So You’ve Got Some Cash…
However you got it, you’ve got it now. Cash, and a good chunk of it at that. The big question for you now… Where are you going to put it? When you realize the mattress isn’t a good place to stash it, read on for some ideas!
A Question of Safety and Duration
- Don’t Stick it Here… Courtesy of bedzine
Before you choose what you’re going to do with your money, you need to ask yourself two basic questions.
- When will I need this money?
- How much risk can I stomach?
Your time horizon is the single most important factor in determining your investment. A quick rule of thumb is for any money you will require in the next 5 years, (say, a house down payment on a house or a wedding) you should find a low-risk, stable value investment. If you have a longer horizon, you can ratchet up the risk a bit to juice your returns (of course, with no guarantee of success!).
Mostly Short Term, No (Or Extremely Low) Risk
The lowest risk investment in existence is generally considered United States government debt. Government debt comes in various forms and durations. Treasury Bills, also known as ‘T-Bills’, are ultra-short duration bonds issued with maturities between 28 and 364 days. Treasury Notes, ‘T-Notes’, mature in 2 to 10 years. Treasury Bonds mature over a longer period (up to 30 years). The last option is the Treasury Inflation-Protected Security. It offers a yield of a fixed amount which is increased by the amount of measured inflation. You can buy all of these securities directly from the Treasury at TreasuryDirect. Tax information can be found on this site.
In the ‘slightly more risk’ category are the various bank options. Certificates of Deposit (although currently offering low yields for short maturity CDs) are a solid option for short term investing. Ratchet up a ladder of CDs, say 3 months, 6 months, 9 months, and a year, and when the CDs mature, roll them into a year long CD. Other bank options are money market funds, savings accounts, and even new high-interest checking options. Visit the Bank Deals blog or BankRate.com for a better overview of bank options than I can provide in this post. Most banking products are guaranteed by the FDIC.
Various Ranges, Some Risk
Moving into the ‘even more risky’ category, you’ll get more yield for more risk. Municipal bonds are a prime example. They are generally free from federal and state taxes (if you get an bond issued in your home state). Because of this, you shouldn’t look at the yield but the ‘tax equivalent yield‘. Here’s an example calculation:
Joe Sixpack, our hero, makes $50,000 a year in California. He pays a marginal tax rate of 9.55% to the state and 25% to the federal government. He calculates the tax free yield of a 4% municipal bond:
Calculation: 4% / (100% – 34.55%) = .04 / .6545 = .0611, or a 6.11% tax equivalent yield. The higher your marginal tax rate, the better the equivalent yield.
For more information on municipal bonds, see this site. Note that while municipal bonds are safe, they can default.
Corporate bonds are another option. Bonds are rated by rating agencies which estimate the quality of the company’s debt. The yields offered on corporate bonds are generally higher than the yields on the other securities mentioned because of the perceived and actual risk of investing in single companies. You can research corporate bonds through your broker.
Risky and Possibly More Rewarding…
Now moving into longer durations of investment duration, we can discuss securities such as stocks and REITs (Real Estate Investment Trusts). Over a long enough timeline stocks often will appreciate faster than any other investment (except when they don’t!). You can invest in individual securities or ETFs (exchange traded funds) or Mutual Funds, which will spread out your risk to many companies. See Morningstar for a great source of information on securities and mutual funds.
Wrap it Up…
I leave you with a chart from William Bernstein. Bernstein is a fan of encouraging investors to passively invest their stock portion of their portfolio in funds that track market indexes. Get his book for a full exploration of his findings… it’s chock-full of great information on historical asset class returns over a long time period. Of course, this table would need some updating from the last 11 years, but surprisingly not as much as you think.
| T-Bills | 3.77% |
| 5-Year Treasuries | 5.31% |
| Large Stocks | 11.22% |
Figures denote historical returns, 1926 – 1998, courtesy of William Bernstein in The Intelligent Asset Allocator
For your money you don’t need soon, stocks and funds are the way to go. I’ll take a look at some more exotic investments in future articles, and examine the tax equivalent yield of debt. For now, dig the money out of your mattress and put it to work!
Coins thumbnail originated from www.flickr.com/photos/26887305@N00/26249105.
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