Where Should You Put Your Money?

Even a small nest egg should be divided among several investment options - understand what this means to you.

It is never too late to start saving money! In today's competitive investing environment there are many options open to you, the investor. With all of these options, how are we supposed to choose which is right for us? The answer is all of them. Do you remember your mother telling you not to put all of your eggs into one basket? It is not likely that she was talking about investing, but that advice will hold true for anyone who is looking to maximize his or her investment portfolio. About 15 years ago a study was done about the performance of investment portfolios, concluding that only four elements contribute to investment results. These four elements were individual security selection, market timing, costs, and asset allocation. The most important of these was asset allocation, as 95% of the investment results were attributed to how money was divided among the assets, like stocks, bonds, and cash. Asset allocation, or diversification, means dividing your assets among several investments to minimize your risk and maximize your return.

Savings Accounts

The simplest and safest way to save your money is in a savings account. Although a savings account has a relatively low rate of return when compared to other forms investments, it is insured by the federal government for up to $100,000. This guarantees your money to be safe in the event of bank failure, fire, flood, or any other event. Another advantage of a savings account is that the funds within it are relatively liquid, or easily converted to cash.

Certificates of Deposit

Another way to make your money grow in a relatively safe environment is through the use of Certificates of Deposit, or CDs. These are purchased for as little as $500, but generally cost $1,000, $5,000, or $10,000. A CD generally returns a fixed rate of interest over a specific amount of time. These are good short- to medium-term investments as they are an interest bearing, FDIC insured debt instrument.

U.S. Savings Bonds

A U.S. Savings Bond is a registered, non-transferable bond issued by the U.S. Government, and backed by its full faith and credit, an unconditional commitment to pay interest and principal on debt, with face values ranging from $50 to $10,000. A U.S. Savings Bond earns interest through a market-based savings bond rate. The savings bond rate is a percentage of market yields on outstanding five-year treasury securities. There are two types of U.S. Savings Bonds, the Series EE bond and the Series HH bond:

Series EE: Available at most banks and through payroll deduction, these are purchased for 50% of their face value, or the amount the bond is worth when it matures. These types of bonds reach maturity in 8-12 years and are exempt from state and local taxes, meaning you don't pay any taxes on the earnings received from this type of investment. A Series EE bond can earn interest for up to 30 years, with the earnings payable upon redemption. This type of bond cannot be redeemed until six months after its issue date and, if it is redeemed within five years, the holder will not receive the three most recent months' interest.

· Series HH: These are purchased at face value from a Federal Reserve Bank or through the Treasury, and can only be purchased by trading Series EE bonds that have reached maturity. These bonds will mature in 10 years, with the interest paid semi-annually via check or an electronic funds transfer to the bondholder's bank account. The interest earned on a Series HH bond is also exempt from state and local taxes.

U.S. Treasury Securities

The final type of savings investment is U.S. Treasury Securities. There are three different types, which are sold in multiples of $1,000, $5,000, and $10,000:

· T-Bills: A negotiable debt obligation issued by the U.S. government and backed by its full faith and credit, an unconditional commitment to pay interest and principal on debt, having maturity of one year or less. T-Bills are exempt from state and local taxes.

· T-Bond: Carries the same guarantees as a T-Bill, but it carries a maturity of more than seven years.

· T-Note: Same as T-Bill, with maturity occurring between one and seven years.

All of the previous investment options are quite safe, offering relatively low returns on the initial investment. As an investor, if you wish for higher returns, you are forced to take more of a risk when investing your money. The following are types of investments in which you will incur a greater risk, but also the opportunity for higher returns or interest earnings is greater.

Stocks

A stock investment may provide the best long-run rate of return, but over the short and intermediate term they have a tendency to fluctuate. By purchasing shares of a common stock, you are becoming a part owner of the company. If the company does well over time, the value of the stock should go up. About 80% of large companies distribute a portion of their profits to shareholders in the form of dividends, a taxable payment declared by a company's board of directors and given to its shareholders out of the company's current or retained earnings. A dividend is usually given as cash, but it can also take the form of stock or other property. The advantage of stock investments is that, over the long run, the market will continue to grow. It is absurd to think that, over time, the world's economy will shrink. If you are willing to keep your money invested in a stock regardless of the market cycles, you will find that stocks tend to pay the highest rewards. Any assets you won't need for 10 or more years should be invested into stocks.

Bonds

For an investment that is under 10 years in length, you should consider a lower risk asset like a bond. The rate of return for a bond is about half that of stocks, so over the long run bonds will become an opportunity cost to you, the investor. When you purchase a bond, you loan money to a company or a governmental unit. In exchange for the loan to the company, the borrower, or bond issuer, promises to repay the initial investment with interest. The price of a bond will fluctuate as the interest rates fluctuate. When investing in municipal bonds, which are used to finance capital projects for the public good, investors will receive a lower rate of return in exchange for having income exempt from federal income tax. A "Junk Bond" is a type of speculative high-risk, high-interest rate bond; the default rate is much higher on these types of bonds. The amount of bonds that you should hold should be directly related to the amount of income you will need over the short run.

Mutual Funds

Perhaps the safest type of higher-risk investment is the mutual fund. A mutual fund is an investment corporation that pools together investor's money to purchase stocks and bonds. The advantage offered by this type of investment is that it is diverse and not dependent on the performance of a single stock or bond. Over the years, mutual funds have been an attractive investment offering not only convenience and diversity, but also a record of performance to the individual investor. When you choose a mutual fund, you should consider your tolerance for risk, need for returns, and the timeframe in which you intend to invest. As with all investment options, there are many different types of mutual funds that you, the investor, may choose:

· No-Load Funds: This is a type of fund that is sold without a fee. These are generally sold directly from the fund rather than through an intermediary, who would add a fee for the services rendered.

· Large Cap Funds: These are comprised of companies that have a large capitalization, or sum of a corporation's long-term debt, stock, and retained earnings. These funds include the "blue chip" stocks, and their performance has averaged 10%-11% return each year for a half century.

· Small Cap Funds: Composed of companies having small capitalization. These funds tend to include start-up companies whose stock prices have done well in recent years. If you were looking for tomorrow's Microsoft, these funds would be the place to look.

· Utilities Funds: Investments made in America's utility companies. Traditionally, these have been the steadiest and most conservative investments. In recent years, with the strong performance of telecommunications stocks and the gradual deregulation of many utility investments, a higher risk has been taken on utilities, which, in turn, can mean more reward.

· Money Market Funds: An open mutual fund, which invests only in money markets. A money fund only invests in highly liquid, short-term debt securities, such as commercial paper, negotiable certificates of deposit, and Treasury Bills. These investments carry a maturity of one year or less, and often are 30 days or less. These tend to be safe, highly liquid investments. In recent years, money market mutual funds have gained popularity as an alternate savings vehicle.

· Market Neutral Funds: An investment vehicle for the investor who wants to grow capital at a reasonable rate with reduced exposure to market fluctuations.

Real Estate

The single biggest investment for the average investor, real estate, is quite often overlooked. Just like any other investment, a home can either appreciate or depreciate in value. Real estate investment is not limited to home ownership, though. One can purchase a publicly traded Real Estate Investment Trust, REIT, which is similar to a mutual fund in operation except that it invests in real estate. REIT investing tends to be a complicated investment option. Before you consider this as investment vehicle, you may want to do some research.

Other Investments

There are other types of investments available to you, but most often these tend to be a bit riskier. One of these is Futures Contracts, which are commitments to buy or sell a specific amount of a commodity at a specific future date and price. These tend to be very speculative investments and should only be used by those with the financial means to take such a high risk. If you should choose to practice this type of investment, it should never be more than a small portion of your portfolio. Another of these high-risk investments is through the purchase and sale of collectibles, such as stamps, antiques, and sports memorabilia. This is a type of investment that can be a hobby, as oftentimes there is great satisfaction in building a collection. The problem with collectibles is that they pay no interest or dividends and are dependent on an increase in value over time for return on the investment. The rewards and losses both have the potential for being great.

Goals

The key objective of asset allocation is to produce liberal returns over time while taking the very minimum possible risk to generate them. As you decide where to invest your money, you must consider the following factors - yield, risk, and liquidity. It is now time to decide which markets to enter and which to avoid. After this is done, you must then decide what portion of your assets to put in each class, cash or cash equivalents, stocks, bonds, and real restate, in order to reach your goals. How you allocate your assets among these classes is a critical investment decision, as 95% of your portfolio's performance is attributed to asset allocation.