Laura answers a podcast listener's question about how to invest money for higher returns. Find out how much and where to put your money so you create financial security without taking too much risk.
In order to reach big financial goals—like having enough for a comfortable retirement—you’ve got to invest money on a regular basis as early as possible. But investing also means that you could possibly lose money.
The potential for investment risk creates a tension that keeps many people from getting started investing in the first place. Or they they may save money in an ultra-safe place, like a bank savings account, that only earns fraction of a percent each year.
I recently received a question from an anonymous Money Girl Podcast listener about this topic. She or he says, “I have about $20,000 sitting in a savings account losing value. I haven’t put it in an IRA because I’ve been worried that I’ll need the money. But I’m also worried that I’ve waited too long to start investing because I’m in my early 40s. If I go ahead and max out an IRA, how should I invest the rest?”
In this post I’ll answer the listener’s question with recommendations for how to invest money wisely. You’ll know exactly how much and where to put your money so you create financial security without taking too much risk.
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What Money Should Be Invested?
There’s one rule of investing that you should always remember: Never expose your money to more risk than is absolutely necessary to accomplish your goals.
That means you have to take a step back and be clear about why you’re investing in the first place. It’s critical to know when you’ll need to spend the money you plan to invest, because that determines what you should do with it.
If there was no risk to getting a big return on your money, everyone would run to the highest-yielding investments. But high return investments usually bring higher risks, so they need to be used carefully.
For instance, a stock mutual fund with an 8% average return over the previous 12 months is riskier than a bank savings with a guaranteed 0.5% return. If the financial markets decline, you might earn much less than you expected from the mutual fund—but the savings account has no volatility and will always pay a reliable, but very low, return.
It’s critical to know when you’ll need to spend the money you plan to invest, because that determines what you should do with it.
If your long-term goal is to have a nest egg that allows you to stop working and to maintain your existing lifestyle in 20 or 30 years, keeping money in a safe place—like a savings account or a low-yield CD—simply won’t get you there.
For example, if you save $500 a month in a bank account with an average return of 1% over 30 years, you’ll accumulate about $200,000. But if you invest the same amount over 30 years with an average 8% return, you’ll have close to $750,000 to spend. That could make the difference between scraping by or being comfortable in retirement.
Therefore, taking calculated investment risk is an important part of your financial life. Without it, your money won’t grow fast enough to achieve your long-term goals. Keeping money safe and cozy in a low-interest savings account stunts its potential and doesn’t give it the opportunity to grow.
The reality is that not taking enough investment risk might actually be the riskiest move of all! That’s because you could fall short of your goals or run out of money during retirement.
Whether you avoid risk intentionally or have simply been procrastinating investing, the result could be devastating to your financial future. So I’d encourage the anonymous podcast listener to get started investing as quickly as possible. I’ll explain where to invest in just a moment.
See also: 8 Tips to Invest Without Too Much Risk
What Money Should Be Saved (and Never Invested)?
But what about short-term goals, like building an emergency fund, buying a car, or putting a down payment on a house in a few years? As I mentioned, the timing for spending your money determines what you should do with it.
The money you want to use for short-term goals should not be exposed to market volatility. In other words, money that you might need to access quickly should never be invested because there’s a real possibility that an investment could drop in value at the moment you need it.