Do you know how to invest $5,000? If not, you can ask yourself a few questions and you’ll know how exactly how to invest that money. You can use these same questions to decide how to invest $500,000 too.
Please understand that investment decisions are rarely made just based on returns. You also have to consider your investment time frame and appetite for risk. For a simple way to balance all these needs, I suggest you use a point system. Ask yourself the following questions and score your results. If you have a high total score, consider investing in growth mutual funds or exchange traded funds. If you score somewhere in the middle, split your $5,000 between growth and fixed income. This is the sweet spot if you’re looking for the smart investments for retirement income. If your score is on the low side, you can’t afford much risk. Deposit the $5,000 in the bank. (This assumes that you have no credit card debt. If you do, my strong recommendation is to forgo the investments right now and just get out of credit card debt. The interest they charge is much higher than you can reasonably expect to earn on your investments.)
1. When do you need to spend this money?
If you need the money within a year or two, deposit it in a bank. I know the interest rate is very low right now, but that doesn’t matter. The liquidity value (the accessibility) is more important. Say you need that $5,000 to pay for a home repair project next year. You know that if you invest the money and lose it or portion of it, you won’t have the money to do the job. If you can’t take that risk, you can’t invest in anything that exposes your money to any risk whatsoever. The only investment that provides that kind of safety is a bank.
If you don’t think you’ll need the money for two to five years, you might consider a hybrid approach. The longer the investment period, the more you might weight your investment allocation toward growth mutual funds.
If you can’t imagine a situation where you’d need to use that $5,000 within the next 10 years, you can invest for growth.
Bank CD – 0 Points
Hybrid – 5 Points
Growth – 10 Points
YOUR SCORE ______
2. Do you need the income now?
Keep in mind that with $5,000, you’ll earn about $250 a year if you can earn 5%. At 2%, you’ll earn $100 in interest each year. As you can see, $5,000 doesn’t generate that much income. If you really need a lot more income, search for a second job. Don’t try to earn very high rates with this small amount of money. If you do, you’ll risk losing it all.
With that in mind, do you want to invest to create income now?
Yes __ 5 Points
No __ 10 Points
3. What’s the most money you ever lost, and how did it make you feel?
If you invest money, you’re going to experience losses sooner or later. The question is how do you react to those losses? Let’s look at the extremes: if you barely flinched when you lost everything on a hot tip, that’s one thing. If you went into a vegetative state when your account went down 5%, that’s another story.
How do you react to investment losses?
I can’t stand losing any money whatsoever. _ 0 Points
I’ve lost 10% or less before. I didn’t like it, but it didn’t bother me all that much. _ 4 Points
I’ve lost 20% and learned to accept it. _ 7 Points
I’ve lost more than 20% and it didn’t bother me in the least. _10 Points
Neal’s Notes: If you are concerned about huge market drops and protecting your money, consider using graphs to guide your investment decisions.
4. Do you expect your investment to make money every single month and year?
When you receive your investment statements, how do you react?
If they don’t show investment gains each month, it really bothers me. _0 Points
If I see my account drop by 5% from one month to the next, I can tolerate it. _ 5 Points
I don’t even look at my monthly statements. _ 10 Points
Based on your results, you should know how to invest that $5,000. The highest possible score is 40. The lowest is 5. As I said, the higher the score, the more you might consider weighting your investments toward growth. A higher score means you can tolerate risk. A lower score means you can’t.
For a more detailed discussion of advanced investment terms, read “Price to Book Ratio.”)
photo by Qole Pejorian, Flikr