Faced with an array of investment options available it can be overwhelming today to decide where to put money. Whether you are new to investing or an old salt, it sometimes helps us to have some sort of guide to investments before we commit our hard earned cash. Our goal of course is to get the biggest bang for our buck, and to make our money grow without putting too much effort into it. I know because as I write this article I am faced with the same decisions my readers might be. It does not matter if you’re going to devote a hundred or a billion dollars, you have to have some sort of strategy. Well do not worry I am going to give you some tips that have worked for investors big or small for years.
You may or may not have heard of Modern Portfolio Theory (MPT), which is most often accredited to Harry Markowitz. Markowitz introduced MPT way back in 1952, so it’s probably not what most of us would consider a modern theory by any means. The MPT basically attempts to reduce risk and maximize potential return by carefully choosing various assets to put your investment capital into. MPT has been criticized by many because it does not take into account that markets today are not rational. Despite criticism MPT still works today. Basically in a nutshell MPT is diversification at its best.
Okay enough about what MPT. Hopefully you have not gone to sleep on me, because with all that information we still have not gotten to the point of why you’re reading this article in the first place. You came here to help you decide where to put money.
Let us at least start with a short list of places you could devote your money. But do not despair. Hopefully you will come away from this article with some strategy as well. If you get bored reading about the types of investments do not leave, but feel free to skip ahead to the last few paragraphs because you do not want to miss the tips there. I even marked it for you.
Stocks: I’m going to assume you know that stocks represent ownership in a company. When you buy stocks you become a business owner whether you intended to or not. Keep in mind if you own common stock in a company you will be the last one to get your money if the business closes shop. As you probably know stocks are usually traded on the stock market, but that is not the only way you could buy stocks. Stocks can be a volatile investment, but are a very popular choice among investors. You sometimes hear how someone made it big with the stock market.
Bonds: Again I’m going to assume you know that bonds represent a loan to a company or institution. When you buy bonds you are essentially giving a loan to a company or institution like the U.S. Government. As the bond holder you get interest payments and the principal back at sometime in the future. Bonds are sometimes used by an income investor to have a steady income stream that is backed by the underlying security of an asset or guarantee from the company or institution to repay the principal. Bond holders get their money before stock holders do if the business closes, and they are considered safer than stocks.
Real Estate: By real estate I am not really talking about your own home. Although that may be your largest investment I do not really consider your own home an investment, and if you have ever read one of Robert Kiyosaki’s books you know what I mean. You can invest directly into real estate by owning a piece of real property that provides return on your investment through both income (such as rents) and appreciation. Wealthy people often have some part of their portfolio in real estate, but keep in mind they understand real estate investment strategies.
Commodities: Commodities are investments in things like gold, silver, copper, oil, and the like. They are basically items that are marketed to satisfy needs of consumers. Commodities can be very volatile investments. You really have to know what you are doing when risking your money with them. With commodities trading you could not only lose your entire investment capital, but you may even lose more which you have to pay up when a trading contract expires. Some commodities trading is used as a hedge or bet that prices in the future will be higher or lower than they are now. You can be on both sides of the bet.
Bank Savings Accounts/Certificates of Deposit/Money Market: I put these three into one asset class because they act very similar. I assume you know what a bank savings account is and that they pay you interest on your money deposited with them. Certificates of Deposit (CD) are very similar except you have to keep you money invested in the CD for a certain period of time or pay a penalty. Money markets are similar to savings accounts, except the bank loans your money out usually overnight to companies, other banks, etc. and pays you interest in exchange. With money markets your money is basically floating around out there somewhere when you are not using it. Banks pay low interest that does not keep pace with inflation. So that is why these places are not really good for investments, but they are a good place to save your emergency funds and what you will need access to in a short time. Chase Bank is paying me .01% on the money I have there, and that is one of the reasons why I am dumping them for Ally Bank.
[SKIP TO HERE IF YOU WANT] These are just a few places you could place your money. So how could you invest in all those places in an attempt to stay diversified without a whole lot of work? One way would be with mutual funds. They can offer you a way to diversify your investments and give you nice returns without all the hard work managing your portfolio. With a mutual fund, you could own a piece of hundreds of different stocks, bonds, real estate, some cash, and commodities all wrapped up into one fund. Mutual funds have a value at the end of each day based on the value of the underlying investments. There is a fee charged by the mutual fund manager to manage the investments and sometimes there can be upfront fees to invest in them and even fees to sell them which are called a “load.” However, there are plenty of mutual funds without loads. Mutual funds can be good for most investors, because they spread the risk like MPT does. Mutual funds do have less upside potential than individual stocks mostly because of the fees.
But wait here is another strategy. What if you do not like mutual funds and think they were a thing of the past? Or what if you cannot find a mutual fund that invests the way you want to diversify? That is where exchange-traded funds or ETF’s come in. An ETF is like trading stocks or bonds or real estate or commodities, but they can also allow you to be in a certain sector or track an index like the S&P 500 or the Russell 2000.
Here are some ETF’s you might consider, but keep in mind these are strictly stock ETF’s.
SPDR S&P Dividend (SDY). This ETF has $9.29B in assets and attempts to track the performance of the S&P High Yield Dividend Aristocrats Index. They have posted 5.93% YTD returns for 2012 and 18% 3-year returns as of April 29, 2012. The cool thing is they also pay dividends, and dividends are hot right now. Having a stock with a dividend is a great way to invest long-term and have income now. Just ask Berkshire and Hathaway, they know about dividends.
iShares S&P U.S. Preferred Stock Index (PFF). This ETF has $8.49B and tracks a select group of stocks. It has posted a 10.77% YTD return and 21.99% 3-year return as of April 29, 2012. This ETF also pays dividends.
I’m over 1,400 words in this article alone (I know a no, no) and we just barely touched the surface on how you could diversify with ETF’s. Stay tuned for more articles in the future to cover diversification investing strategies with ETF’s.
