you put together yourself. The Personal Fund. It is no-load, of course, because you don’t charge yourself a nickel. And not just low-expense, like an index fund, but, rather, no expense.
This “personal fund” approach is exactly what my friend Sparky was trying to describe to me in our conversation last week. I like the idea of using some portion of my portfolio for a personal mutual fund. It’s easier for me to pay attention to my investments when they’re stocks I picked myself. But I will always want the core of my investments to be in index funds.
Despite the dissenters, most experts agree: index funds are an excellent way to get rich slowly. Dowie’s article on the subject is long, but is worth reading if you’re serious about your stock investments. Bookmark it. Print it. Save it for later. But make some time to read it.
Suze Orman set off quite a stir a few months ago in a New York Times interview. Although some folks were all atwitter to find out she was gay, what really had people in the personal finance world talking was the fact that the most successful personal finance writer in the country had the bulk of her $25 million portfolio in conservative municipal bonds, with only about $1 million invested in the stock market.
My buddy Chuck Jaffe, a MarketWatch columnist and not exactly a Suze fan, had a particularly good time that little factoid. Chuck has often criticized Suze’s advice as too conservative, and her lack of personal exposure to the stock market confirmed his suspicions that she was out of touch with the needs of everyday people. “In short,” he thundered, “the person being trusted as everyone’s financial adviser has a portfolio that few people could live with.”
I think Suze should be allowed to invest any way she wants to, but the whole kerfluffle points up an irony of personal finance columnizing: the more successful we pundits are, the less our lives resemble those of the majority of our readers.
I was thinking about that when J.D. asked if I’d be willing to write a little exposé for his site on how well I follow my own advice.
“I always wonder just how personal finance gurus lead their lives,” J.D. wrote in an email. “Do they really follow the advice they give? Are they frugal? Do they put their money in index funds? Do they drive older cars? I think this is a question many people have. I also think it’s one reason they read Get Rich Slowly: I quite clearly do follow my own advice, or try to.”
So do I — mostly. At J.D.’s request, I’m pulling back the curtain a bit to show you where I walk my talk, and where I’m full of (well-meaning) hot air.
In case you’re not familiar with my work: I’m the most-read personal finance columnist on the Web. I write a twice-weekly column for MSN Money and a nationally syndicated newspaper column. I’m also the author of three books about finance:
You can find out more about me, if you want, at asklizweston.com. But in answer to J.D.’s questions:
Am I frugal? Congenitally. Most of the time.
I grew up in a middle-class family with a dad who worked as an electric journeyman at the local power plant and a stay-at-home mom who had the Depression-era baby’s classic aversion to debt. We had a garden, we canned, we rinsed and reused baggies. My mom went back to work to help pay my college tuition, while I worked two to four part-time jobs each semester to make ends meet. I graduated without student loan or credit card debt.
I’ve never been much of a shopper, and was taught to pay credit card balances in full every month. (I have carried credit card debt a couple of times in my life — for cash flow reasons, not because we couldn’t pay the whole bill.) Since my early 20s, when I started working as a daily newspaper reporter, I’ve saved 15% to 20% — and sometimes more — of my income. Most of it goes into retirement funds and the majority of those are invested in stock mutual funds.
But a lot of the things I used to do to save money I now do mostly to save the environment: things like turning off lights, using a programmable thermostat, walking or biking instead of driving the car.
And now that I travel a lot, I’ve developed an appreciation for luxuries that would have been unthinkable in my salad days: things like membership to an airline lounge and occasionally paying for a first-class ticket, when I can’t qualify for an upgrade with frequent flyer miles. Flying coach these days reminds me way too much of riding the Greyhound bus during college, and I’m lucky enough to be able to afford an alternative.
Do I put my money in index funds? Yes. Mostly.
I’m a confirmed believer that people who think they’re going to beat the market probably are deluding themselves. I know I would be; I’m way too busy to monitor individual stocks or actively-managed mutual funds.
But a recent review of our portfolio showed that while most of our money is in broad-market index funds, we’re still hanging on to a few actively-managed funds I bought before I’d become firmly convinced of the futilely of trying to predict market-beaters. Like the cobbler’s children with no shoes, my portfolio’s overdue for a clean-up and rebalancing. Thanks, J.D., for goading me into it.
Do I drive an older car? Oh, boy. Do I.
I’m the proud driver of a 1993 SUV with—ta-da—250,000 miles on it. I inherited it from my husband, who upgraded to a later-model Volvo. (The man actually cares what he drives, unlike me.) I’d eventually like to replace it with a more fuel-efficient car, but at this point I drive so few miles that it doesn’t make sense to replace it. Besides that, I’m oddly curious to see how long the old beast will hold out.
I’ve also learned a lot about money over the years by making mistakes. I bought “retirement property” when I was in my 20s (anybody want 14 acres in Alaska, 80 miles from the nearest road?). After years of railing about the insanity of the dot-com boom, I sunk $2,000 into a tech fund in — get this — March 2000, about a week before the bubble started to burst. And the last time we bought a house, I forgot (yes, forgot) about closing costs, and had to sell off some investments at the last minute to cover closing costs. (Fortunately, the stock market cooperated with me for once — you’re not supposed to keep short-term money, like down payments and closing costs, in stock or stock mutual fund investments lest they take a dive right when you need the money.)
But yeah, overall I’ve followed my own advice. I’ve avoided toxic debt including credit card debt; put a pile away for retirement; and invested a ton of money over the years in fun and experiences. I’ve traveled around the world, earned my pilot’s license, threw some great parties, took two sabbaticals to care for my dying mother, and am in the process of raising a wonderful daughter (who may turn out to be our more expensive experience yet, but is soooo worth it). I firmly believe that managing money well helps you live life well, and that’s the message I hope to communicate to readers — regardless of where they happen to be on the road to financial health.
In 1973, Burton Malkiel published A Random Walk Down Wall Street, in which he argued that a blindfolded monkey could pick stocks as well as a professional investor. Though I bought a copy of Random Walk for $3.99 at the local Goodwill last year, I haven’t read it. It looks dense. I know it’s written for the layman, but it still seems rather academic.
In 2003, Malkiel published The Random Walk Guide to Investing, “a book of less than 200 pages in length that boils down the time-tested advice from Random Walk into an investment guide that [is] completely accessible for a reader who knows nothing about the securities markets and who hates numbers.”
Several patient GRS-readers have been recommending this book for the past year. When I stayed home sick yesterday, I finally found time to read it. I’m impressed. Malkiel has produced an easy-to-read straightforward investment guide that I’m happy to recommend to anyone. His philosophy matches my own:
The advice in this book is both simple and realistic. There is no magic potion in the investment world because the truth is that one doesn’t exist. There is no quick road to riches. And if someone promises you a path to overnight riches, cover your ears and close your pocketbook. If an investment idea seems too good to be true, it is too good to be true. What I offer are ten simple, time-tested rules that can build wealth and provide retirement security. Think of the rules as the proven way to get rich slowly.
Malkiel’s rules are familiar. We’ve discussed most of them here before:
Start saving now, not later. Don’t worry about whether the market is high or low — just begin investing. “Trust in time rather than timing,” Malkiel writes. “The secret to getting rich slowly (but surely) is the miracle of compound interest.”
Keep a steady course. “The most important driver in the growth of your assets is how much you save,” writs Malkiel, “and saving requires discipline.” To develop discipline, the author recommends that you learn to pay yourself first (invest before anything else, even paying bills), implement a budget, change spending habits, and pay off debt.
Don’t be caught empty-handed. Malkiel recommends that readers open an emergency fund. He doesn’t specify how much should be set aside, but he does cover a variety of places to put the cash: money market accounts, certificates of deposit, and online savings accounts. He also recommends purchasing term life insurance.
Stiff the tax collector. Make the most of tax-advantaged savings: Open an Individual Retirement Account, contribute to your company’s retirement plan, take advantage of tax-free savings for your child’s education, buy your home rather than rent. All of these things help to reduce the bite that taxes take out of your money.
Match your asset mix to your investment personality. Based on your risk tolerance and your investment horizon, choose the best mix of cash, bonds, stocks, and real estate. (Malkiel encourages investors to buy each of these through mutual funds.)
Never forget that diversity reduces adversity. Don’t just buy stocks — buy stocks, bonds, and other investments classes. Within each category, diversify further. And don’t just buy one stock — buy mutual funds of many stocks. (Malkiel makes his case with the stark example of a 58-year-old Enron employee who had a $2.5 million 401k — of Enron stock. When Enron went bust, the employee not only lost her job, but her retirement savings vanished completely.) Finally, the author recommends “diversification over time” — making investments at regular intervals using dollar-cost averaging.
Pay yourself, not the piper. Interest and fees are drags on your wealth. “Paying off credit card debt is the best investment you will ever make.” Avoid expensive mutual funds. “The only factor reliably linked to future mutual fund performance is the expense ratio charged by the fund.” In fact, the author advises that costs matter for all financial products.
Bow to the wisdom of the market. “No one can time the market,” Malkiel says. It’s too unpredictable. Professional money managers can’t beat the market, financial magazines can’t beat the market — nobody can beat the market on a regular basis. The best way to earn consistent gains is to invest in broad-based index funds. It’s boring, but it works.
Back proven winners. After Malkiel has preached the virtues of index funds, presumably converting the reader to his religion, he spends a chapter suggesting possible index funds and asset allocations.
Don’t be your own worst enemy. Malkiel concludes by admonishing readers to stay the course, warning them against faulty thinking. He discusses the sort of money mistakes I’ve mentioned before: overconfidence, herd behavior, loss aversion, and the sunk-cost fallacy.
Ultimately, Malkiel’s advice can be stated in a few short sentences: Eliminate debt. Establish an emergency fund. Begin making regular investments to a diversified portfolio of index funds. Be patient. But the simplicity of his message does not detract from its value. The Random Walk Guide to Investing is an excellent book because it sticks to the basics:
It’s short.
It’s written in plain English — there’s no jargon.
It’s easy to understand — concepts are simplified so the average person can grasp them.
It’s filled with great advice.
This book refers often to other books to bolster its arguments, and includes quotes from financial professionals like John Bogle and Warren Buffett. Though the advice may seem elementary, it’s advice that works. If you want to invest but don’t know where to start, pick up The Random Walk Guide to Investing at your local library.
As you might expect, most of my personal investments are safely tucked away in index funds, those mutual funds designed to track the performance of a particular stock market index. This is a smart way for the average investor to achieve solid growth over the long-term.
However, I continue to hold about 5% of my investment capital in reserve as “mad money”. While the rest of my investments are conservative, I use this money to purchase whatever investment strikes my fancy.
I don’t do a good job.
In 2006 I gained about 20% with my mad money. Last year I lost about 33%. I’ve lost even more this year. I’m just not educated enough to pick and choose individual stocks. I buy and sell at the wrong times. Obviously, this is further anecdotal evidence in support of index funds. Undaunted, I recently made a trip to the library to borrow a book about individual investing, John Wasik’s The Kitchen-Table Investor: Low-Risk, Low-Maintenance Wealth-Building Strategies for Working Families.
At first, the book made me wary. In the preface, Wasik writes:
My low-risk, long-term strategy makes it possible for any investor to share in the great wealth Wall Street is producing — by investing as little as $25 a month…By following a handful of rules, real wealth is certainly attainable even if you don’t have the the money to invest. I’ll not only show you how to invest small sums of money but help you find the money to invest automatically on a regular basis.
Real wealth is attainable even without money to invest? What? Despite this bold claim, this book is not a get-rich-quick screed. Wasik offers sound personal finance advice. In fact, his philosophy often echoes classics like Your Money or Your Life: “In saving money, we are preserving our own natural resources, that is, our life energy.”
Wasik’s approach to low-maintenance investing follows eight steps. Here are my comments on each:
Find money to invest. Wasik preaches the virtues of compound interest: “If you can save at least 10% of your annual income — no matter how much you make — you will have [prosperity].” But how do you find the money to save? Avoid advertising, Wasik says, especially television advertising. Avoid credit card debt. Buy a sensible home and a sensible car. Spend less than you earn.
Join an investment club. Wasik is a huge fan of investment clubs. These groups provide amateur investors with an opportunity to pool their money to make larger purchases. They also teach members to research stocks and to track their portfolios. The book contains a lot of good information on running an effective investment club.
Find a place to park your money. You need someplace to stash your money while you’re saving to make your stock purchases. Wasik recommends money market funds. Nowadays, parking the money in a high-yield savings account probably makes the most sense. (Many of these are money market funds, anyhow.)
Fund your company plans. “Welcome to the golden age of retirement vehicles,” Wasik says. He provides an overview of various pension plans, including 401(k)s, 403(b)s, traditional IRAs, and Roth IRAs. “Fund your plans for maximum growth,” he recommends.
Buy stocks for growth. Wasik offers his five fundamental rules of stock-picking:
Find quality companies that are growing earnings consistently from 10% to 15% per year.
Sales and earnings per share should be increasing in lockstep with earnings. Look for companies with at least five years of earnings.
Buy a stock for the long term.
Keep your costs low and your commitment high. Reinvest all dividends.
Automatically purchase shares on a regular basis to reduce market risk.
He offers tips on screening companies, and explains how to read an annual report.
Buy mutual funds. What if you don’t want to pick individual stocks? What if you’re not interested in gambling whether you can beat the market? Create a portfolio comprising four essential mutual funds: one that tracks the Wilshire 5000 index, an international fund, a value fund, and a “wild card” fund. The latter can be any aggressive fund that focuses on one sector of the economy.
Be patient. Don’t panic. “Investing is a matter of rational faith,” says Wasik. Buy and hold. Don’t pay attention to the financial report. Don’t check your stock prices every day. Don’t try to second guess the market. Be patient, rebalancing your portfolio every year. Accept the risk and sleep at night.
Become an automatic investor. Wasik loses his way in the final chapter. This ought to have read like David Bach’s The Automatic Millionaire. Instead, it’s a list of ways to save money through frugality. That’s fine, but it has nothing to do with automatic investing.
The Kitchen-Table Investor is not a bad book — in fact, I think it would be quite useful for many Get Rich Slowly readers — it’s just not everything I had hoped. Still, bits and pieces are quite good. I like that Wasik provides examples from his own life. He’s not afraid to share the mistakes he’s made in order to illustrate a point.
Though some of the book’s advice is dated, and there’s more delivery than payoff, The Kitchen-Table Investor is worth reading if you’re interested in a more active approach to self-directed investing. If you want to try picking your own stocks, then consider borrowing this book from your local library. It’ll give you a solid introduction to the basics.