Here’s an excerpt from note I got from a reader named Janice last week that pretty much sums up where a lot of Americans are right now. Take a look:
My husband and I are not big spenders. We save 20%-30% of our income every month. Our cars are paid off. We live in a house that we can afford and it is the only debt we have. We pay off our credit cards every month. However, we feel like we are not getting ahead.
We are coasting — but we don’t want to coast anymore. We want our money to grow faster than … well … not. We already have allotted 20k for emergency and that’s really all we need. Not sure what’s the next step. Try the stock market? What’s your advice for people like us who kinda have the right intentions and habits but just not the smartest game plans?
This sentiment is probably a common one. While there are indeed a host of Americans who remain in tough shape due to hardship like the loss of a home or job, millions more are fiscally secure right now … but just not getting anywhere long term.
If you’re looking to grow your cash but interested in keeping risk down, the best thing you can do is decide on an asset allocation and stick to it. That means picking how much money you need to keep locked up tight, how much money you want to take mild risk with, and how much money you’re willing to take reasonable chances with in the hopes of making it grow.
A decent rule of thumb is to subtract your age from 100, and that will tell you what percentage of your cash should be in riskier assets like stocks. The idea is to grow your money when you can take risk in your peak earning years, and to protect it as you get older and have no choice but to live off your savings.
Just in case this isn’t abundantly clear, here’s the breakdown.
- Age 35 – 65% risky, high-growth investments; 35% safe, slow-growth investments
- Age 50 – 50% risky; 50% safe
- Age 65 — 35% risky; 65% safe
- Age 85 – 15% risky; 85% safe
Here’s how I would categorize the most common forms of investment to help you build out your portfolio:
Safe, Slow-Growth Investments
Keep in mind, there is no thing as “no risk.” Consider that if you put a $10 bill in a safe in 1980, it would still be $10 … but thanks to inflation, that cash actually has lost some of its value. Capital preservation is important, but growing your money is important, too. So remember that these methods do little to grow.
High-yield savings or CDs: While it’s true that conventional bank accounts don’t yield anything right now, that’s no excuse to just park your cash in checking until you need it. “High-yield” savings accounts are out there from American Express (NYSE:AMX) and others that deliver about 0.85% in annual interest, with no minimum balance and the ability to withdraw your cash if you need it. Some CDs yield north of 1% but are inflexible and don’t give you ready access to cash or demand minimum balances. Of course, “high yield” is relative, since that rate may not keep up with inflation … but something is better than nothing. Sites like Bankrate.com allow you to compare rates and characteristics among savings vehicles.
Treasuries: The best low-risk alternative to cash is highly rated bonds. The safest of all safe havens is a U.S. Treasury bond. Interest rates are only slightly better than those savings accounts, at about 1.7% right now for a 10-year Treasury bond — but it’s a step up. You can buy Treasuries right from the U.S. government at TreasuryDirect.gov, but there are also mutual funds that do the bond investing for you. For instance, the Vanguard Intermediate-Term Treasury Fund Investor Shares (MUFT:VFITX) invests in Treasury bonds that are mostly three to 10 years in duration.
Other top-rated government bonds: Almost as safe as the federal government are local municipal bonds, or bonds from other top-rated nations like Germany or Canada. There is a little bit higher risk here, especially after the recent trouble in the eurozone and a few rare municipal bankruptcies in the wake of the Great Recession. But top-rated government debt remains almost as bulletproof as Treasuries, and can yield a bit more — 2% or higher.
Top-rated corporate bonds: Other alternatives are investment-grade corporate bonds from reliable companies. Bonds are really just debt, where you are the lender and you get paid interest as the corporation repays your loan to them. Companies like Johnson & Johnson (NYSE:JNJ), Microsoft (NASDAQ:MSFT) and ExxonMobil (NYSE:XOM) get top marks from credit ratings agencies because they have borrowed regularly for decades and always pay their bills. The safest corporate bonds yield between 2% and 4% right now. You can buy corporates directly through a broker — but if you’re really concerned with risk, a better option is to invest in a diversified corporate bond fund that spreads your money across a host of debt. Some bond funds like the Fidelity Investment Grade Bond Fund (MUTF:FBNDX) even add in some high-rated government debt to keep risk down and diversify your investment.
Riskier, High-Growth Investments
The risk of market declines should be obvious after the financial crisis. But keep in mind that since 2009 the major stock market indices have doubled — and have started to set new highs. Looking at the long-term performance of stocks, the trend is invariably upward … but you have to be prepared to let your investment ride and not punch out too early. That’s why as you age and as the need for capital increases, you shouldn’t be as exposed to risky investments because you may have to record a steep loss to free up cash for the bills, and then miss out on the rebound a year or two later.
If you have the money and patience to let your cash ride in a riskier investment over the long term, here are some tactics:
Index funds: Study after study proves that active management stinks. Why pay a boatload in trading fees and high-priced research tools only to lag the market anyway because some hifalutin trader picked the wrong stocks to buy? There are a host of low-cost index funds out there that give you built-in diversification to smooth out your performance. For instance, the very popular SPDR S&P 500 ETF (NYSE:SPY) gives you a little bit of the 500 stocks that comprise the well-known Standard & Poor’s index … and charges a mere $1 annually for every $1,000 you invest! You get built-in diversification across 500 of the biggest corporations on Wall Street at a great price.
Buy-and-hold dividend stocks: Over the long term, dividend-paying stocks are a powerful way to grow your portfolio or provide regular income. These investments deliver quarterly payouts to you simply as a way of saying “thanks for investing!” These dividend payers can deliver 3%, 4% or more each year in dividends alone — so even if shares don’t budge, you get a better return on your initial investment than in bonds. The risk, of course, is that if shares slide your dividends will be offset by losses in your investment. But if shares go up, you get paid twice. And if you don’t want to pick individual winners or if you want to focus on diversification, you have plenty of dividend-focused mutual funds to choose from.
Junk bonds: High-yield bonds are in favor right now because they deliver nice annual returns, sometimes as high as 6%. But this kind of debt is called “junk” for a reason — because the borrowers don’t have a very good track record or have risks that could prevent them from making payments. I would never advocate picking individual junk bonds, but some diversified mutual funds in the space allow you to spread your risk across a host of borrowers to offset any bonds that go bad. A good example is the Eaton Vance Income Fund of Boston A (MUTF:EVIBX), run by veteran portfolio manager Mike Weilheimer. Weilheimer has been watching the bond market since the late 1980s and knows what borrowers to avoid — fueling 9% returns on average across the past decade. Just remember that past performance is no guarantee of future success, of course.
One final note: Only you know what your retirement goals are, what your risk tolerance is, and what asset classes are best for you. I strongly advise that you do some research on all of these areas, and then that you consider spending a day with a registered investment adviser or some other financial professional who can create a custom plan.
There is no magic bullet here, and there is no sure thing. But arming yourself with information and teaming up with a financial professional can help you craft a plan to get ahead in the long term.
Jeff Reeves is the editor of InvestorPlace.com and the author of “The Frugal Investor’s Guide to Finding Great Stocks.” Write him at firstname.lastname@example.org or follow him on Twitter via @JeffReevesIP. At the time of publication, he had no positions in the securities mentioned.