The 10-year yield (ticker: US10Y) describes what 10-year U.S. Treasury notes will pay over 10 years if bought today. Also known as T-notes, Treasury notes are a low-risk fixed-income investment that pays a set rate of interest every six months.
Considered one of the lowest-risk investments on the U.S. market, 10-year Treasurys are a “risk-free” benchmark against which other investments and debt are compared. (Three-month Treasury bills are another.)
While no investment is ever completely risk-free, Treasury notes come close if held to maturity. As a result, some investors and analysts look to demand for T-notes as one way to assess investor confidence in the economy.
Treasury notes are one of four main types of U.S. government debt securities. The others are Treasury bills, Treasury bonds and Treasury Inflation-Protected Securities (TIPS). They vary in their duration, interest payments and yields.
Competitive bid
When a bidder specifies the conditions of the Treasury (such as rate and yield) that they’re willing to accept.
Non-competitive bid
When a bidder agrees to accept whatever conditions, such as rate and yield, are established at the auction.
The face value of a Treasury note, or what you pay to loan the government money.
Treasury bill
The shortest-term U.S. debt security, Treasury bills mature in less than a year. They’re also known as a zero-coupon bond. T-bills do not pay interest like other Treasurys, and instead are sold at a discount. The difference between the face value of the T-bill and its discount rate is the “interest earned.”
Treasury bond
A long-term U.S. debt security maturing in 20 or 30 years.
Treasury note
A type of U.S. debt security maturing in 2, 3, 5, 7 or 10 years.
Market ticker for the 10-year Treasury yield.
The interest rate the U.S. government pays on its debt, or how much you can earn from investing in a Treasury note.
Price vs. yield
Treasury prices and yields tend to move in opposite directions, and are affected by supply and demand and the health of the economy. The purchase price or face value of a Treasury note is what you pay to buy it. The T-note’s yield is the interest rate you earn for loaning the government money.
Treasury notes are sold at auction through a bidding process. The Treasury first accepts any noncompetitive bids, or bids from investors who accept the current T-note rate and yield. Then, the Treasury accepts the highest competitive bid.
If demand for Treasury notes is high, they may sell for more than their face value. If demand is low, on the other hand, Treasurys can sell for less than their face value.
The Treasury may raise the yield of newly issued 10-year notes if the price of existing 10-year notes starts to fall on secondary bond markets (because of market forces like inflation). If there’s high inflation, for example, the potentially higher yield of newly issued 10-year notes will make them more attractive than previously issued T-notes.
This effect is also known as interest rate risk and is most relevant for investors trying to sell T-notes on a secondary market. If held for their full duration, Treasury notes still pay their coupon payments and principal in full. But if a T-note-holder were to sell early, they may have to discount the price.
Longer-term investments tend to offer higher yields to offset any potential price impact from interest rate or other risks.
Why is the 10-year Treasury yield important?
As one of the lowest-risk investments on the market, the 10-year Treasury and its yield are important for several reasons. First, the 10-year Treasury is a baseline against which the risk of other investments is assessed.
Treasury rates also affect interest rates for other types of consumer debt, like real estate and mortgage loans. Consumers often compare the return they could earn on Treasurys to certificates of deposit, money market accounts, corporate bonds and even mortgage-backed securities. So when yields for 10-year T-notes go up, so too do rates for real estate and mortgage debt.
Finally, supply and demand for Treasurys fluctuate with the economic climate. When markets or world events turn tumultuous, investors tend to flock to Treasurys in search of a safe haven. When times are good, though, investors tend to seek out other investments that can provide a more favorable return.
Are 10-year Treasury notes a good investment?
Whether 10-year Treasurys are a good investment for you depends on your investment goal. If your goal is to let your money grow slowly and conservatively over time, Treasury notes are considered a low-risk investment if held to maturity since they’re backed by the U.S. government.
One of the main risks with Treasury notes is what’s known as “opportunity cost”: You could forgo potential profits by investing in T-notes instead of a security with a higher potential return.
What is the 10-year treasury yield today?
Here is today’s 10-year Treasury note yield, alongside other Treasury securities for reference.
Rates are sourced from Google Finance and may be delayed. Data is solely for informational purposes, not for trading.
How do you buy 10-year Treasury notes?
Treasury notes can be bought in increments of $100 directly from the U.S. government via TreasuryDirect, or through a bank or broker. T-notes can also be purchased bundled together in the form of a Treasury exchange-traded fund.
Do you pay tax on T-notes?
Investors pay federal income taxes but no state or local taxes on T-notes and other Treasurys.
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The sudden collapse of Silicon Valley Bank in March 2023 was a sobering reminder that even the biggest banks can fail — and potentially take their customers’ deposits with them.
The federal government stepped in to cover Silicon Valley Bank’s customers’ deposits, preventing large-scale deposit losses. But because SVB’s failure occurred in part because it mismanaged its customers’ deposits, the ordeal got regular people asking: What do banks and credit unions actually do with our money?
The short answer is pretty simple and probably not too surprising: Banks mostly use your money to make more money for themselves. There’s more to the story, though. And exactly how banks use deposits to make more money is an important consideration when choosing a bank and assessing how safe your deposits really are.
What Do Banks Do With Your Money?
Banks keep a relatively small amount of deposits accessible. This portion is known as a cash or capital reserve or sometimes fractional reserve.
Until March 2020, federal regulators required banks to maintain specific minimum reserves to cover withdrawal requests and offset possible losses on loans and other investments. The Federal Reserve managed a three-tiered system that set reserve requirements as a percentage of net transaction value. The Fed still updates the tiers because the laws requires it to do so, but it no longer enforces compliance.
Banks still keep some cash in reserve to cover withdrawal requests, but the government no longer requires them to maintain a specific minimum.
Banks use most of their deposits to fund loans and investments they hope will turn a profit. They aim to earn more on these loans and investments than they pay out in interest on deposits.
While they maintain detailed accounts of their customers’ funds, banks treat cash held in most common account types more or less the same. Whether you have a checking account, savings account, money market account, or CD — or all four — your bank keeps some of the cash in reserve and uses the rest to make money.
How Bank Reserves Work
In the old days, reserves would be literal cash in bank vaults.
Banks still keep some physical cash on hand, but a lot of their spare money sits in special accounts with the U.S. Federal Reserve Bank. That’s safer and more secure, anyway, and in an increasingly cashless world, it’s more practical too.
How Lending & Investing Work
The exact proportion of total deposits a given bank lends depends on factors like its lending strategy, financial health, economic conditions, and operating expenses.
However, under normal circumstances, banks try to lend as much of their cash as possible while still fulfilling their reserve requirements, which for practical reasons they likely still have internally whether the government enforces it or not. That’s how most banks make their money.
“Lend” can mean many different things, including some less obvious to nonexperts. In fact, it’s more accurate to think of a bank’s lending activities as part of its broader investment strategy. That’s how the bank sees it.
And while many banks stick to investing in various types of consumer and business loans, some also invest in more exotic (and risky) assets like public and private company stock, venture capital funds, and commercial real estate.
These common bank lending activities rely on customer deposits:
Issuing credit cards: Credit cards are super-profitable for many banks, from big names like Capital One to small players you’ve probably never heard of. That’s because credit card interest rates are much higher than the rates banks pay on even the highest-yielding savings accounts and CDs.
Making unsecured installment loans and lines of credit: Many banks make good money on unsecured personal loans and lines of credit. Because the bank can’t seize an asset to cover losses on these loans, they’re relatively risky and carry higher interest rates than mortgages or auto loans.
Making secured installment loans and lines of credit: These include mortgages, vehicle loans, and home equity loans and lines of credit. They generally have lower interest rates than unsecured loans and lines because they’re less risky for banks, but they still can be very profitable.
Providing financing to businesses: Many banks and credit unions offer financing to businesses and nonprofits. Community banks are particularly active in this space and tend to serve businesses in their own communities — an important consideration for bank customers who want to help local entrepreneurs indirectly.
Buying bonds: You can expect predictable interest payments and eventually the return of your initial investment in bonds. Banks appreciate bonds’ relative safety and predictability, though they’re not risk-free — Silicon Valley Bank failed in part because it made bad bond bets.
How Do Banks Protect Your Money?
When you open and fund a deposit account, you give your bank or credit union the right to use your deposits as it sees fit. But you’re still the rightful owner of that money and can withdraw it pretty much on demand, allowing for reasonable restrictions and penalties that depend on the account type and are spelled out in the deposit agreement.
So your bank or credit union is obligated to protect your money and ensure it’s available for withdrawal when you need it. It does this in several ways, some voluntary and others required by law or regulation.
Capital Reserves
Although the Federal Reserve eliminated specific capital reserve requirements in March 2020, every bank keeps a significant amount of its customers’ money in cash and cash equivalent, like short-term Treasury notes.
Capital reserves don’t directly protect your money. Your bank doesn’t maintain separate reserve accounts for each customer account. But it does know about how much customers withdraw in a typical day and ensures it has more than enough on hand to cover those requests.
In an even less direct sense, your bank’s reserves protect your money by ensuring the bank can pay its bills and keep operating normally.
Daily Withdrawal Limits
Banks can’t keep all their customers’ money in reserve. With no spare cash to make loans, they’d go out of business in short order. In fact, banks want to keep as little cash in reserve as possible while still covering operating expenses and expected withdrawals.
To manage the tension between their obligation to fulfill withdrawal requests and their prerogative to make money, banks often set daily withdrawal limits on all or certain accounts.
These limits tend to be lowest for cash transactions. For example, you might be limited to just a few hundred dollars per day in ATM withdrawals. They’re usually higher for electronic and wire transfers — typically $50,000 or more.
Deposit Insurance Coverage
State and federal banking regulations require banks and credit unions to carry deposit insurance.
The Federal Deposit Insurance Corporation provides federal deposit insurance to banks, while the National Credit Union Administration provides federal deposit insurance to credit unions.
For both, the maximum deposit insurance limit is $250,000 per account ownership type, which means you have full insurance on up to $250,000 across all individual accounts with the same bank and full insurance on another $250,000 across all joint accounts in that bank. (There are other account ownership types, but individual and joint are the most common.)
In addition to directly protecting customer deposits, deposit insurance helps prevent bank runs by providing assurances that customers won’t lose insured funds if the bank fails.
When that happens, the FDIC steps in and temporarily takes control of the bank, with the short-term goal of either finding another bank to assume its deposits or to sell off its assets piecemeal. In either case, deposit insurance kicks in and protects customer deposits.
This process has proven extremely reliable over the years. Since the FDIC’s inception in 1933, no bank customers have lost funds under the FDIC insurance limit. Uninsured losses have occurred, but in recent years, the federal government has gone to extraordinary lengths to protect deposits above the insurance limit as well. Despite well over 90% of its deposits being uninsured, Silicon Valley Bank didn’t lose a cent of its customers’ money when it failed.
Final Word
Your bank probably uses most of the money in your accounts to fund loans to other customers. It might also buy government or corporate bonds with your money. It reserves a small slice of your cash to cover withdrawal requests and operating expenses.
That’s pretty much it. The details can get really convoluted, but you don’t need a finance degree to gain a basic understanding of how banks use customers’ money. And if you’re like me, you probably find that oddly reassuring.
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Brian Martucci writes about credit cards, banking, insurance, travel, and more. When he’s not investigating time- and money-saving strategies for Money Crashers readers, you can find him exploring his favorite trails or sampling a new cuisine. Reach him on Twitter @Brian_Martucci.
Long, long ago, in a mystical forest with good Wi-Fi, Goldilocks opened an investing account with $3,000 to invest.
At first, she considered pouring more money into her retirement accounts (which only holds mutual fund investments). But her Roth IRA was already maxed out for the year. Moreover, she knew that she would need this money sooner than age 65.
“Too cold!” she said.
Next, she considered investing in individual stocks. But even though she’d done her due diligence, she knew that investing in individual securities can be very risky. She didn’t need to become a millionaire overnight – she just wanted to make enough money to buy a cottage in a few years.
“Too hot!” she said.
Finally, she began browsing ETFs. ETFs are generally more stable, diverse, and safe investments than individual stocks, but they’re also more accessible than your retirement account.
“Juuuuust right!” she said aloud.
10 years later, Goldilocks’ investment had paid off – thanks to a steady 10% APY, her $3,000 investment had become nearly $8,000, so she was finally able to pay restitution and legal fees to the family of bears down the way.
Thanks to inherent diversity and steady returns, ETFs are a great place to stash a few grand to help you save for a big expense years or decades down the line.
What’s Ahead:
Large-cap stock ETFs
Large-cap ETFs typically bundle together blue-chip stocks or even an entire index, providing steady, sizeable returns. Warren Buffet once famously said:
“I just think that the best thing to do is buy 90% in S&P 500 index fund.”
So I’ve included two such options on the list.
You’ll also see a lot of Vanguard funds on this list because, well, they’re just awesome all the way around. Vanguard funds are extremely popular among investors because they combine industry-leading returns with incredibly low expense ratios.
ETF
Symbol
Fund info
Expense ratio
Schwab US Large-Cap Growth ETF™
SCHG
The fund’s goal is to track as closely as possible, before fees and expenses, the total return of the Dow Jones U.S. Large-Cap Growth Total Stock Market Index.
0.04%
SPDR S&P 500 ETF
SPY
The SPDR® S&P 500® ETF Trust seeks to provide investment results that, before expenses, correspond generally to the price and yield performance of the S&P 500® Index (the “Index”).
0.0945%
Vanguard S&P 500 ETF
VOO
The Vanguard S&P 500 ETF invests in stocks in the S&P 500 Index, representing 500 of the largest U.S. companies.
0.03%
Vanguard Russell 1000 Growth ETF
VONG
The investment seeks to track the performance of the Russell 1000® Growth Index. The index is designed to measure the performance of large-capitalization growth stocks in the United States.
0.08%
Mid-cap stock ETFs
Goldilocks’ choice – mid-cap ETFs – bundle together companies that have an exciting growth curve before them, but are established enough not to fold overnight.
If you can tolerate a little more risk in exchange for higher potential returns than an index fund, consider these top picks:
ETF
Symbol
Fund info
Expense ratio
Vanguard Mid-Cap Growth ETF
VOT
VOT seeks to track the performance of the CRSP US Mid Cap Growth Index, which measures the investment return of mid-capitalization growth stocks.
0.07%
iShares Core S&P Mid-Cap ETF
IJF
IJF seeks to track the investment results of an index composed of mid-capitalization U.S. equities.
0.05%
Vanguard Mid-Cap ETF
VO
VO seeks to track the performance of the CRSP US Mid Cap Index, which measures the investment return of mid-capitalization stocks.
0.04%
Schwab U.S. Mid-Cap ETF
SCHM
SCHM’s goal is to track as closely as possible, before fees and expenses, the total return of the Dow Jones U.S. Mid-Cap Total Stock Market Index.
0.04%
Small-cap stock ETFs
If you’ve looked at your asset portfolio recently and thought “hmm… needs a little more spice,” then a small-cap ETF might add just the right amount of kick.
These ETFs track small companies with big potential, so they present higher risk but higher potential reward than large- or mid-cap ETFs.
ETF
Symbol
Fund info
Expense ratio
Vanguard S&P Small-Cap 600 Growth ETF
VIOG
VIOG employs an indexing investment approach designed to track the performance of the S&P SmallCap 600® Growth Index, which represents the growth companies, as determined by the index sponsor, of the S&P SmallCap 600 Index.
0.15%
Vanguard Small-Cap ETF
VB
VB seeks to track the performance of the CRSP US Small Cap Index, which measures the investment return of small-capitalization stocks.
0.05%
iShares Core S&P Small-Cap ETF
IJR
IJR seeks to track the investment results of an index composed of small-capitalization U.S. equities.
0.06%
Schwab U.S. Small-Cap ETF
SCHA
SCHA’s goal is to track as closely as possible, before fees and expenses, the total return of the Dow Jones U.S. Small-Cap Total Stock Market Index.
0.04%
International stock ETFs
ETF
Symbol
Fund info
Expense ratio
Vanguard Emerging Markets ETF
VWO
VWO invests in stocks of companies located in emerging markets around the world, such as China, Brazil, Taiwan, and South Africa.
0.10%
Vanguard Total International Stock ETF
VXUS
VXUS seeks to track the performance of the FTSE Global All Cap ex US Index, which measures the investment return of stocks issued by companies located outside the United States.
0.08%
SPDR® MSCI EAFE Fossil Fuel Free ETF
EFAX
EFAX seeks to offer climate-conscious investors exposure to international equities while limiting exposure to companies owning fossil fuel reserves.
0.20%
Vanguard FTSE Developed Markets ETF
VEA
VEA provides a convenient way to match the performance of a diversified group of stocks of large-, mid-, and small-cap companies located in Canada and the major markets of Europe and the Pacific region.
0.05%
Fixed income ETFs
ETF
Symbol
Fund info
Expense ratio
iShares Core U.S. Aggregate Bond ETF
AGG
AGG seeks to track the investment results of an index composed of the total U.S. investment-grade bond market.
0.05%
Vanguard Total Bond Market ETF
BND
BND’s investment objective is to seek to track the performance of a broad, market-weighted bond index.
0.035%
Vanguard Intermediate-Term Corporate Bond ETF
VCIT
VCIT seeks to provide a moderate and sustainable level of current income by investing primarily in high-quality (investment-grade) corporate bonds.
0.05%
Schwab 1-5 Year Corporate Bond ETF
SCHJ
SCHJ’s goal is to track as closely as possible, before fees and expenses, the total return of an index that measures the performance of the short-term U.S. corporate bond market.
0.05%
What does large-cap, mid-cap, etc. mean?
To start, “cap” refers to market capitalization, or the total value of a company’s shares on the market. For example, if a company has 1 million shares on the market valued at $10 a pop, their market cap would be $10 million.
Large-cap ETFs are comprised of companies each with a market cap of $10 billion or higher. The Vanguard Mega Cap ETF (MGC), for example, contains around 250 of the biggest companies in the USA, from Amazon to Apple. Since they’re often full of blue-chip stocks that provide slow-but-steady returns, large-cap ETFs are considered a safe, long-term investment.
Mid-cap ETFsare comprised of companies each with a market cap in the $2 to $10 billion range. All ETFs are designed to succeed and make money, so mid-cap ETFs are filled with midsized companies that are in the middle of their “growth curve,” so to speak – they’re high-performing, high-potential companies that may become the next blue-chip, so mid-cap ETFs balance risk and reward.
Small-cap ETFsare comprised of companies each with a market cap of “just” $300 million to $2 billion. Fund managers who design small-cap ETFs cast a wide net, aiming to scoop up “the next big thing.” As a result, these ETFs have higher growth potential than most ETFs, but also steeper downside if the smaller companies within end up folding.
International ETFsare, as the name so subtly hints, full of non-U.S. stocks and securities. There are country-specific ETFs, foreign industry ETFs (think non-U.S. automotive stocks), and even ETFs representing emerging markets like sub-Saharan Africa and Brazil.
Fixed income ETFs, aka bond ETFs, give you access to diverse bond investments. For the uninitiated, bonds are like loans you make to companies or governments that they pay back with interest. You can read more about bonds here, but the bottom line is this: fixed-income ETFs provide steady income in the form of dividends, so they’re a good choice if you want a safe investment that gives you a paycheck!
Read more:How To Invest In ETFs
Which type of ETF is right for you?
Well, it depends on both your goals and your risk tolerance.
If you can tolerate some risk in your portfolio, and want your ETF investment to pay off sooner than later (within five years), you may want to consider small-cap and mid-cap ETFs. They’re riskier, but have higher upside potential.
If you’re looking for a safer investment that will multiply your money over a longer horizon (5+ years), a large-cap ETF is probably a fit.
If you’d like your ETF investment to provide a trickle of cashback each month, fixed income ETFs are probably your best bet.
And finally, if you don’t mind doing a little research or believe strongly in the economic performance of a foreign market, you’ll be a fan of international ETFs.
Read more: How To Determine Your Investing Risk Tolerance
About our criteria
With hundreds of commission-free ETFs available, how did these become the winners?
To make this list, ETFs had to impress in all of the following categories:
Earnings potential.Naturally, the first thing looked at was the ETF’s performance over the past five years. A good sign of a healthy ETF is how quickly it bounced back in Q3 2020 after the market panic surrounding the COVID-19 pandemic. Springboarding back and surpassing Q1 levels are a sign of investor confidence, and helped solidify the ETF’s place on this list.
Expense ratio.Next, I looked at the ETF’s expense ratio. Your expense ratio is the percentage of your investment you pay to the fund manager for having shares of the ETF. Although measured in fractions of a percent, expense ratios make a difference – 0.80% of $10,000 is $80 and 0.04% is just $4, so ETFs with an expense ratio below 0.20% were favored.
Fund reputation. You’ll see a lot of repeated names on this list because funds like Schwab, BlackRock (iShares), and especially Vanguard have a proven track record of building well-crafted, reliable ETFs with low expense ratios. Fund reputation matters in the long run because big funds attract big money, which helps to generate higher returns for you!
Solid fundamentals.ETFs aren’t just random grab bags of stock and securities – each one is a carefully curated list, with selection criteria driven by both AI and human logic. There are some wacky and unique ETFs out there – such as Millennial ETFs and Space ETFs – and I’ll cover more of them in an upcoming piece. But this list isn’t for the experimental, exciting stuff – it’s for safe, dare I say boring, places to stash and multiply your savings.
Conscious investing.Finally, this was more of a small thing in the back of my mind, but I wanted each ETF on this list to score average or above average for “conscious capitalism.” No fossil fuels, no sin stocks (learn more about sin stocks here) – and not just because it’s not the way of the future, but because investments in conscious capitalism generally outperform “sinful” investments in the long term.
Commission-free ETFs solve a big problem for young investors
Commission-free ETFs aren’t just great because they’re cheap – they actually solve a pretty serious problem plaguing young ETF investors.
You see, ETFs have heftier commissions and trade fees than stocks because ETFs can be resource-intensive to create. Let’s say you’re a fund manager and you have an idea for an ETF. The process to get your ETF approved by the SEC isn’t unlike getting your new drug approved by the FDA; you have to research a ton, understand the risks, and propose your ETF to the government.
Once your ETF is approved and available, you probably want some additional compensation for your work beyond just capital gains from your ETF.
You don’t want to charge a high percentage trade fee, because big-ticket investors will be turned off. So, instead, you charge a $10 to $20 fee per trade of your ETF.
Big-ticket investors who drop $50,000 on a trade couldn’t care less about a $20 fee, since that represents just 0.04% of their investment. But if you’re a young investor, investing maybe $50 to $100 out of each monthly paycheck, a $20 per-trade fee is way too high – basically pricing us out of ETF investing. 🙁
Thankfully, many brokerages have realized that their per-trade fees are too high for young investors and have eliminated commissions on trades of certain ETFs. At first, funds like Vanguard and Fidelity only let you trade commission-free on their own platforms, but now, they’ve expanded their commission-free goodness to wide platforms like J. P. Morgan Self-Directed Investing.
And it’s not just the junk ETFs that get traded commission-free – in fact, it’s often quite the opposite. Firms like Vanguard and Fidelity will let you trade their most successful ETFs for free – presumably because they don’t really need the commission.
Disclosure – INVESTMENT AND INSURANCE PRODUCTS ARE: NOT A DEPOSIT • NOT FDIC INSURED • NO BANK GUARANTEE • MAY LOSE VALUE
Summary
If you’re looking for an investment vehicle falling somewhere between your boring retirement account and your exciting individual stock purchases, ETFs are an excellent choice. And now that the big funds are waiving commissions on their top-performing ETFs, there’s never been a better time to dive into the world of ETFs and inject some low- to mid-risk into your portfolio.
ETFs are also an excellent investment if you’re looking to multiply your money and cash out within 2 to 10 years. You can even leave your ETF investment until retirement, if you want, so it has plenty of time to multiply under compound interest.
Not all ETFs are made the same, however – and the SEC has approved some stinkers over the years, for sure. These ETFs, on the other hand, are universally considered top-ranked and well-supported within the investor community – and are a superb place to start.
When I told readers that January would be “back to basics” month at Get Rich Slowly, the number-one request I received was to write about how to invest.
Rather than scatter investing info throughout the month, I decided to collect the essentials into one mammoth article. Here it is: all you need to know about how to invest — even if you’re a beginner.
In writing this article, I tried not to bog it down with jargon and definitions. (I’m sure I let some of that slip through the cracks, though. I apologize.) Nor did I dive deep. Instead, I aimed to share the basic info you need to get started with investing.
What follows are eight simple rules for how to invest. And in the end, I’ll show you how to put these rules into practice. First, let’s dispel some popular misconceptions.
Investing isn’t Gambling — and It isn’t Magic either
Investing scares many people. The subject seems complicated and mysterious, almost magical. Or maybe it seems like gambling. When the average person meets with his financial adviser, it’s often easiest to sit still, smile, and nod.
One of the problems is that the investing world is filled with jargon. What are commodities? What’s alpha? An expense ratio? How do bonds differ from stocks? And sometimes, familiar terms – such as risk – mean something altogether different on Wall Street than they do on Main Street.
Plus, we’re bombarded by conflicting opinions. Everywhere you look, there’s a financial expert who’s convinced she’s right. There’s a never-ending flood of opinions about how to invest, and many of them are contradictory. One guru says to buy real estate, another says to buy gold. Your cousin got rich with Bitcoin. One pundit argues that the stock market is headed for record highs, while her partner says we’re due for a “correction”. Who should you believe?
Perhaps the biggest problem is complexity – or perceived complexity. To survive and seem useful, the financial services industry has created an aura of mystery around investing, and then offered itself as a light in the darkness. (How convenient!) As amateurs, it’s easy to buy into the idea that we need somebody to lead us through the jungle of finance.
Here’s the truth: Investing doesn’t have to be difficult. Investing is not gambling, and it’s not magic.
You are perfectly capable of learning how to invest. In fact, it’s likely that — even if you know nothing right now — you can earn better investment returns than 80% of the population without any scammy tricks or expensive tips sheets.
Today, I want to convince you that if you keep things simple, you can do your own investing and receive above-average returns – all with a minimum of work and worry. Sound good? Great! Let’s learn how to invest.
Table of Contents
Investing rule #1: Get started
Investing rule #2: Think long-term
Investing rule #3: Spread the risk
Investing rule #4: Keep costs low
Investing rule #5: Keep it simple
Investing rule #6: Make it automatic
Investing rule #7: Ignore the noise
Investing rule #8: Conduct an annual review
Investing Rule #1: Get Started
The first thing you need to know about investing is that you should start today. It doesn’t matter how much money you have. What matters is getting started — then making it a habit. There are many investment apps out there that make investing easier than ever.
“The amount of [money] you start with is not nearly as important as getting started early,” writes Burton Malkiel in The Random Walk Guide to Investing, which is an excellent beginner’s book on how to invest. “Procrastination is the natural assassin of opportunity. Every year you put off investing makes your ultimate retirement goals more difficult to achieve.”
The secret to getting rich slowly, he says, is the extraordinary power of compound interest. Given enough time, even modest stock market gains can generate real wealth.
As you’ll recall from your junior high math class, compounding is the snowball-like growth that occurs as the interest (or other return) from an investment generates more interest. Let’s look at some examples.
If you make a one-time contribution of $5000 to a retirement account and receive an 8% annual return, you’ll earn $400 during the first year, giving you a total of $5400.
During the second year, you’ll receive 8% not only on the initial $5000, but also on the $400 in investment returns from the first year, for total earnings of $432.
In the third year, you’ll earn returns of $466.56. And so on.
After ten years of receiving an 8% annual return, your initial $5000 will have more than doubled to $10,794.62!
Compounding is powerful, but it needs time to work its magic. The longer you wait to begin investing, the less time your money has to grow.
Assume you a one-time $5000 contribution to your retirement account at age twenty. And assume that your account somehow manages to earn an 8% annual return every year. If you never touch the money, your $5000 will grow to $159,602.25 by the time you’re 65 years old. But if you wait until you’re forty to make that single investment, your $5000 would only grow to $34,242.38.
The power of compounding can be accentuated through regular investments. It’s great that a single $5000 investment can grow to nearly $160,000 in 45 years, but it’s even more exciting to see what happens when you make saving a habit. If you were to invest $5000 annually for 45 years, and if you left the money to earn an 8% annual return, your savings would total over $1.93 million. A golden nest egg indeed! You’d have more than eight times the amount you contributed.
This is the power of compounding.
It’s human nature to procrastinate. A lot of people put off investing for retirement (and other goals) because they get distracted by the demands of daily life. (Studies show that only about half of Americans have money in the stock market.) “I can start saving next year,” they tell themselves. But the costs of delaying are enormous. Even one year makes a difference.
The following chart illustrates the cost of procrastination.
If, starting when you’re twenty, you invest $5000 per year and receive an 8% return, your account would have $1,932,528.09 when you’re 65 years old. But if you wait even five years, you’d have to increase your annual contributions to nearly $7500 to have that same amount by age 65. And if you were to wait until you were forty to begin investing, you’d have to contribute over $25,000 per year to hit the same target!
When investing, time is your friend. Start as soon as you can. Tomorrow is good. Today is better. (You can’t invest yesterday, so now will have to do.)
True story: For a brilliant example of compounding in real life, turn to American statesman Benjamin Franklin. When he died in 1790, Franklin left the equivalent of $4400 to each of two cities, Boston and Philadelphia. But his gift came with strings attached. The money had to be loaned out to young married couples at five percent interest. What’s more, the cities couldn’t access the funds until 1890 – and they couldn’t have full access until 1990. Two hundred years later, Franklin’s $8800 bequest had grown to more than $6.5 million between the two cities! True story.
Investing Rule #2: Think Long-Term
A lot of people have the mistaken idea that investing requires following daily stock market movement, then buying and selling stocks frequently. That’s how it’s done in the movies, but you know what? People who invest like that actually tend to make less than the people who do nothing. I’m not making this up.
Smart investing is a waiting game.
It takes time – think decades, not years – for compounding to do its thing. But there’s another reason to take the long view.
In the short term, investment returns fluctuate. The price of a stock might be $90 per share one day and $85 per share the next. And a week later, the price could soar to $120 per share. Bond prices fluctuate too, albeit more slowly. And yes, even the returns you earn on your savings account change with time. (High-interest savings accounts yielded five percent annually in the U.S. just a few years ago; today, the best savings accounts yield about 1.5%.)
Short-term returns aren’t an accurate indicator of long-term performance. What a stock or fund did last year doesn’t tell you much about what it’ll do during the next decade.
In Stocks for the Long Run, Jeremy Siegel analyzed the historical performance of several types of investments. Siegel’s research showed that, for the period between 1926 and 2006 (when he wrote the book):
Stocks produced an average real return (or after-inflation return) of 6.8% per year.
Long-term government bonds produced an average real return of 2.4%.
Gold produced an average real return of 1.2%.
My own calculations – and those of Consumer Reports magazine – show that real estate returns even less than gold over the long term.
Although stocks tend to provide handsome returns over the long term, they come with a lot of risk in the short term. From day to day, the price of any given stock can rise or fall sharply. Some days, the price of many stocks will rise or fall sharply at the same time, causing wild movement in entire stock-market indexes.
Even over one-year time spans, the stock market is volatile. While the average stock-market return over the past 80 years was about 10% (about 7% after inflation), the actual return in any given year can be much higher or lower. In 2008, U.S. stocks dropped 37%; in 2013, they jumped over 32%.
Here’s a table showing the rise and fall of the S&P 500 index over a fifteen-year timespan. Looks like a roller coast, right?
During any one-year period, stocks will outperform bonds only 60% of the time. But over ten-year periods, that number jumps to 80%. And over thirty years, stocks almost always win.
Despite the stock market’s ongoing wins, the average person almost always underperforms the market as a whole. Even investment professionals tend to underperform the market.
During the 20-year period ending in 2012, the S&P 500 returned an average 8.21%. The average investor in stock-market mutual funds only earned 4.25%. Why? Because they tended to panic and sell when prices dropped, and then bought back in as prices rose – just the opposite of the “buy low, sell high” advice we’ve all heard.
Investing is a game of years, not months.
Don’t let wild market movements make you nervous. And don’t let them make you irrationally exuberant either. What your investments did this year is far less important than what they’ll do over the next decade (or two, or three). Don’t let one year panic you, and don’t chase after the latest hot investments. Stick to your long-term plan.
Investing Rule #3: Spread the Risk
While the stock market as a whole returns a long-term average of ten percent per year, individual stocks experience drastically different fortunes. In 2013, the S&P 500 index grew 29.60%. But some of the 500 companies that made up the index did much better than others. Stock in Netflix (NFLX) soared 297.06%. Best Buy (BBY) was up 237.64% and Delta Airlines up 130.33%. Meanwhile, Newmont Mining (NEM) dropped 51.16% and Teradata (TDC) fell 27.18%.
To smooth the market’s wild ups and downs, smart investors spread their money around. Surprisingly, studies show that while diversification reduces risk, it doesn’t affect average performance much — if at all. (For more info, check out this guide to diversification from the U.S. Securities and Exchange Commission.)
Buying individual stocks isn’t really investing — it’s gambling. I know this from experience. In the past, I thought I could outsmart the market. In 2000, enamored by the PalmPilot, I bought shares of the company that made the devices. I paid close to $90 per share. Just over a year later, the shares had lost 90% of their value. (I made similar mistakes with The Sharper Image and Countrywide Financial.)
By owning more than one stock, you reduce your risk. If you have ten stocks and one of them tanks, the damage isn’t as bad because you still own nine others. True, you don’t reap all of the rewards if a stock skyrockets like Netflix did in 2013, but the smoother ride is generally worth it.
Investors also reduce risk by owning more than one type of investment. As we’ve seen, over the long term stocks are better investments than bonds or gold or real estate. But over the short term, stocks only outperform bonds about two-thirds of the time. Because the prices of stocks and bonds move independently of each other, investors can reduce risk by owning a mix of both.
One popular guideline is to base how much you put into bonds on your age. If you’re 35 years old, put 35% into bonds and 65% into stocks. If you’re 53, put 53% into bonds and 47% into stocks. This is a fine starting point for the average investor.
One of the best ways to spread risk when investing is through the use of mutual funds.
Mutual funds are collections of investments. They let people like you and me pool our money to buy small pieces of many companies all at once. Imagine, for instance, the hypothetical Awesome Fund, which invests in fifty different stocks and ten different corporate bonds. By buying one share of the Awesome Fund, You, Inc. would have a piece of sixty different investments. If one goes bust, the damage is minimized.
Mutual funds make diversification easy by letting you own shares in many companies at once. Plus, when you own a mutual fund, somebody else does the research and buys and sells the stocks so you don’t have to.
Because mutual funds offer great advantages to individual investors, they’ve soared in popularity over the past 30 years. But they’re not without drawbacks.
Investing Rule #4: Keep Costs Low
The biggest drawback to mutual funds is their cost. With stocks and bonds, you usually only pay when you buy and sell. But with mutual funds, there are ongoing costs built into the funds. (You don’t pay these costs directly; instead, they’re subtracted from the fund’s total return.) Some of these costs are obvious, but others aren’t.
All together, mutual-fund costs typically run about 2% annually. So for every $1,000 you invest in mutual funds, $20 gets taken out of your return each year. (On average.) This may not seem like much, but 2% is huge when it comes to investments.
In fact, according to a 2002 study by Financial Research Corporation, the best way to predict a mutual fund’s future performance was to compare its expense ratio with similar funds. Mutual funds with lower fees tend to have better performance. Again and again, other studies have found the same thing.
In his book Your Money & Your Brain, Jason Zweig notes:
“Decades of rigorous research have proven that the single most critical factor in the future performance of a mutual fund is that small, relatively static number: its fees and expenses. Hot performance comes and goes, but expenses never go away.”
There are a couple of reasons mutual funds are so expensive.
First, most funds are run by a team of people who research opportunities, buy and sell individual investments, and do other work necessary to maintain the fund. These “actively managed” funds subtract their operating costs from whatever money they earn (or lose) for their investors.
Many funds also carry a “load”, which is a one-time sales charge or commission. These loads are generally around five percent. Think about that. When you purchase a mutual fund with a load, you’re basically agreeing to handicap yourself by five percent before you even begin to run the investment race. That doesn’t sound like a smart investment to me!
Fortunately, there’s an alternative to these expensive actively managed funds. Some funds are “passively managed”.
Passively managed funds – also called index funds – try to mimic the performance of a specific benchmark, like the Dow Jones Industrial Average or S&P 500 stock-market indexes. Because these funds try to match (or index) a benchmark and not beat it, they don’t require much intervention from the fund manager and her staff, which means their costs are much lower.
The average actively managed mutual fund has a total of about 2% in costs, whereas a typical passive index fund’s costs average only about 0.25%. So, to come out ahead on a passively managed fund, the average fund manager doesn’t just have to beat his benchmark index — he has to beat it by 1.75%! And since both types of funds — active and passive — earn market-average returns before expenses, investors who own actively managed funds typically earn 1.75% less than those who own index funds!
Although this 1.75% difference in costs between actively and passively managed mutual funds may not seem like much, there’s a growing body of research that says it makes a huge difference in long-term investment results.
Further reading: If you’re a math nerd and want to see all the calculations and proof as to why index funds do better than actively-managed fund, check out this short (but dense) paper from Stanford professor William Sharpe: “The Arithmetic of Active Management”.
Investing Rule #5: Keep It Simple
Index funds offer another great advantage for individual investors like you and me.
Instead of owning maybe twenty or fifty stocks, an index fund owns the entire market. (Or, if it’s an index fund that tracks a specific portion of the market, they own that portion of the market.) For example, an index fund like Vanguard’s VFINX, which attempts to track the S&P 500 stock-market index, owns all of the stocks in S&P 500 and in the same proportions as they exist in the market.
The bottom line is this: The only investments you need to hold are index funds. They provide lower risk, lower costs, and lower taxes than stocks or actively managed mutual funds. Yet they provide the same returns as the market as a whole.
I’m not the only one who believes this. Over the past twenty years, many intelligent investors have come to this same conclusion. In fact, the greatest investor of all time — Warren Buffett — has publicly and repeatedly argued that 99% of people should be invested in index funds.
Still, there many different index funds from which to choose. Plus, how many should you own? As always, it pays to keep things simple.
One good way to get started is to use a lazy portfolio, a balanced collection of index funds designed to do well in most market conditions with a minimum of fiddling from you. Think of them as recipes: A basic bread recipe contains flour, water, yeast, and salt, but you can build on it to get as elaborate as you’d like.
This two-fund portfolio from financial columnist Scott Burns may be the simplest way to achieve balance. He calls it his “couch potato portfolio”. It’s evenly split between stocks and bonds:
50% Vanguard 500 Index (VFINX)
50% Vanguard Total Bond Market Index (VBMFX)
Burns has also created a “couch potato cookbook” that lists several different lazy portfolios and answers some common questions.
In his book How a Second Grader Beats Wall Street, Allan Roth (no relation to your humble author) explains how he taught his son how to invest. He used this lazy portfolio:
40% Vanguard Total Bond Market Index (VBMFX)
40% Vanguard Total Stock Market Index (VTSMX)
20% Vanguard Total International Stock Index (VGTSX)
This is the medium-risk version of Roth’s second-grader portfolio. For higher risk, you’d put 10% into bonds, 60% into American. stocks, and 30% into international stocks. A lower-risk allocation would be 70% in bonds, 20% in American stocks, and 10% in foreign stocks.
Though I’m a passive investor, I don’t actually use a lazy portfolio. But if I were to use one, it’d follow three simple rules. First, I’d want the bond portion to equal my age. Second, I’d want 10% in real estate to spread risk a little more. And third, I’d want the stock portion to be two-thirds American stocks and one-third international stocks. Since I’m 48 years old, it’d look like this:
48% Vanguard Total Bond Market Index (VBMFX)
28% Vanguard Total Stock Market Index (VTSMX)
14% Vanguard Total International Stock Index (VGSTX)
10% Vanguard REIT Index (VGSIX)
This lazy portfolio changes with your age, which I like. It takes on more risk when you’re younger and then eases into bonds as you get older.
These are just a few suggestions. There are scores of index funds out there, and countless ways to build portfolios around them. In fact, there’s a subculture of investors who love lazy portfolios. You can read more about lazy portfolios at sites like Bogleheads and Marketwatch.
There’s no one right approach to index-fund investing. Yes, it’s simple, but you can spend a long time deciding which asset allocation is right for you. While it’s important to do the research and educate yourself, you probably shouldn’t spend too much time sweating over which choice is “best.” Just pick one and get started. You can always make changes later.
Investing Rule #6: Make It Automatic
After you’ve set up your investment account, it’s time to remove the human element from the equation. As always, you should do what it can to automate good behavior.
If you plan to do all your investing through your employer’s retirement plan, it’s easy to get started. Contact HR to have retirement contributions automatically taken out of your paycheck. You should at least contribute as much as your employer matches. But remember: The more you contribute, the sooner you’ll reach the goals in your personal action plan. Funnel as much profit as possible into investing for the future.
Many company plans don’t offer index funds. In that case, find funds that have low costs and are widely diversified. So-called lifecycle or “target-date” funds are often an okay backup option. If your employer-sponsored plan doesn’t offer a lot of choices, ask HR if it’s possible to get more. They might say “no,” but then again, they might expand the company’s menu of mutual funds. It never hurts to ask!
If you plan to invest on your own — whether instead of or in addition to investing through your company’s plan — contact the mutual fund companies directly instead of going through a broker. Three of the larger no-load mutual fund companies are:
If you’re just learning how to invest, you should probably pick one company and stick with it; that’ll make things easier because you’ll be able to track all your investments in one place. Vanguard is probably the most popular company for passive investors. Personally, I use Fidelity. T. Rowe Price is fine too.
For a more detailed discussion of how to automate your investing, pick up a copy of David Bach’s The Automatic Millionaire.
Investing Rule #7: Ignore the Noise
As you’re learning how to invest, one important skill to master is ignoring all of the noise. Ignore the news. Ignore your friends. Ignore everyone. Make a plan. Put that plan into action. Make it automatic. Then forget about it. Seriously, this is the secret to investing success.
People tend to pour money into stocks in the middle of bull markets — after the stocks have been rising for some time. Speculators pile on, afraid to miss out. Then they panic and bail out after the stock market has started to drop. By buying high and selling low, they lose a good chunk of change.
It’s better to buck the trend. Follow the advice of Warren Buffett, the world’s greatest investor: “Be fearful when others are greedy, and be greedy when others are fearful.”
In his 1997 letter to Berkshire Hathaway shareholders Buffett — the company’s chairman and CEO — made a brilliant analogy: “If you plan to eat hamburgers throughout your life and are not a cattle producer, should you wish for higher or lower prices for beef?” You want lower prices, of course: If you’re going to eat lots of burgers over the next 30 years, you want to buy them cheap.
Buffett completes his analogy by asking, “If you expect to be a net saver during the next five years, should you hope for a higher or lower stock market during that period?”
Even though they’re decades away from retirement, most investors get excited when stock prices rise (and panic when they fall). Buffett points out that this is the equivalent of rejoicing because they’re paying more for hamburgers, which doesn’t make any sense: “Only those who will [sell] in the near future should be happy at seeing stocks rise.” He’s driving home the age-old wisdom to buy low and sell high.
Following this advice can be tough. For one thing, it goes against your gut. When stocks have fallen, the last thing you want to do is buy more. Besides, how do you know the market is near its peak or its bottom? The truth is you don’t. The best solution is to make regular, planned investments — no matter whether the market is high or low.
Meanwhile, ignore the financial news.
In Why Smart People Make Big Money Mistakes, Gary Belsky and Thomas Gilovich cite a Harvard study of investing habits. The results?
“Investors who received no news performed better than those who received a constant stream of information, good or bad. In fact, among investors who were trading [a volatile stock], those who remained in the dark earned more than twice as much money as those whose trades were influenced by the media.”
Though it may seem reckless to ignore financial news, it’s not: If you’re saving for retirement 20 or 30 years down the road, today’s financial news is mostly irrelevant. So make decisions based on your personal financial goals, not on whether the market jumped or dropped today.
Investing Rule #8: Conduct an Annual Review
During a given year, some of your investments will have higher returns than others. For example, if you started the year with 60% in stocks and 40% in bonds, you may find that you now have 66% in stocks and 34% in bonds. What’s more, your goals may have changed, or you might discover you can’t stomach as much risk as you thought you could (this happened to a lot of folks in 2008).
To compensate, rebalance your investments at the end of each year. This simply means you should shift money around so your assets are allocated the way you want them to be. Doing this is another way to take the emotion out of investing.
There are two ways to rebalance.
You can sell your winners and buy your losers. By selling the investments that have grown and buying those that lag behind, you’re buying low and selling high, just as you should. Be aware, though, that you might owe taxes if you go this route, so check out the tax implications before you sell any securities.
If you can afford it, contribute new money to your investment account, but only to buy the assets that need to catch up. By doing this, you don’t have to worry about taxes, but you’ll need some cash on hand.
Though many investment professionals swear by rebalancing, there’s some research that shows it’s not as important as people once thought. In The Little Book of Common Sense Investing, John Bogle writes, “Rebalancing is a personal choice, not a choice that statistics can validate. There’s nothing the matter with doing it…but also no reason to slavishly worry about small changes…” In other words: Rebalance if your asset allocation is way out of line but don’t worry about small changes — especially if you’d end up paying a lot of fees by rebalancing.
The Bottom Line
In this article, you’ve learned that the stock market provides excellent long-term returns, and that you can do better than 95% of individual investors by putting your money into index funds. But how do you put this knowledge to work? What’s the best way to take advantage of the things you’ve learned?
The answer is shockingly simple: To get started investing, set up automatic investments into a portfolio of index funds. Here’s how:
Put as much as you can into investment accounts – as soon as possible. Fund tax-advantaged accounts (such as retirement accounts) before taxable accounts.
Invest in a low-cost stock index fund, such as Vanguard’s Total Stock Market Index Fund (VTSMX) or Fidelity’s Spartan Total Market Index Fund (FSTMX).
If the stock market makes you nervous, or you want to spread the risk, put some of your money into a bond fund like Vanguard’s Total Bond Market Index Fund (VBMFX) or Fidelity’s Total Bond Market Index Fund (FTBFX).
If you want diversification with less work, invest in a low-cost combo fund like Vanguard’s STAR Fund (VGSTX) or Fidelity’s Four-in-One Index Fund (FFNOX).
After that, ignore the news no matter how exciting or scary things get. Once a year, go through your investments to be sure your investments still match your goals. Then continue to put as much as you can into the market—and let time take care of the rest.
That’s it. That’s how to invest so that you earn great returns without stress and worry. Seriously. Do this and you should outperform most other individual investors over the long term.
This strategy isn’t just great for investing novices. Even market professionals endorse it. In his 2013 letter to shareholders, for instance, Warren Buffett outlined what will happen to his vast wealth when he dies. Most of it will go to charity; some will go to his wife. How will his wife’s money be handled?
“My advice to the trustee couldn’t be more simple: Put 10% of the cash in short-term government bonds and 90% in a very low-cost S&P 500 index fund. (I suggest Vanguard’s.) I believe the trust’s long-term results from this policy will be superior to those attained by most investors…”
Are there other investment strategies that might provide similar returns? Sure. But these approaches also require greater education, sophistication, and attention on the part of the investor.
Unless you know for a certainty that you have this knowledge, sophistication, and attention, you’re better off sticking with index funds.
Footnote: How I Invest
Do I practice what I preach? You bet! All of my money is in index funds and individual bonds. Here are my top four holdings as of today:
That gives me an overall asset allocation that looks like this:
I’m 48 years old and have 80% of my portfolio in stocks, 10% in bonds, and 10% in other investments. I do still own 1115 shares of now-worthless Sharper Image stock. I keep it to remind me of my past stupidity.
One of my personal goals over the next few years is to gain the knowledge and sophistication necessary to dabble in other forms of investing. (I believe I have the mindset already.) For now, I’m content heeding Warren Buffett’s advice. It’s served me well.
The yield on the 2-year Treasury note continued to decline last week and finished the week at a lower yield than at the start of 2009. The fact the 2-year Treasury yield is now lower on a year-to-date basis is startling considering the robust performance of riskier investments such as Corporate Bonds, High-Yield Bonds, Commodities, and even stocks. On the surface, a new low for the year on the 2-year note would indicate a budding flight-to-safety rally. However, there are several rational reasons for the drop in 2-year Treasury yields, none of which are related to heightened risk aversion among investors about a renewed economic downturn.
T-Bill Supply Reduction
The most dominant factor has been a notable reduction in T-bill supply. In mid-September the Treasury announced it was not going to re-issue $185 billion in maturing T-bills originally issued as part of the Supplementary Financing Program (SFP). The SFP was launched during the fourth quarter of 2008 to assist bond market liquidity during the height of the financial crisis. With bond market liquidity vastly improved and the Treasury Department looking to extend the average maturity of outstanding debt, the Treasury decided to let all but $15 billion of SFP T-bills simply mature. The result was a 10% reduction of the T-bill market as the last SFP T-bill matured in late October.
The drop in supply comes at the wrong time as we approach year-end funding needs. As year-end approaches, banks and other institutions prepare to tidy up balance sheets by purchasing T-bills and other high quality short-term investments. To avoid illiquid trading conditions over the holidays, this process often begins before Thanksgiving. The commercial paper market, essentially the corporate version of a T-bill, is substantially reduced as a result of de-leveraging and disappearance of special purpose financing vehicles (SPVs), thereby leaving a greater-than-usual emphasis on T-bills as the vehicle of choice. Demand to fund over year-end is already reflected in zero yields on all T-bills that mature in January. Additionally, money market assets have decreased, but at $3.3 trillion they represent a hefty source of steady buying power.
The Fed is Your Friend
A friendly Federal Reserve has also been a key driver of the 2-year yield. The Fed continues to emphasize the “extended period” language when referring to the Fed funds rate. Last week, Fed Chairman Ben Bernanke, speaking before the NY Economic Club, once again reiterated that the Fed funds rate would remain low for an “extended period”. His remarks made absolutely no reference to the removal of monetary stimulus or taking steps to more proactively reduce cash in the financial system.
Most Fed speakers have reiterated Bernanke’s message with cautious remarks about removing stimulus too soon. Recently, St. Louis Fed President Bullard suggested the Fed may wish to keep the option open on bond purchase programs beyond March 2010 and when asked about timing for the first rate increase, Chicago Fed President Evans remarked “into at least the middle of 2010,” and the fi rst increase might not come until “late 2010, perhaps later in terms of 2011.” Fed fund futures pricing, one of the better gauges of Fed rate expectations, indicate the first rate increase will come at the September FOMC meeting. Previously Fed fund futures indicated the first rate increase would occur at the June FOMC meeting.
Where’s the Two Year Rate?
The decline of the 2-year note yield to 0.73% still keeps it in a range we roughly consider fair value. The 2-year maintains a tight relationship with the target Fed funds rate. Typically, when the Fed is on hold, the 2-year yield has traded 0.50% to 1.00% above the Fed funds rate. With target Fed funds currently 0.0% to 0.25%, the current 2-year yield is roughly in line with historical ranges. It is not uncommon for the 2-year yield to be lower than the Fed funds rate when the market expects a rate reduction. Although there is clearly no room for a lower Fed funds rate, the 2-year yield could drop further if the market truly believed that the economy was weakening again or that other monetary stimulus was forthcoming.
Domestic banks and foreign central banks have also played roles in a lower 2-year Treasury yield. Weak loan demand has left domestic banks with excess money reserves. With cash yielding next to nothing, banks are investing in longer-term securities such as the 2-year note. Short-term securities are much less sensitive to interest rate changes and when the Fed emphasizes it is on hold for longer, the risk in holding such a position is reduced.
Foreign central banks have purchased 2-year Treasuries as part of a renewed effort in currency intervention. The decline in the US dollar to its lowest point of the year has prompted concern from foreign governments whose economies are dependent on exports to the U.S. Foreign governments, via their central banks, have recently attempted to prop up the dollar via the purchase of short-term Treasuries.
The decline in the 2-year Treasury note yield to levels witnessed during the peak of the financial crisis has certainly caught the attention of investors. The drop in the 2-year yield has been particularly notable given the strong performance of riskier investments in 2009. However, several factors including a decline in T-bill supply, the Fed reiterating its “extended period” message, excess bank reserves, and foreign buying, have worked together to push the 2-year to its lowest levels of the past 12 months. These factors, and not a renewed flight-to-safety buying on renewed economic worries, have been responsible for the drop in 2-year Treasury yields.
IMPORTANT DISCLOSURES
This was prepared by LPL Financial. The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. To determine which investment(s) may be appropriate for you,
consult your financial advisor prior to investing. All performance reference is historical and is no guarantee of future results. All indices are unmanaged and cannot be invested into directly.
Government bonds and Treasury Bills are guaranteed by the U.S. government as to the timely payment of principal and interest and, if held to maturity, offer a fixed rate of return and fixed principal value. However, the value of funds shares is not guaranteed and will fluctuate.
The market value of corporate bonds will fluctuate, and if the bond is sold prior to maturity, the investor’s yield may differ from the advertised yield.
Bonds are subject to market and interest rate risk if sold prior to maturity. Bond values will decline as interest rates rise and are subject to availability and change in price.
High yield/junk bonds are not investment grade securities, involve substantial risks and generally should be part of the diversified portfolio of sophisticated investors.
Mortgage-Backed Securities are subject to credit risk, default risk, prepayment risk that acts much like call risk when you get your principal back sooner than the stated maturity, extension risk, the opposite of prepayment
risk, and interest rate risk.
Municipal bonds are subject to availability, price and to market and interest rate risk is sold prior to maturity.
Bond values will decline as interest rate rise. Interest income may be subject to the alternative minimum tax.
Federally tax-free but other state and local taxed may apply.
The fast price swings of commodities will result in significant volatility in an investor’s holdings.
Stock investing involves risk including possible loss of principal.
A common misbelief is that one must be rich to invest. It’s easy to invest with little money in a variety of assets and save for your goals. More platforms let you “micro invest” and purchase small amounts of expensive assets.
Even if you only invest a few dollars each month, that money can start building wealth.
Consistently investing small amounts can be more effective than waiting to accumulate a lump sum because you can earn compound interest.
Some people may never invest because they don’t think they have enough money.
In This Article
Best Ways to Start Investing with Little Money
It’s possible to invest as little as $5 at a time and diversify your portfolio. As your financial situation improves, you can increase your monthly investments and try more ideas.
1. Invest in Index Funds
Investing in index funds can be the best option to start investing small amounts of money.
First, index funds let you invest in hundreds of companies with a single investment to quickly diversify your portfolio and minimize risk.
Second, most index funds have low investing fees and expense ratios. For example, a fund with a 0.03% expense ratio costs 30 cents in annual fees.
Most brokers don’t charge trade commissions to buy or sell index funds. Paying fewer fees means you can invest more cash.
Some of the types of index funds you can invest in include:
US stocks
International stocks
Emerging markets
Corporate bonds
Government bonds
Real estate investment trusts (REITs)
The various online stock brokers offer stock and bond index exchange-traded funds (ETFs). These funds trade like individual stocks. The share price fluctuates during the market day and you can buy shares at any time.
Your 401k provider likely offers index mutual funds. The investing strategy is the same except the share price updates once a day after the stock market closes.
Most online brokers offer index funds and don’t charge any trade commissions. However, some can be easier to invest with when you have little money.
Minimum Investment: $5 (varies by broker)
Betterment
Using a robo-advisor like Betterment can be one of the easiest ways to invest in index funds. This fully-automated investing app automatically rebalances your portfolio to maintain your target asset allocation.
You can also enable tax-loss harvesting to minimize your taxable investment income by selling investment losses to offset your investment gains.
You will answer several questions about your age, investment goals and risk tolerance to recommend an investment portfolio of stock and bond index ETFs.
As you grow older, Betterment shifts your portfolio to a more conservative allocation.
Not having to manage your portfolio is one advantage of using a robo-advisor when you don’t have the time or desire to self-manage your investments.
Betterment also offers fractional investing so you can buy partial shares of funds to instantly diversify your portfolio.
Other brokers may require you to buy whole shares which makes buying multiple funds at once difficult if you have limited funds.
You can create a portfolio with $0 and start investing with a $10 initial deposit. The annual account fee for Betterment is 0.25% of your portfolio value.
Acorns
Another unique way to invest in index funds is by using Acorns. This micro-investing app invests your spare change by rounding up your debit and credit card purchases.
You can choose to invest in a premade portfolio of stocks and bonds with different risk levels.
Acorns buys fractional shares of index ETFs when with as little as $5. Taxable and retirement investment accounts are available along with an online checking account.
Monthly plan fees range between $1 and $5 per month.
2. Workplace Retirement Accounts
A workplace retirement account such as a 401k, 403b or a Thrift Savings Plan (TSP), this can be the best place to start investing with little money. See if your employer offers matching contributions. If so, invest enough each month to earn the full match and invest “free money.”
If your workplace doesn’t offer a retirement plan or matching contributions, you can open an individual retirement account (IRA). Most brokers offer IRAs with no account fees or minimum initial deposits. You have multiple investment options.
One perk of investing with a retirement account is the tax benefits. You only pay taxes once. Traditional contributions reduce your current annual income, grow tax-deferred and you pay income taxes when you make a withdrawal. Roth contributions require you to pay income taxes upfront but your withdrawals are tax-free.
Your workplace retirement account investment options can include:
Stock index mutual funds
Bond index mutual funds
Target date funds
Company stock
The investment options are different for each employer yet most plans offer target date funds. Choosing a target date fund that’s nearest to your planned retirement year can be a good option. The fund invests in stocks and bonds and adjusts to a conservative risk tolerance as retirement approaches.
If you only decide to invest in a target date fund, you won’t have to rebalance your asset allocation. However, you should monitor the target date fund performance. You may also decide to self-manage your portfolio by buying index funds to reduce your investment fees.
You can invest as little as $1 at a time into each fund. If you’re uncomfortable managing your own retirement account, Blooom can provide a free portfolio analysis and recommend a portfolio allocation.
Minimum investment: $1
3. Individual Stocks
After establishing an index fund portfolio, you may decide to buy stock in individual companies. There are many online brokers to choose from and most don’t charge account fees or trade commissions to buy or sell shares.
You may decide to buy dividend-paying stocks to earn consistent passive income. Another option is holding companies with strong growth potential that can beat the stock market but may not pay a dividend.
M1 Finance is one of the best free investing apps. You can buy fractional shares of stocks and ETFs with a minimum $25 investment. There are also premade ETF portfolios that can make it easier to diversify. As you invest new money, M1 rebalances your asset allocation.
The minimum initial deposit is $100 for taxable accounts and $500 for retirement accounts to start using M1 Finance.
You can also consider investing with Charles Schwab. You can buy fractional stock slices as small as $5 for many stocks and there are no trade fees or account minimums. But, you will need to self-manage your investment portfolio.
Minimum investment: $5
Tip: Using one of the top investment sites can make it easier to research stocks.
4. Crowdfunded Real Estate
Real estate is a longstanding way to earn passive income without relying on the stock market. However, owning investment properties is expensive and can be time-consuming.
Thanks to real estate crowdfunding, you can invest small amounts of money into commercial and multi-family real estate. These properties have multiple tenants and can provide a more stable income than a single-family rental property. A property manager screens the tenants, collects rent and makes repairs.
You can earn recurring dividends from monthly rent payments. It’s also possible to make money when a property sells for a higher value than the original purchase price.
DiversyFund is one of the best crowdfunding platforms. You can start investing as little as $500. The Growth REIT lets you invest in multifamily apartments across the United States.
One downside of crowdfunded real estate is the multi-year investment commitment. Most platforms require a five-year investment to avoid early redemption fees. As a tradeoff for the long-term commitment, you can earn annual returns that compete with the historical S&P 500 average return of 7% per year.
Minimum investment: $500
5. Small Business Bonds
The bond index funds you invest in hold corporate and government debt. Investing in small business bonds can help you earn a higher yield. Worthy Bonds yield 5% per year and let you invest as little as $10 at a time.
Each bond matures in 36 months but you can sell your position sooner with no early withdrawal penalty.
Read our Worthy Bonds review to learn more.
Minimum investment: $10
6. High-Yield Savings Accounts
It’s wise to keep cash that you need instant access to in a high-yield savings account. Banks are a low-risk way to earn passive income but your returns are not as high.
You might consider keeping your emergency fund in a high-yield savings account that doesn’t charge any account fees. Also, consider opening separate “sinking fund” accounts for various savings goals to avoid borrowing money. A savings account can also be a good place to park cash until you decide where to invest it and earn a higher potential return.
Ally Bank has a competitive interest rate for the high-yield savings account. There are no account fees or minimum balance requirements. The Surprise Savings booster tool can help you calculate a “safe-to-spend” amount and transfer your extra cash into savings.
Minimum investment: $1
7. Certificates of Deposit
Investing in stocks and bonds can provide higher investment returns but carry more risk. A bank certificate of deposit locks in a specific interest rate for the investment term. For example, a 12-month term CD has the same interest rate for the next 12 months.
Instead of keeping your free cash in an interest-bearing savings account, consider opening a bank CD with a similar or higher interest rate.
If the savings account interest rate drops, the CD can earn more interest until the CD matures. Most CDs have early redemption penalties if you withdraw the cash before the term ends. At the end of the term, you can redeem your CD balance penalty-free or renew the CD at the then-current term.
Some banks, including CIT Bank, offer no-penalty CDs. These CDs don’t charge an early withdrawal penalty but may offer lower yields than a term CD.
As bank interest rates are low, the passive income you earn from CDs can be lower than the inflation rate. But earning some interest income can be better than nothing.
Minimum investment: $100
8. Peer-to-Peer Investing
You earn income from savings accounts and bank CDs as the bank lends your money at a higher interest rate. Peer-to-peer lending platforms let you earn a higher rate as you lend directly to the borrower and bypass the bank.
Prosper lets you invest in crowdfunded personal loans with a three-year or five-year repayment term. Borrowers make monthly payments and you make money from the interest payment, minus a 1% service fee. The historical annual returns are between 3.5% and 7.6%.
You can lose money if the borrower defaults on the loan. To avoid losing money, Prosper lets you buy notes in $25 increments and recommends a $2,500 initial investment to properly diversify. You can invest in multiple loans to diversify your portfolio.
Prosper also assigns each borrower a risk rating and you can see basic credit profile details. There’s also an auto-invest feature that spreads your investment across multiple risk ratings. You might be able to easily diversify your portfolio by auto-investing and avoid investing in too many risky loans.
Minimum investment: $25
9. Physical Gold
Precious metals such as physical gold and silver are a popular alternative asset. Unless you invest in gold royalty stocks, you won’t earn dividend income. You make money by selling your precious metal investments above your purchase price.
Buying gold coins and bars can be one of the best ways to invest in gold. Physical gold is expensive and you may not be able to buy an entire ounce or gram at once.
Vaulted lets you buy fractional shares of physical gold bars. Your stash is held at the Royal Canadian Mint. Once your balance is high enough, you can request FedEx delivery to receive your physical gold. There is a 1.8% transaction fee to buy or sell and a 0.4% annual maintenance fee.
It’s also possible to invest in gold trust ETFs that trade on the stock market. Most investing apps let you trade these funds. The share price mimics the price of physical gold.
But most gold ETFs don’t offer physical delivery as the fund family owns the bullion.
Minimum investment: $10
10. Cryptocurrency
When you’re deciding what to invest in first, cryptocurrency probably isn’t going to be at the top of the list. After all, this digital asset is highly volatile and doesn’t earn interest.
Many people who buy crypto do so as an alternative to stocks and gold.
For example, you might buy cryptocurrency as a way to diversify once you hold a sufficient amount of stocks, index funds and gold.
The most popular cryptocurrency is Bitcoin. This cryptocoin has the best name recognition and more merchants accept it as payment instead of paper currency.
There are other “alt-coins” like Ethereum that can also be worth owning if you believe in the long-term potential of cryptocurrency.
It has been fairly difficult to buy cryptocurrency but more platforms are making it easy to buy cryptocurrency. PayPal and Square let you buy Bitcoin and use it to pay for purchases.
However, you won’t be able to move your Bitcoin balance off of their platform.
Another easy way to buy cryptocurrency is through an online broker like eToro. You can trade cryptocurrency futures after a minimum $50 initial deposit.
EToro also lets you copy the investment portfolios of experienced cryptocurrency investors which can improve your income potential.
A third way to buy cryptocurrency is using a digital currency exchange such as Coinbase. Buying directly from an exchange lets you own real Bitcoin and alt-coins. You can transfer them to a cryptocurrency wallet for added security from hackers.
No matter where you decide to buy cryptocurrency, you can buy fractional shares of Bitcoin and other coins. Investment minimums and transaction fees vary by platform.
Minimum investment: $2 (varies by platform)
11. Treasury Bonds
Most investors get exposure to government bonds by holding bond index funds in their brokerage account or 401k workplace retirement plan.
As bonds can be pricey and confusing to buy, bond funds make it easy to earn passive income.
You can have more control over which bonds you own by buying U.S. Treasury bonds. You can choose the maturity date. Each Treasury bond has a $100 minimum investment with a maturity date of up to 30 years.
It’s also possible to buy Treasury Inflation-Protected Securities (TIPs) as a hedge against future inflation.
Another option is purchasing Series I or Series EE Savings Bonds. Both types of savings bonds have a $25 minimum investment.
You can buy Treasury bonds from TreasuryDirect.
Minimum investment: $100 for Treasury notes and bonds ($25 for savings bonds)
12. Fine Wine
A long-term investing idea is owning fine wine. You can open a standard portfolio at Vinovest with a $1,000 minimum initial investment.
Vinovest automatically builds your wine portfolio making it easy to start if you’re unfamiliar with wine investing.
Each bottle in your portfolio remains in climate-controlled cellars across the world and is insured against damages. You decide when to sell your wine. It’s possible to request delivery if you want to open a bottle.
Collectible wine can increase in value as it ages and the scarcity of unopened bottles increases. Wine investing is like owning physical gold and doesn’t earn dividend income.
It can take up to 30 years to earn the best value before you sell a bottle.
Minimum investment: $1,000
13. Fine Art
Another unique investment option is investing in fine art. Masterworks lets you buy shares in classic and modern pieces with a $1,000 minimum investment.
The holding period for most pieces is between three and ten years. You earn a profit if the piece sells for a profit.
Due to the relatively high initial minimum investment and waiting years to earn income, you may invest small amounts of money in other ideas first to make money fast.
Minimum investments: $1,000
Summary
There are many ways to start investing little money today and earn recurring income. Many platforms have small minimum investments which make it easy to try several ideas and diversify your portfolio.
As you increase your income, you can boost your monthly investment.
How do you invest your money? Which idea are you going to try first?
Josh is a personal finance writer and Founder of MoneyBuffalo.com. He has been featured in publications like Student Loan Hero, Well Kept Wallet and the US News and World Report.
The mortgage-backed securities market might be heading to a prolonged period of wide spreads to Treasurys, which should continue to attract patient money managers willing to ride out this part of the cycle while feasting on the income.
Profiting from the current phase of the market will certainly involve more than parking and enjoying fattened yields in the months ahead, mortgage investment and research professionals said during a Mortgage Bank Association event on Tuesday. Expectations for a U.S. recession have not abated, and money managers will have to be savvy and stay vigilant about potential global risks.
Buyers of mortgage-backed securities—and agency MBS in particular—have changed significantly over time, Jeana Curro, a managing director and head of agency MBS research at Bank of America, told conference delegates during the session, “A look ahead at the expanding MBS supply.” Byron L. Boston, chief executive officer and co-chief investment officer at Dynex Capital and Steven Abrahams, managing director and head of investment strategy at Santander U.S. Capital Markets, joined Curro at the panel where Mike Fratantoni, PhD, chief economist and senior vice president of research and industry technology at MBA served as moderator.
Money managers entered the MBS investment ecosystem as the Federal Reserve began to wind down its holdings, and more recently, banks began to shed certain holdings from their balance sheets.
Curro describes the money managers entering the MBS space as those who are passive investors and relative value investors. When the former receives inflows, they tend to allocate it to what is outstanding, with mortgages getting about 30%. The latter emerged and increased demand for mortgage-backed products when mortgages were cheap, she said.
While getting themselves comfortable with MBS returns, money managers have become an important source of demand, and those portfolios could even dominate the MBS market in about three to five years, Abrahams said. He added that at some point the MBS market will attract stronger interest from the real estate investment trust (REIT) sector, especially because rates make it easier to hold assets in a leveraged position.
To hear Boston tell it, money managers bring a stabilizing influence on the market.
“The system only works if there are long-term holders of the risk,” Boston said, drawing on his experience with the industry going back to 1986. A 30-year, fixed mortgage is an unusual beast, globally, he said, adding that no one else would give another human being a 30-year loan with a prepayment option. “It’s a great asset for our country.”
Referring to 1998—when spreads between conforming, 30-year fixed rate mortgages and 10-year Treasurys were wide for a while—particularly where government policy drives returns, Boston said. The question circulating at Dynex Capital is ‘at what prices will investors take up MBS assets’, implying that they assets will eventually find a home on balance sheets. Buyers just need to have in-depth industry experience, especially to help them sense when global risks might introduce volatility to their buying endeavors.
Abrahams agreed, saying “they cannot be a closet indexer. It takes a lot of work, skill and conviction. Some managers have it, and some do not.”
When comparing MBS’ attractiveness to other credit assets, like corporate bonds, MBS could still look like a boon to the right asset manager, Curro said. Bank of America anticipates a mild recession in in Q3, which should spur demand for safe-haven assets.
“At the end of the day you have a government-guaranteed asset with 180-basis point spreads to Treasurys,” Curro said, of agency single-family MBS. “It is very attractive.”
In Best Low-Risk Investments for 2023, I provided a comprehensive list of low-risk investments with predictable returns. But it’s precisely because those returns are low-risk that they also provide relatively low returns.
In this article, we’re going to look at high-yield investments, many of which involve a higher degree of risk but are also likely to provide higher returns.
True enough, low-risk investments are the right investment solution for anyone who’s looking to preserve capital and still earn some income.
But if you’re more interested in the income side of an investment, accepting a bit of risk can produce significantly higher returns. And at the same time, these investments will generally be less risky than growth stocks and other high-risk/high-reward investments.
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Determine How Much Risk You’re Willing to Take On
The risk we’re talking about with these high-yield investments is the potential for you to lose money. As is true when investing in any asset, you need to begin by determining how much you’re willing to risk in the pursuit of higher returns.
Chasing “high-yield returns” will make you broke if you don’t have clear financial goals you’re working towards.
I’m going to present a large number of high-yield investments, each with its own degree of risk. The purpose is to help you evaluate the risk/reward potential of these investments when selecting the ones that will be right for you.
If you’re looking for investments that are completely safe, you should favor one or more of the highly liquid, low-yield vehicles covered in Best Low-Risk Investments for 2023. In this article, we’re going to be going for something a little bit different. As such, please note that this is not in any way a blanket recommendation of any particular investment.
Best High-Yield Investments for 2023
Table of Contents
Below is my list of the 18 best high-yield investments for 2023. They’re not ranked or listed in order of importance. That’s because each is a unique investment class that you will need to carefully evaluate for suitability within your own portfolio.
Be sure that any investment you do choose will be likely to provide the return you expect at an acceptable risk level for your own personal risk tolerance.
1. Treasury Inflation-Protected Securities (TIPS)
Let’s start with this one, if only because it’s on just about every list of high-yield investments, especially in the current environment of rising inflation. It may not actually be the best high-yield investment, but it does have its virtues and shouldn’t be overlooked.
Basically, TIPS are securities issued by the U.S. Treasury that are designed to accommodate inflation. They do pay regular interest, though it’s typically lower than the rate paid on ordinary Treasury securities of similar terms. The bonds are available with a minimum investment of $100, in terms of five, 10, and 30 years. And since they’re fully backed by the U.S. government, you are assured of receiving the full principal value if you hold a security until maturity.
But the real benefit—and the primary advantage—of these securities is the inflation principal additions. Each year, the Treasury will add an amount to the bond principal that’s commensurate with changes in the Consumer Price Index (CPI).
Fortunately, while the principal will be added when the CPI rises (as it nearly always does), none will be deducted if the index goes negative.
You can purchase TIPS through the U.S. Treasury’s investment portal, Treasury Direct. You can also hold the securities as well as redeem them on the same platform. There are no commissions or fees when buying securities.
On the downside, TIPS are purely a play on inflation since the base rates are fairly low. And while the principal additions will keep you even with inflation, you should know that they are taxable in the year received.
Still, TIPS are an excellent low-risk, high-yield investment during times of rising inflation—like now.
2. I Bonds
If you’re looking for a true low-risk, high-yield investment, look no further than Series I bonds. With the current surge in inflation, these bonds have become incredibly popular, though they are limited.
I bonds are currently paying 6.89%. They can be purchased electronically in denominations as little as $25. However, you are limited to purchasing no more than $10,000 in I bonds per calendar year. Since they are issued by the U.S. Treasury, they’re fully protected by the U.S. government. You can purchase them through the Treasury Department’s investment portal, TreasuryDirect.gov.
“The cash in my savings account is on fire,” groans Scott Lieberman, Founder of Touchdown Money. “Inflation has my money in flames, each month incinerating more and more. To defend against this, I purchased an I bond. When I decide to get my money back, the I bond will have been protected against inflation by being worth more than what I bought it for. I highly recommend getting yourself a super safe Series I bond with money you can stash away for at least one year.”
You may not be able to put your entire bond portfolio into Series I bonds. But just a small investment, at nearly 10%, can increase the overall return on your bond allocation.
3. Corporate Bonds
The average rate of return on a bank savings account is 0.33%. The average rate on a money market account is 0.09%, and 0.25% on a 12-month CD.
Now, there are some banks paying higher rates, but generally only in the 1%-plus range.
If you want higher returns on your fixed income portfolio, and you’re willing to accept a moderate level of risk, you can invest in corporate bonds. Not only do they pay higher rates than banks, but you can lock in those higher rates for many years.
For example, the average current yield on a AAA-rated corporate bond is 4.55%. Now that’s the rate for AAA bonds, which are the highest-rated securities. You can get even higher rates on bonds with lower ratings, which we will cover in the next section.
Corporate bonds sell in face amounts of $1,000, though the price may be higher or lower depending on where interest rates are. If you choose to buy individual corporate bonds, expect to buy them in lots of ten. That means you’ll likely need to invest $10,000 in a single issue. Brokers will typically charge a small per-bond fee on purchase and sale.
An alternative may be to take advantage of corporate bond funds. That will give you an opportunity to invest in a portfolio of bonds for as little as the price of one share of an ETF. And because they are ETFs, they can usually be bought and sold commission free.
You can typically purchase corporate bonds and bond funds through popular stock brokers, like Zacks Trade, TD Ameritrade.
Corporate Bond Risk
Be aware that the value of corporate bonds, particularly those with maturities greater than 10 years, can fall if interest rates rise. Conversely, the value of the bonds can rise if interest rates fall.
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4. High-Yield Bonds
In the previous section we talked about how interest rates on corporate bonds vary based on each bond issue’s rating. A AAA bond, being the safest, has the lowest yield. But a riskier bond, such as one rated BBB, will provide a higher rate of return.
If you’re looking to earn higher interest than you can with investment-grade corporate bonds, you can get those returns with so-called high-yield bonds. Because they have a lower rating, they pay higher interest, sometimes much higher.
The average yield on high-yield bonds is 8.29%. But that’s just an average. The yield on a bond rated B will be higher than one rated BB.
You should also be aware that, in addition to potential market value declines due to rising interest rates, high-yield bonds are more likely to default than investment-grade bonds. That’s why they pay higher interest rates. (They used to call these bonds “junk bonds,” but that kind of description is a marketing disaster.) Because of those twin risks, junk bonds should occupy only a small corner of your fixed-income portfolio.
High Yield Bond Risk
In a rapidly rising interest rate environment, high-yield bonds are more likely to default.
High-yield bonds can be purchased under similar terms and in the same places where you can trade corporate bonds. There are also ETFs that specialize in high-yield bonds and will be a better choice for most investors, since they will include diversification across many different bond issues.
5. Municipal Bonds
Just as corporations and the U.S. Treasury issue bonds, so do state and local governments. These are referred to as municipal bonds. They work much like other bond types, particularly corporates. They can be purchased in similar denominations through online brokers.
The main advantage enjoyed by municipal bonds is their tax-exempt status for federal income tax purposes. And if you purchase a municipal bond issued by your home state, or a municipality within that state, the interest will also be tax-exempt for state income tax purposes.
That makes municipal bonds an excellent source of tax-exempt income in a nonretirement account. (Because retirement accounts are tax-sheltered, it makes little sense to include municipal bonds in those accounts.)
Municipal bond rates are currently hovering just above 3% for AAA-rated bonds. And while that’s an impressive return by itself, it masks an even higher yield.
Because of their tax-exempt status, the effective yield on municipal bonds will be higher than the note rate. For example, if your combined federal and state marginal income tax rates are 25%, the effective yield on a municipal bond paying 3% will be 4%. That gives an effective rate comparable with AAA-rated corporate bonds.
Municipal bonds, like other bonds, are subject to market value fluctuations due to interest rate changes. And while it’s rare, there have been occasional defaults on these bonds.
Like corporate bonds, municipal bonds carry ratings that affect the interest rates they pay. You can investigate bond ratings through sources like Standard & Poor’s, Moody’s, and Fitch.
Fund
Symbol
Type
Current Yield
5 Average Annual Return
Vanguard Inflation-Protected Securities Fund
VIPSX
TIPS
0.06%
3.02%
SPDR® Portfolio Interm Term Corp Bond ETF
SPIB
Corporate
4.38%
1.44%
iShares Interest Rate Hedged High Yield Bond ETF
HYGH
High-Yield
5.19%
2.02%
Invesco VRDO Tax-Free ETF (PVI)
PVI
Municipal
0.53%
0.56%
6. Longer Term Certificates of Deposit (CDs)
This is another investment that falls under the low risk/relatively high return classification. As interest rates have risen in recent months, rates have crept up on certificates of deposit. Unlike just one year ago, CDs now merit consideration.
But the key is to invest in certificates with longer terms.
“Another lower-risk option is to consider a Certificate of Deposit (CD),” advises Lance C. Steiner, CFP at Buckingham Advisors. “Banks, credit unions, and many other financial institutions offer CDs with maturities ranging from 6 months to 60 months. Currently, a 6-month CD may pay between 0.75% and 1.25% where a 24-month CD may pay between 2.20% and 3.00%. We suggest considering a short-term ladder since interest rates are expected to continue rising.” (Stated interest rates for the high-yield savings and CDs were obtained at bankrate.com.)
Most banks offer certificates of deposit with terms as long as five years. Those typically have the highest yields.
But the longer term does involve at least a moderate level of risk. If you invest in a CD for five years that’s currently paying 3%, the risk is that interest rates will continue rising. If they do, you’ll miss out on the higher returns available on newer certificates. But the risk is still low overall since the bank guarantees to repay 100% of your principle upon certificate maturity.
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7. Peer-to-Peer (P2P) Lending
Do you know how banks borrow from you—at 1% interest—then loan the same money to your neighbor at rates sometimes as high as 20%? It’s quite a racket, and a profitable one at that.
But do you also know that you have the same opportunity as a bank? It’s an investing process known as peer-to-peer lending, or P2P for short.
P2P lending essentially eliminates the bank. As an investor, you’ll provide the funds for borrowers on a P2P platform. Most of these loans will be in the form of personal loans for a variety of purposes. But some can also be business loans, medical loans, and for other more specific purposes.
As an investor/lender, you get to keep more of the interest rate return on those loans. You can invest easily through online P2P platforms.
One popular example is Prosper. They offer primarily personal loans in amounts ranging between $2,000 and $40,000. You can invest in small slivers of these loans, referred to as “notes.” Notes can be purchased for as little as $25.
That small denomination will make it possible to diversify your investment across many different loans. You can even choose the loans you will invest in based on borrower credit scores, income, loan terms, and purposes.
Prosper, which has managed $20 billion in P2P loans since 2005, claims a historical average return of 5.7%. That’s a high rate of return on what is essentially a fixed-income investment. But that’s because there exists the possibility of loss due to borrower default.
However, you can minimize the likelihood of default by carefully choosing borrower loan quality. That means focusing on borrowers with higher credit scores, incomes, and more conservative loan purposes (like debt consolidation).
8. Real Estate Investment Trusts (REITs)
REITs are an excellent way to participate in real estate investment, and the return it provides, without large amounts of capital or the need to manage properties. They’re publicly traded, closed-end investment funds that can be bought and sold on major stock exchanges. They invest primarily in commercial real estate, like office buildings, retail space, and large apartment complexes.
If you’re planning to invest in a REIT, you should be aware that there are three different types.
“Equity REITs purchase commercial, industrial, or residential real estate properties,” reports Robert R. Johnson, PhD, CFA, CAIA, Professor of Finance, Heider College of Business, Creighton University and co-author of several books, including The Tools and Techniques Of Investment Planning, Strategic Value Investing and Investment Banking for Dummies. “Income is derived primarily from the rental on the properties, as well as from the sale of properties that have increased in value. Mortgage REITs invest in property mortgages. The income is primarily from the interest they earn on the mortgage loans. Hybrid REITs invest both directly in property and in mortgages on properties.”
Johnson also cautions:
“Investors should understand that equity REITs are more like stocks and mortgage REITs are more like bonds. Hybrid REITs are like a mix of stocks and bonds.”
Mortgage REITs, in particular, are an excellent way to earn steady dividend income without being closely tied to the stock market.
Examples of specific REITs are listed in the table below (source: Kiplinger):
REIT
Equity or Mortgage
Property Type
Dividend Yield
12 Month Return
Rexford Industrial Realty
REXR
Industrial warehouse space
2.02%
2.21%
Sun Communities
SUI
Manufactured housing, RVs, resorts, marinas
2.19%
-14.71%
American Tower
AMT
Multi-tenant cell towers
2.13%
-9.00%
Prologis
PLD
Industrial real estate
2.49%
-0.77%
Camden Property Trust
CPT
Apartment complexes
2.77%
-7.74%
Alexandria Real Estate Equities
ARE
Research Properties
3.14%
-23.72%
Digital Realty Trust
DLR
Data centers
3.83%
-17.72%
9. Real Estate Crowdfunding
If you prefer direct investment in a property of your choice, rather than a portfolio, you can invest in real estate crowdfunding. You invest your money, but management of the property will be handled by professionals. With real estate crowdfunding, you can pick out individual properties, or invest in nonpublic REITs that invest in very specific portfolios.
One of the best examples of real estate crowdfunding is Fundrise. That’s because you can invest with as little as $500 or create a customized portfolio with no more than $1,000. Not only does Fundrise charge low fees, but they also have multiple investment options. You can start small in managed investments, and eventually trade up to investing in individual deals.
One thing to be aware of with real estate crowdfunding is that many require accredited investor status. That means being high income, high net worth, or both. If you are an accredited investor, you’ll have many more choices in the real estate crowdfunding space.
If you are not an accredited investor, that doesn’t mean you’ll be prevented from investing in this asset class. Part of the reason why Fundrise is so popular is that they don’t require accredited investor status. There are other real estate crowdfunding platforms that do the same.
Just be careful if you want to invest in real estate through real estate crowdfunding platforms. You will be expected to tie your money up for several years, and early redemption is often not possible. And like most investments, there is the possibility of losing some or all your investment principal.
Low minimum investment – $10
Diversified real estate portfolio
Portfolio Transparency
10. Physical Real Estate
We’ve talked about investing in real estate through REITs and real estate crowdfunding. But you can also invest directly in physical property, including residential property or even commercial.
Owning real estate outright means you have complete control over the investment. And since real estate is a large-dollar investment, the potential returns are also large.
For starters, average annual returns on real estate are impressive. They’re even comparable to stocks. Residential real estate has generated average returns of 10.6%, while commercial property has returned an average of 9.5%.
Next, real estate has the potential to generate income from two directions, from rental income and capital gains. But because of high property values in many markets around the country, it will be difficult to purchase real estate that will produce a positive cash flow, at least in the first few years.
Generally speaking, capital gains are where the richest returns come from. Property purchased today could double or even triple in 20 years, creating a huge windfall. And this will be a long-term capital gain, to get the benefit of a lower tax bite.
Finally, there’s the leverage factor. You can typically purchase an investment property with a 20% down payment. That means you can purchase a $500,000 property with $100,000 out-of-pocket.
By calculating your capital gains on your upfront investment, the returns are truly staggering. If the $500,000 property doubles to $1 million in 20 years, the $500,000 profit generated will produce a 500% gain on your $100,000 investment.
On the negative side, real estate is certainly a very long-term investment. It also comes with high transaction fees, often as high as 10% of the sale price. And not only will it require a large down payment up front, but also substantial investment of time managing the property.
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11. High Dividend Stocks
“The best high-yield investment is dividend stocks,” declares Harry Turner, Founder at The Sovereign Investor. “While there is no guaranteed return with stocks, over the long term stocks have outperformed other investments such as bonds and real estate. Among stocks, dividend-paying stocks have outperformed non-dividend paying stocks by more than 2 percentage points per year on average over the last century. In addition, dividend stocks tend to be less volatile than non-dividend paying stocks, meaning they are less likely to lose value in downturns.”
You can certainly invest in individual stocks that pay high dividends. But a less risky way to do it, and one that will avoid individual stock selection, is to invest through a fund.
One of the most popular is the ProShares S&P 500 Dividend Aristocrat ETF (NOBL). It has provided a return of 1.67% in the 12 months ending May 31, and an average of 12.33% per year since the fund began in October 2013. The fund currently has a 1.92% dividend yield.
The so-called Dividend Aristocrats are popular because they represent 60+ S&P 500 companies, with a history of increasing their dividends for at least the past 25 years.
“Dividend Stocks are an excellent way to earn some quality yield on your investments while simultaneously keeping inflation at bay,” advises Lyle Solomon, Principal Attorney at Oak View Law Group, one of the largest law firms in America. “Dividends are usually paid out by well-established and successful companies that no longer need to reinvest all of the profits back into the business.”
It gets better. “These companies and their stocks are safer to invest in owing to their stature, large customer base, and hold over the markets,” adds Solomon. “The best part about dividend stocks is that many of these companies increase dividends year on year.”
The table below shows some popular dividend-paying stocks. Each is a so-called “Dividend Aristocrat”, which means it’s part of the S&P 500 and has increased its dividend in each of at least the past 25 years.
Company
Symbol
Dividend
Dividend Yield
AbbVie
ABBV
$5.64
3.80%
Armcor PLC
AMCR
$0.48
3.81%
Chevron
CVX
$5.68
3.94%
ExxonMobil
XOM
$3.52
4.04%
IBM
IBM
$6.60
5.15%
Realty Income Corp
O
$2.97
4.16%
Walgreen Boots Alliance
WBA
$1.92
4.97%
12. Preferred Stocks
Preferred stocks are a very specific type of dividend stock. Just like common stock, preferred stock represents an interest in a publicly traded company. They’re often thought of as something of a hybrid between stocks and bonds because they contain elements of both.
Though common stocks can pay dividends, they don’t always. Preferred stocks on the other hand, always pay dividends. Those dividends can be either a fixed amount or based on a variable dividend formula. For example, a company can base the dividend payout on a recognized index, like the LIBOR (London Inter-Bank Offered Rate). The percentage of dividend payout will then change as the index rate does.
Preferred stocks have two major advantages over common stock. First, as “preferred” securities, they have a priority on dividend payments. A company is required to pay their preferred shareholders dividends ahead of common stockholders. Second, preferred stocks have higher dividend yields than common stocks in the same company.
You can purchase preferred stock through online brokers, some of which are listed under “Growth Stocks” below.
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Preferred Stock Caveats
The disadvantage of preferred stocks is that they don’t entitle the holder to vote in corporate elections. But some preferred stocks offer a conversion option. You can exchange your preferred shares for a specific number of common stock shares in the company. Since the conversion will likely be exercised when the price of the common shares takes a big jump, there’s the potential for large capital gains—in addition to the higher dividend.
Be aware that preferred stocks can also be callable. That means the company can authorize the repurchase of the stock at its discretion. Most will likely do that at a time when interest rates are falling, and they no longer want to pay a higher dividend on the preferred stock.
Preferred stock may also have a maturity date, which is typically 30–40 years after its original issuance. The company will typically redeem the shares at the original issue price, eliminating the possibility of capital gains.
Not all companies issue preferred stock. If you choose this investment, be sure it’s with a company that’s well-established and has strong financials. You should also pay close attention to the details of the issuance, including and especially any callability provisions, dividend formulas, and maturity dates.
13. Growth Stocks
This sector is likely the highest risk investment on this list. But it also may be the one with the highest yield, at least over the long term. That’s why we’re including it on this list.
Based on the S&P 500 index, stocks have returned an average of 10% per year for the past 50 years. But it is important to realize that’s only an average. The market may rise 40% one year, then fall 20% the next. To be successful with this investment, you must be committed for the long haul, up to and including several decades.
And because of the potential wide swings, growth stocks are not recommended for funds that will be needed within the next few years. In general, growth stocks work best for retirement plans. That’s where they’ll have the necessary decades to build and compound.
Since most of the return on growth stocks is from capital gains, you’ll get the benefit of lower long-term capital gains tax rates, at least with securities held in a taxable account. (The better news is capital gains on investments held in retirement accounts are tax-deferred until retirement.)
You can choose to invest in individual stocks, but that’s a fairly high-maintenance undertaking. A better way may be to simply invest in ETFs tied to popular indexes. For example, ETFs based on the S&P 500 are very popular among investors.
You can purchase growth stocks and growth stock ETFs commission free with brokers like M1 Finance, Zacks Trade, Wealthsimple.
14. Annuities
Annuities are something like creating your own private pension. It’s an investment contract you take with an insurance company, in which you invest a certain amount of money in exchange for a specific income stream. They can be an excellent source of high yields because the return is locked in by the contract.
Annuities come in many different varieties. Two major classifications are immediate and deferred annuities. As the name implies, immediate annuities begin paying an income stream shortly after the contract begins.
Deferred annuities work something like retirement plans. You may deposit a fixed amount of money with the insurance company upfront or make regular installments. In either case, income payments will begin at a specified point in the future.
With deferred annuities, the income earned within the plan is tax-deferred and paid upon withdrawal. But unlike retirement accounts, annuity contributions are not tax-deductible. Investment returns can either be fixed-rate or variable-rate, depending on the specific annuity setup.
While annuities are an excellent idea and concept, the wide variety of plans as well as the many insurance companies and agents offering them, make them a potential minefield. For example, many annuities are riddled with high fees and are subject to limited withdrawal options.
Because they contain so many moving parts, any annuity contracts you plan to enter into should be carefully reviewed. Pay close attention to all the details, including the small ones. It is, after all, a contract, and therefore legally binding. For that reason, you may want to have a potential annuity reviewed by an attorney before finalizing the deal.
15. Alternative Investments
Alternative investments cover a lot of territory. Examples include precious metals, commodities, private equity, art and collectibles, and digital assets. These fall more in the category of high risk/potential high reward, and you should proceed very carefully and with only the smallest slice of your portfolio.
To simplify the process of selecting alternative assets, you can invest through platforms such as Yieldstreet. With a single cash investment, you can invest in multiple alternatives.
“Investors can purchase real estate directly on Yieldstreet, through fractionalized investments in single deals,” offers Milind Mehere, Founder & Chief Executive Officer at Yieldstreet. “Investors can access private equity and private credit at high minimums by investing in a private market fund (think Blackstone or KKR, for instance). On Yieldstreet, they can have access to third-party funds at a fraction of the previously required minimums. Yieldstreet also offers venture capital (fractionalized) exposure directly. Buying a piece of blue-chip art can be expensive, and prohibitive for most investors, which is why Yieldstreet offers fractionalized assets to diversified art portfolios.”
Yieldstreet also provides access to digital asset investments, with the benefit of allocating to established professional funds, such as Pantera or Osprey Fund. The platform does not currently offer commodities but plans to do so in the future.
Access to wide array of alternative asset classes
Access to ultra-wealthy investments
Can invest for income or growth
Learn More Now
Alternative investments largely require thinking out-of-the-box. Some of the best investment opportunities are also the most unusual.
“The price of meat continues to rise, while agriculture remains a recession-proof investment as consumer demand for food is largely inelastic,” reports Chris Rawley, CEO of Harvest Returns, a platform for investing in private agriculture companies. “Consequently, investors are seeing solid returns from high-yield, grass-fed cattle notes.”
16. Interest Bearing Crypto Accounts
Though the primary appeal of investing in cryptocurrency has been the meteoric rises in price, now that the trend seems to be in reverse, the better play may be in interest-bearing crypto accounts. A select group of crypto exchanges pays high interest on your crypto balance.
One example is Gemini. Not only do they provide an opportunity to buy, sell, and store more than 100 cryptocurrencies—plus non-fungible tokens (NFTs)—but they are currently paying 8.05% APY on your crypto balance through Gemini Earn.
In another variation of being able to earn money on crypto, Crypto.com pays rewards of up to 14.5% on crypto held on the platform. That’s the maximum rate, as rewards vary by crypto. For example, rewards on Bitcoin and Ethereum are paid at 6%, while stablecoins can earn 8.5%.
It’s important to be aware that when investing in cryptocurrency, you will not enjoy the benefit of FDIC insurance. That means you can lose money on your investment. But that’s why crypto exchanges pay such high rates of return, whether it’s in the form of interest or rewards.
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17. Crypto Staking
Another way to play cryptocurrency is a process known as crypto staking. This is where the crypto exchange pays you a certain percentage as compensation or rewards for monitoring a specific cryptocurrency. This is not like crypto mining, which brings crypto into existence. Instead, you’ll participate in writing that particular blockchain and monitoring its security.
“Crypto staking is a concept wherein you can buy and lock a cryptocurrency in a protocol, and you will earn rewards for the amount and time you have locked the cryptocurrency,” reports Oak View Law Group’s Lyle Solomon.
“The big downside to staking crypto is the value of cryptocurrencies, in general, is extremely volatile, and the value of your staked crypto may reduce drastically,” Solomon continues, “However, you can stake stable currencies like USDC, which have their value pegged to the U.S. dollar, and would imply you earn staked rewards without a massive decrease in the value of your investment.”
Much like earning interest and rewards on crypto, staking takes place on crypto exchanges. Two exchanges that feature staking include Coinbase and Kraken. These are two of the largest crypto exchanges in the industry, and they provide a wide range of crypto opportunities, in addition to staking.
Invest in Startup Businesses and Companies
Have you ever heard the term “angel investor”? That’s a private investor, usually, a high net worth individual, who provides capital to small businesses, often startups. That capital is in the form of equity. The angel investor invests money in a small business, becomes a part owner of the company, and is entitled to a share of the company’s earnings.
In most cases, the angel investor acts as a silent partner. That means he or she receives dividend distributions on the equity invested but doesn’t actually get involved in the management of the company.
It’s a potentially lucrative investment opportunity because small businesses have a way of becoming big businesses. As they grow, both your equity and your income from the business also grow. And if the business ever goes public, you could be looking at a life-changing windfall!
Easy Ways to Invest in Startup Businesses
Mainvest is a simple, easy way to invest in small businesses. It’s an online investment platform where you can get access to returns as high as 25%, with an investment of just $100. Mainvest offers vetted businesses (the acceptance rate is just 5% of business that apply) for you to invest in.
It collects revenue, which will be paid to you quarterly. And because the minimum required investment is so small, you can invest in several small businesses at the same time. One of the big advantages with Mainvest is that you are not required to be an accredited investor.
Still another opportunity is through Fundrise Innovation Fund. I’ve already covered how Fundrise is an excellent real estate crowdfunding platform. But through their recently launched Innovaton Fund, you’ll have opportunity to invest in high-growth private technology companies. As a fund, you’ll invest in a portfolio of late-stage tech companies, as well as some public equities.
The purpose of the fund is to provide high growth, and the fund is currently offering shares with a net asset value of $10. These are long-term investments, so you should expect to remain invested for at least five years. But you may receive dividends in the meantime.
Like Mainvest, the Fundrise Innovation Fund does not require you to be an accredited investor.
Low minimum investment – $10
Diversified real estate portfolio
Portfolio Transparency
Final Thoughts on High Yield Investing
Notice that I’ve included a mix of investments based on a combination of risk and return. The greater the risk associated with the investment, the higher the stated or expected return will be.
It’s important when choosing any of these investments that you thoroughly assess the risk involved with each, and not focus primarily on return. These are not 100% safe investments, like short-term CDs, short-term Treasury securities, savings accounts, or bank money market accounts.
Because there is risk associated with each, most are not suitable as short-term investments. They make most sense for long-term investment accounts, particularly retirement accounts.
For example, growth stocks—and most stocks, for that matter—should generally be in a retirement account. While there will be years when you will suffer losses in your position, you’ll have enough years to offset those losses between now and retirement.
Also, if you don’t understand any of the above investments, it will be best to avoid making them. And for more complicated investments, like annuities, you should consult with a professional to evaluate the suitability and all the provisions it contains.
FAQ’s on High Yield Investment Options
What investment has the highest yield?
The investment with the highest yield will vary depending on a number of factors, including current market conditions and the amount of risk an investor is willing to take on. Generally speaking, investments with the potential for high yields also come with a higher level of risk, so it’s important for investors to carefully consider their options and choose investments that align with their financial goals and risk tolerance.
Some examples of high-yield investments include:
1. Stocks: Some stocks may offer high dividend yields, which is the annual dividend payment a company makes to its shareholders, expressed as a percentage of the stock’s current market price.
2. Real estate: Investing in real estate, either directly by purchasing property or indirectly through a real estate investment trust (REIT), can potentially generate high returns in the form of rental income and appreciation of the property value.
3. High-yield bonds: High-yield bonds, also known as junk bonds, are bonds that are issued by companies with lower credit ratings and thus offer higher yields to compensate for the added risk.
4. Private lending: Investing in private loans, such as through peer-to-peer lending platforms, can potentially offer high yields, but it also carries a higher level of risk.
5. Commodities: Investing in commodities, such as precious metals or oil, can potentially generate high returns if the prices of those commodities rise. However, the prices of commodities can also be volatile and subject to market fluctuations.
It’s important to note that these are just examples and not recommendations. As with any investment, it’s crucial to carefully research and consider all the potential risks and rewards before making a decision.
Where can I invest my money to get high returns?
There are a number of places you can invest your money to get high returns. One option is to invest in stocks, which typically offer higher returns than other investment options. Another option is to invest in bonds, which are considered a relatively safe investment option.
You could also invest in real estate, which has the potential to provide high returns if done correctly. Finally, you could also invest in commodities, such as gold or silver, which can be a risky investment but can also offer high returns.
What investments can I make a 10% return?
It’s difficult to predict exactly what investments will generate a 10% return, as investment returns can vary depending on a number of factors, including market conditions and the performance of the specific investment. Some investments, such as stocks and real estate, have the potential to generate returns in excess of 10%, but they also come with a higher level of risk. It’s important to remember that past performance is not necessarily indicative of future results, and that all investments carry some degree of risk
The role of municipal bond insurance continues to decline in the municipal market, with insured bonds comprising only 11% of year-to-date new issuance through July.
Ambac, one of the largest bond insurers, was downgraded further into “junk” territory in July, and of the ten municipal bond insurers, only three maintain a financial strength rating of AA or higher.
Some positive news may lie on the horizon for investors seeking the highest rated municipals bonds, but it is unlikely insurance will return to the pre-crisis role it played in the municipal market.
While the diminished role of insurance is a negative, we believe it is not enough to offset positive aspects driving performance of the municipal bond market.
The role of bond insurance continues to decline in the municipal market, with insured bonds comprising only 11% of year-to-date new issuance through July.
Prior to the start of the financial crisis in 2007, municipal bond insurers backed roughly half of the entire municipal market.
In 2008, municipal bond insurers began to lose their AAA ratings status, as projected losses on complex mortgage-backed securities led to downgrades from both Moody’s and S&P. For bond issuers, insurance from a company with less than a AAA rating offered little value.
The percentage of newly issued insured bonds dropped to 18% in 2008 and to 11% so far in 2009 according to Bloomberg.
More Junk in the Municipal Realm
Negative headlines continued in July as Ambac, one of the four largest bond insurers, was downgraded further into “junk” territory. Ambac’s ratings were reduced to Caa2 by Moody’s and to CC by S&P, and the downgrades have forced the company to postpone plans to separate its municipal insurance business from its structured mortgaged-backed securities business into a new, more viable company. Of the major municipal bond insurers, only three maintain a rating of AA or better. In table 1, “Credit Watch” indicates a possible rating change in the coming weeks or months; “Outlook” indicates the likely longer-term ratings direction over the next six to twelve months; and “Developing” implies that any change (positive, negative, or none) is possible.
Moody’s has taken a particularly harsh path towards the municipal insurers, stating that a municipal-only insurance model is not viable. Although the ratings agency’s reasoning has been less than clear and perhaps politically motivated, Moody’s believes a AAA-rating is unobtainable for any company given the uncertainty inherent in their business models.
Market impact from negative news, such as the Ambac headlines, has become more muted in 2009. Most insured bonds were already trading in relation to their underlying ratings. The insurers actually took great care with their municipal business (unlike their mortgage business in many cases) and focused on higher quality issuers. Roughly 90% of insured bonds carry an underlying rating of A or better, so insurer downgrades below A have caused fewer corresponding bond downgrades. So although Ambac’s downgrade did result in some subsequent bond downgrades, the ratings on the majority of Ambac insured bonds were unaffected. An insured municipal bond is rated at the higher of the insurer’s rating or its underlying rating (the rating based solely on the municipality’s credit profile).
What’s next for Municipal Bond Insurance?
Since there is no economic value from bond insurance unless it results in at least an A rating for the bond, many of the insurers rated below BBB are now in “runoff” mode. In runoff, the insurers do not underwrite new business (as is the case with Ambac) and simply collect money on insurance premiums already written. Over several years, the insurer hopes that premiums will be enough to offset potential losses on all claims and then attempt to reestablish the business or simply return any excess proceeds to equity and/or bondholders.
An insurer is still liable to pay claims (i.e., a default or missed interest payment) even if in runoff, since they maintain some claims paying ability. Given the potential mountain of claims against the existing capital base (particularly from those subject to sub-prime mortgage exposure), it is uncertain whether these insurers will be able to meet future claims. A bond insurer is required to make up any missed interest payments, but principal repayment, in the case of default, is not made until maturity or until bankruptcy is resolved, whichever comes first.
Potential positives
A potential new insurer and possible new federal legislation could be positive developments for investors seeking the highest quality municipal bonds. Municipal and Infrastructure Assurance Corporation (MIAC), backed by investment bank Macquarie Group and private equity firm Citadel, is attempting to enter the market over coming months as a AAA-rated, municipal bond only insurer. Increasing the pool of AAA-rated bonds would bring in more investors to the municipal market.
The House Financial Services Committee has proposed two bills to be voted on this fall that could affect municipal bond ratings:
The Municipal Bond Fairness Act would require the rating agencies to rate municipal bonds more consistently with other bonds, such as corporate bonds. Since investment grade municipal bonds have exhibited a much lower default rate than comparably rated corporate bonds, this requirement could result in one to two-notch upgrades for thousands of municipal bonds. Moody’s was set to implement such a plan last fall but indefinitely postponed the implementation due to the credit crisis and recession.
The Municipal Bond Insurance Enhancement Act would create a federal financial guarantor to reinsure bonds backed by municipal only insurers. However, the proposed dollar amount of $50 billion is relatively small and could have a limited impact.
Even if these events come to fruition, we don’t expect bond insurance to return to its pre-crisis status. The municipal bond market continues to forge ahead regardless.
We think the rally in municipal bonds will continue, even with insurance questions lingering, but at a more gradual pace. The diminished role of municipal bond insurance is one reason why municipal valuations remain cheap by historical norms despite the impressive rally so far this year. Even without insurance, however, high-quality municipal bonds have exhibited very low default rates. The municipal market continues to benefit from a favorable supply-demand balance, attractive valuations, and the prospect of higher tax rates. Taken together these factors should outweigh insurance woes. On a longer-term basis, the expiration of the Bush tax cuts in 2010 alone could more than offset the lack of insurance and be a catalyst to still higher municipal bond valuations.
IMPORTANT DISCLOSURES
The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. To determine which investment(s) may be appropriate for you, consult your financial advisor prior to investing. All performance reference is historical and is no guarantee of future results. All indices are unmanaged and cannot be invested into directly.
Neither LPL Financial nor any of its affiliates make a market in the investment being discussed nor does LPL Financial or its affiliates or its officers have financial interest in any securities of the issuer whose investment is being recommended neither LPL Financial nor its affiliates have managed or co-managed a public offering of any securities of the issuer in the past 12 months.
Government bonds and Treasury Bills are guaranteed by the US government as to the timely payment of principal and interest and, if held to maturity, offer a fixed rate of return and fi xed principal value. However, the value of funds shares is not guaranteed and will fluctuate.
The market value of corporate bonds will fluctuate, and if the bond is sold prior to maturity, the investor’s yield may differ from the advertised yield. Bonds are subject to market and interest rate risk if sold prior to maturity. Bond values will decline as interest rates rise and are subject to availability and change in price. High Yield/Junk Bonds are not investment grade securities, involve substantial risks and generally should be part of the diversified portfolio of sophisticated investors. GNMA’s are guaranteed by the U.S. government as to the timely principal and interest, however this guarantee does not apply to the yield, nor does it protect against loss of principal if the bonds are sold prior to the payment of all underlying mortgages.
Muni Bonds are subject to market and interest rate risk if sold prior to maturity. Bond values will decline as interest rates rise. Interest income may be subject to the alternative minimum tax. Federally tax-free but other state and state and local taxes may apply.
Investing in mutual funds involve risk, including possible loss of principal. Investments in specialized industry sectors have additional risks, which are outlines in the prospectus.
Stock investing involves risk including loss of principal.
How to Make $500 a Month in Passive Income – SmartAsset
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You can produce $500 a month in passive income through savings accounts, certificates of deposit, stocks, bonds, funds and other investment vehicles. Each offers varying rates of return, degrees of safety, convenience, and liquidity. And each requires a significant initial investment to produce the required amount of passive income.
A financial advisor will be able to help with your investment decisions.
How to Make $500 a Month in Passive Income
Passive income generally refers to money you receive automatically without having to do anything such as work for wages. The most common way to generate passive income is through purchasing investments that pay you interest or dividends.
Producing passive income in this way calls for putting in money rather than putting in the effort. However, once you have invested the money, you can cash checks or receive deposits to your bank account without any intervention on your part.
And there are many investments you can make to produce $500 monthly in passive income. Here are some of the most accessible and reliable:
Savings Account
A bank or credit union savings account is as passive, safe and convenient as you can get. The top-paying savings accounts yield around 4.5% annually. At that rate, depositing approximately $133,333 will give you $500 monthly.
Certificates of Deposit
Certificates of deposit (CDs) are relatively safe, somewhat better-paying and a little less convenient than savings accounts. The best one-year bank certificates of deposit yield about 5% annually. So if you buy a $120,000 12-month CD, you’ll get about $500 in passive income each and every month.
Bonds
Corporate bonds are riskier than bank deposits. But AAA-rated bonds are generally considered safe and historically yield a little over 4%. If you buy $125,000 worth of AA-rated bonds, you can expect to receive the equivalent of $500 a month. That usually comes in quarterly, semi-annual or annual payments.
Dividend-paying Stocks
Shares of public companies that split profits with shareholders by paying cash dividends yield between 2% and 6% a year. With that in mind, putting $250,000 into low-yielding dividend stocks or $83,333 into high-yielding shares will get your $500 a month. Although, most dividends are paid quarterly, semi-annually or annually.
Diversified Securities Portfolio
A diversified securities portfolio of 60% stocks and 40% bonds has returned about 6.1% annually on average for the last decade, according to Vanguard. If future performance matches past performance, which is not guaranteed, $100,000 invested in a well-chosen 60/40 portfolio could grow by about $6,000 a year. The return includes dividends as well as price appreciation, so you may have to sell some of your investments to get $500 a month.
Exchange-Traded Funds
Low in cost and easy to buy, passively managed exchange-traded funds (ETFs) produce returns that vary according to whether they track stock, bond or other indexes. To cite one example, Vanguard’s High Dividend Yield ETF yields approximately 3%. You’d need to invest approximately $167,000 to get $500 a month in passive income from that ETF.
Real Estate
Purchasing shares of a Real Estate Investment Trust (REIT) is one popular way to get passive income from real estate. Publicly traded REITS pay dividends at an average rate of about 3%. So you’d need $167,000 to produce $500 in monthly passive income this way.
Other income opportunities that are somewhat less passive can also provide regular monthly income with varying amounts of effort. Drop shipping, for example, is a business model that involves setting up an online store and taking orders for products that pass directly to a supplier, who fulfills them without you having to do a thing except accept payment.
Direct investments in real estate, such as purchasing rental properties, can produce income that the internal revenue service (IRS) views as passive income, entitling it to more favorable tax treatment than earned income from working. However, managing residential real estate can involve considerable effort and attention on your part unless you pay a management company to take care of leasing, repairs and other tasks.
Bottom Line
To generate $500 a month in passive income you may need to invest between $83,333 and $250,000, depending on the asset and investment type you select. In addition to yield, you’ll want to consider safety, liquidity and convenience when selecting the investments you’ll employ to provide monthly passive income. However, once you’ve made the decision and put down your money, you can expect to receive regular payments without much, if any, additional future effort.
Tips for Investing
Financial advisors help investors analyze various investment options and can help create a plan of action to meet their goals. Before investing in any passive income investments, consider talking with an advisor to understand how it fits within your portfolio. Finding a qualified financial advisor doesn’t have to be hard. SmartAsset’s free tool matches you with up to three vetted financial advisors who serve your area, and you can interview your advisor matches at no cost to decide which one is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, get started now.
When investing your money, it is important to diversify your assets among many different types of stocks and bonds. This helps you gain exposure to multiple sectors of the market and benefit from their growth. Our asset allocation calculator helps you select a profile that’s right for you based on your answers to simple questions.
Mark Henricks
Mark Henricks has reported on personal finance, investing, retirement, entrepreneurship and other topics for more than 30 years. His freelance byline has appeared on CNBC.com and in The Wall Street Journal, The New York Times, The Washington Post, Kiplinger’s Personal Finance and other leading publications. Mark has written books including, “Not Just A Living: The Complete Guide to Creating a Business That Gives You A Life.” His favorite reporting is the kind that helps ordinary people increase their personal wealth and life satisfaction. A graduate of the University of Texas journalism program, he lives in Austin, Texas. In his spare time he enjoys reading, volunteering, performing in an acoustic music duo, whitewater kayaking, wilderness backpacking and competing in triathlons.