Investment Advice for Dummies - The Basics

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We’ve all heard about how the more you risk take on the higher your potential return can be. The problem is how do you find the right balance between risk and reward? Industry investment advice says that the younger you are the more investment risk you can take on because you’ll have time to make up those losses should you experience them. As you get closer to retirement age, taking on less risk makes more sense because you don’t want to have large swings in the balance of your account. 

Let us start with the low risk and low reward investments. 

This includes keeping your cash in a checking/savings account or certificate of deposit (CD). What are CDs? When you put your money in a certificate of deposit, you are loaning money to the bank for X amount of time. Usually somewhere between a month and five years. Unlike a checking or savings account, you will not be able to withdraw that money for X amount of time. If you do so, you will be charged a penalty. The penalty can vary CD to CD. For example, on a one year CD, Bank of America has been known to charge $25 in cash plus 3 percent of principal for early withdrawal. While, Bank of the West charges a penalty of only 30 days of interest.

In exchange for putting your money in a CD, the bank will give you slightly higher interest rates compared to the checking/savings account. If the bank is a FDIC insured bank, that CD is safe. Should the bank default, if your deposit is less than 250,000, the government will give you that money. If you keep your money in a checking or savings account at the current interest rates you will probably earn less than 1% return on your money. With CDs the longer your terms are the higher the payout is. So for example, if you have a CD for 6 months versus a CD for 3 years, the CD for three years will have a higher interest rate. Though at current market levels, in my opinion, for the additional time (6 months to 3 years) you keep your money in a CD, is not worth the additional payout. With these investments, the upside is low, but so is your downside. 

Moderate risk investments include bonds and mutual funds.

Even within bonds there are different risk levels. You have treasury bonds, which are issued by the government and work a lot like CDs. They may have slightly higher rates of returns than CDs, but the terms are for longer periods of time. A CDs can be as short as one month, but bonds usually are for multiple years. Alternatively, you can invest in treasury bills, which are shorter term investments also issued by the government and are comparable to CD terms. Because treasury bonds and bills are issued by the government, they are considered safer investments.

Corporate bonds are issued by corporations looking to borrow money. They are slightly more risky because should the company default, you may or may not get your money back. The upside is that they offer slightly higher rates of return than treasury bonds. Compared to treasury bonds, corporate bonds can provide returns of on average 5% annually whereas the treasury bonds average less than 3% at current levels. With mutual funds, investment companies create portfolios that includes both stocks and bonds thereby spreading the risk out. This might be a good way to go if you don’t want to bother with making your own investment picks. The highest consistent average return I’ve seen for mutual funds is about 10% annual return. 

On the other end of the spectrum (higher risk investments) you have stocks. Unlike bonds and CDs the return is less certain. The return on stocks depending on your time frame can range from -100% to 200% or even 300% return. However, there are certain techniques that can help you manage your risk. Here is the best investment advice I can give newbie investing in stocks.

Based on today’s market conditions, putting your money in stocks and mutual funds is paying off a lot better than bonds, CDs, and bank accounts. It is without a doubt that we are still in a bullish market. Interest rates are still low, which lends to low borrowing costs. In addition, the federal government buying bonds has pushed the price of stocks to all-time highs. Still, there are a lot of risks involved in stocks and mutual funds and hedging that with CDs is not a bad idea.