by Jeff Reeves | October 16, 2012 7:11 am
If you fell into a windfall of $10,000 … what would you do with it?
For many Americans who are out of work or burdened with lots of bills, $10,000 would simply be a way to put out some fires and do damage control. These folks would probably need the money for day-to-day use or maybe an overdue expense such as a new roof on the house or car repairs.
Others who have been in lock-down mode on expenses may simply want to take a well-earned break from frugality and splurge on a vacation or new living room furniture.
But if you have the means and the discipline to invest, perhaps the best thing you can do right now is to take that $10,000 and put it to work by investing it. That’s doubly true if you’re behind on your retirement planning — or worse, if you haven’t even started saving yet!
You may think talk about a $10,000 windfall is fantasy, since you don’t get a year-end bonus and have no rich uncles set to die anytime soon. But even if you don’t get the chunk in one fell swoop, the figure is attainable for many. If you can save $200 a week — the amount that many American families spend simply eating out at restaurants — then you can save $10,000 in a year.
It’s not easy, to be sure, but it’s not impossible. And if you’re committed to long-term planning and a secure retirement, you really can’t afford to not to invest on some scale.
For those of you looking for ways to get started, here are five simple ways to invest $10,000 now:
Getting into the stock market can be intimidating, but mutual funds and exchange-traded funds (ETFs) allow you to invest with built-in diversification. And if you pick a low-cost fund that’s pegged to an index like the S&P 500 or the Dow Jones Industrials Average, you don’t have to worry about a money manager making crazy moves or charging you an arm and leg for his investment strategy.
That’s why I recommend beginner investors purchase a major index like the S&P 500 via mutual funds or ETFs. This ensures you’re diversified across a large group of companies and sectors. For instance, the S&P right now is made up of Apple (NASDAQ:AAPL[1]), Exxon Mobil (NYSE:XOM[2]), General Electric (NYSE:GE[3]) and other well-known companies across a wide range of businesses. Why not just buy a little bit of all those companies by buying the entire index?
Index-focused funds also have the advantage of lower costs because there’s no human manager making subjective stock picks. Whatever stocks are in that index are the ones you’ll own a share of. There’s no research, no overhyped marketing — just a static list of stocks picked by the people at Standard & Poor’s.
For instance, one of the cheapest S&P funds out there is the Vanguard S&P 500 ETF (NYSE:VOO[4]) with a measly 0.05% expense ratio. That means you pay just $5 in fees for every $10,000 you’ve invested. Quite a bargain!
Additional tip: If you have $10,000 to invest, you may be able to open an IRA and get tax benefits for this move. If that’s the case, I advise doing so.
A simple equation all investors should know is that 100 minus your age equals[5] the percentage of your portfolio that should be in stocks. For instance a 45-year-old should have 55% of his money in stocks, while an 85-year-old should have just 15% in stocks.
After all, stocks are risky — and as you get older you want to take on less risk.
So, if you have $10,000 and want to keep an eye on your risk exposure, the easiest way to invest it is to put a portion into a stock-focused mutual fund or ETF and then put the balance into bonds.
We’ve already discussed how to easily buy stocks with an indexed fund like S&P ETFs. And thankfully, similar investments allow you to put bonds into your portfolio. So, it’s just a question of figuring out your allocation, buying an index stock fund and plowing the rest into a bond fund.
Not any bonds of course — low-risk, investment-grade corporate and government bonds are the way to go. So-called junk bonds offer a higher rate of return[6], but that’s because they’re speculative and carry more risk. The purpose of a diversified portfolio is to spread your risk around, so you want to offset the chance of volatility in your stock holdings with a stable position. That means low-risk bonds, even if they may never burn down the house with huge returns.
If you limit yourself to investment-grade bonds, focusing on both corporate and government debt, and avoid funds that use risky strategies like options or swaps to juice returns, you’ll find that the vast bond universe gets narrow fairly quickly.
One such fund that fits these standards is the PIMCO Total Return ETF (NYSE:BOND[7]), which invests only in investment-grade bonds to get low-risk returns under the management of iconic investor Bill Gross. The fund gets five stars from Morningstar, and Gross has a long track record of outperforming his peers.
If reducing your overall risk by investing in a mix of stocks and bonds doesn’t float your boat, what about juicing your return by trying to invest with a more focused and active strategy?
This is actually easier than it sounds. All you have to do is buy a stock fund or a bond fund like we discussed earlier, and then leave a portion of your money set aside to bet on a specific stock or sector you like most.
Are you a gadget geek who owns everything that Apple makes and believe the company will change the world with the iPhone 5 and the next iPad? Then get “overweight” in the stock and tip the scales of your portfolio toward Apple.
It’s as easy as placing a little bit in this company to bet on its future independent of what you put in a broader index fund. That way you get the stability of a diversified portfolio but have 5% or 15% or whatever you choose in the specific investment of your choice.
The same goes for broad-based sector bets. If you believe health care is set for big growth[8] in the future as baby boomers age, you may want to tip the scales toward health care with an investment like the iShares Dow Jones US Healthcare ETF (NYSE:IYH[9]), which contains big names like Johnson & Johnson (NYSE:JNJ[10]), Pfizer (NYSE:PFE[11]) and Merck (NYSE:MRK[12]).
It’s riskier to make this kind of weighted bet on a sector or a stock, of course. But it can pay off big-time if you pick right. Consider that if you invested $10,000 in the S&P 500 five years ago, you would have $9,200 now — a loss of $800. But if you invested $9,000 in the S&P and then $1,000 in Apple stock, you’d have $11,370 — a profit of $1,370 in the same period.
If you trust your instincts and are willing to take a little more risk, this is the way to go. I would never advise putting all of your money in a single investment, but getting “overweight” in a company you believe in can be a great way to beat the market.
If you already have a 401(k) with a diversified portfolio of stocks and bonds, or if you feel like you have the sophistication to build your own investment portfolio, it’s really quite simple to make your own moves — and potentially beat even the “smart money” on Wall Street.
Start by picking a handful of stocks you believe in, preferably in different sectors for diversification and stability. Then just divide your $10,000 nest egg and build your own hedge fund!
Intimidated? Don’t be.
Consider that the Dow Jones Industrials is made up of 30 stocks that collectively have a five-year return of -5%, thanks to the financial crisis. If you decided to cherry-pick your favorite five Dow components, presuming they were in the top half of that list, you would have significantly outperformed the market.
By way of example, let’s say that in 2007 your favorite Dow components were financial stock JPMorgan (NYSE:JPM[13]), tech stock IBM, retailer Wal-Mart (NYSE:WMT[14]), energy giant Exxon and pharma giant Pfizer. That’s a pretty diversified portfolio of big-name stocks, giving you a wide swath of the market. So you put $2,000 in each pick for $10,000 total.
Collectively, these stocks have returned 25% in the last five years — turning your nest egg into $12,500. That’s impressive in itself, but even better since the broader Dow Jones is in the red in the same period!
Obviously, the risk here is that you pick the wrong stocks and actually underperform the market. But as this example shows, it’s not like you have to find some little-known company that’s a huge risk. Simply by being smart about the sectors and companies you invest in, you can significantly outperform the broader stock market.
Of course, it’s worth noting that there’s no need to limit yourself to investing only in the stock market or bond funds. Many good ways to “invest” a $10,000 windfall have nothing to do with capital markets.
What if you want to go back to school for an advanced degree or get training for a new career? That’s a great way to invest in yourself — and presuming you’re happier or better paid in your new vocation, the returns will be very substantial on that investment.
What about paying down your existing debts? If you’re getting charged 3% annually on a car loan or 10% annually on credit card debt, by paying off that balance you’ll not just eliminate a monthly bill but you’ll save the interest charges. Those are real returns that shouldn’t be overlooked.
Or how about something more abstract, like using the money to start your own business? If you want to set out as a contractor remodeling bathrooms and kitchens, you might need some more tools. If you want to start a catering business, you may need new kitchenware and a bigger oven. If you want to sell just about anything online, you may need a Web designer to build you an e-commerce platform.
Buying mutual funds or stocks is the traditional way to invest, but many other options are out there for you. And unlike capital markets, many of these investments could get you more in touch with your interests professionally. That’s a win-win.
Jeff Reeves[15] is the editor of InvestorPlace.com and the author of “The Frugal Investor’s Guide to Finding Great Stocks.”[16] Write him at editor@investorplace.com or follow him on Twitter via @JeffReevesIP. As of this writing, he did not own a position in any of the stocks named here.
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