Working out how to invest your money can be tricky. There are lots of products out there, which makes research both daunting and time-consuming.
But fear not: this handy guide covers the pros and cons of 4 of the most popular investment options today. So read on and discover which option best suits your needs.
Robo-advisors might sound like something from a 1980’s sci-fi movie, but they very much belong to the present.
Robo-advisors are online platforms that manage your portfolio for you. You open an account, answer a few questions about your goals and risk tolerance, and the platform invests your money in a pre-built portfolio that normally consists of low-risk ETFs (Exchange Traded Funds), which pool your capital with other investors.
Consistent returns: Most robo-advisors focus on low-cost index-based ETFs, which makes for consistent growth over time. So if you’re patient, you’ll make healthy returns over the long-term. It also requires little effort — once you’ve set your goals and risk, the platform does the rest.
Low cost: As it’s an online platform, there are few operational costs, which means robo-advisors can charge clients a flat rate of 0.2% to 0.5% for full portfolio management. This compares favorably with financial planners who often charge considerably more, sometimes as much as 4%.
Limited focus on risk tolerance: How much of a loss are you prepared to take before you press the panic button and sell? While robo-advisors do ask you a few questions to establish your risk tolerance, this is no match for a proper evaluation. This could leave you wondering if the platform is doing right by your money.
There’s no human touch: Financial advisors can strategize and assess long-term financial goals in a way that goes beyond what robo-advisors can currently manage — although hybrid robo-advisors could be a game-changer.
Is it worth it?
If you want minimal effort and a steady return, robovesting could be ideal. But for bigger gains, I’d look elsewhere.
2. CDs (Certificates of Deposit)
CDs are savings accounts that pay interest over a fixed period. You’ll get a better deal if you make a longer commitment, with high yield CDs offering up to 3% APY (annual percentage yield) over a five-year term.
CDs offer better returns than savings accounts: the best savings accounts offer around 1.6 APY, around half of what the best CDs offer. The banks are being generous for one reason only: they want to lock customers into long-term fixed agreements so that they can make money lending their deposits.
CDs are secure: the FDIC insures CDs up to $250,000, which means you’re unlikely to ever lose your principal. There is therefore less risk attached to CDs than, say, bonds or stocks, which operate in a more volatile market.
Penalties can be high: It’s a fixed-term savings account, so early withdrawals come at a heavy cost. This could involve sacrificed interest or even the loss of your principal. Always check the early-withdrawal penalties before opening a CD.
There is a downside to fixed rates: A fixed rate means you might lose out on better rates on other products. However, some banks do offer bump-up CDs which give you added flexibility, allowing you to increase your interest rate at some point during the term.
Is it worth it?
If you’ve got a clear financial objective, like saving for a deposit on a home, then CDs could help. But you need to be confident you won’t need that money in the short term. Take note of the penalties for early withdrawal and understand that it takes time to shop around for the best CD — which is more time consuming than robovesting, for example.
3. The Stock Market
If you invest in the stock market you’re essentially becoming part-owner of a company. Of course, how much influence you’ll wield will depend on how many shares you buy. The stock market can deliver high returns, but it can also be extremely volatile.
The stock market can offer big returns: Especially in a strong economy. Think about it: if the economy grows, so do average earnings.
Economic growth means more jobs and more money, which means people spend and consume more, which means more revenue for those cash-rich companies whose shares you want to buy.
You can earn a passive income with dividends: A dividend is a cash reward given out to shareholders as part of the profit made by the company at the end of each financial year. The more shares you buy means the greater the dividend you’ll receive — which can make for a nice little nest egg in passive income.
You may have some influence: You might get a say in company policies, but only if you buy shares directly. If you’ve pooled your resources by investing in a mutual fund there could be thousands of other investors, in which case your opinion probably won’t matter a great deal.
It can be time-consuming: How much time depends on how involved you want to be. Day traders spend a lot of time pouring over financial statements and annual reports to try and beat the market, but you don’t need to do that.
A smarter move might be to invest in mutual and index funds, which are run by a professional advisor and are a simple alternative to trading individual shares. Yeah, you might not earn megabucks, but you can still make a tidy profit and it’s a lot less stressful.
You can lose all your money: A company can go broke or perform poorly. If this happens investors will sell, sending the stock price into free-fall. When you sell, you may lose your principal. Because the market is volatile, you’re more likely to lose money if you’re trying to make quick, short term gains.
If you’re concerned about losing your money, then bonds could be the answer. Bonds come with a fixed income rate and companies are contractually obliged to pay the interest or risk being stripped of assets. There’s no such penalty with stocks. And of course, mutual funds are another option.
Is it worth it?
Some investors fear the stock market will be too difficult, expensive, and risky. But this is not always the case. Mutual funds and other ETFs are perfect low-risk products for those who don’t want to be hands-on, and you can start trading in stocks for as little as $500.
As for the risks, well, common sense goes a long way. For example, don’t invest all your savings in one company. Diversify your portfolio by investing in different stocks. This strategy is the best way to gain excellent, low-risk returns.
4. Peer-to-Peer Lending Platforms
Like robovesting, peer-to-peer (P2P) lending takes advantage of an online platform to simplify the investment process and cut down on fees. But with P2P lending you’re investing in people rather than corporations.
Borrowers sign up online and apply for low-interest loans. An algorithm matches them with investors (lenders) who chip in to help them reach their target. Once the loan is approved, lenders earn interest.
Where banks make money lending your deposits, P2P lending cuts out the middleman. You lend your money directly — and get a much bigger share of the profit.
You are in control: Unlike robo-advisors, P2P lending platforms give you greater control over your portfolio. At Constant, for example, lenders set amounts (no minimums or maximums), rates of return, and the investment term. Constant then matches them with borrowers happy with those conditions.
You get great returns on your investment: Most P2P platforms will encourage you to invest in both high risk and low-risk borrowers in the form of “notes’” which come in different size denominations. By blending your portfolio with a variety of notes, you can easily earn between 3% and 6%, and earn even better returns on riskier loans.
But at Constant, this process is even easier. We don’t categorize borrowers by risk as all loans are over-collateralized. Borrowers put up to 150% of the loan in collateral, which means interest rates can go as high as 10% (as of 7 Jan 2020, the market rate is 8%). This means the lender doesn’t have to waste time worrying about calculating the risk for every loan.
People can be unpredictable: You’re investing in people and people can default for any number of reasons. You should also bear in mind that some borrowers use P2P platforms because they have a poor credit history and have been unable to get more conventional loans from banks.
When investing P2P, always ensure the loans are backed by collateral. Constant only accepts liquid collateral in the form of cryptocurrency (which many people hold for the long term in anticipation of its value increasing). That means it can be sold quickly if the borrower defaults.
Overconfidence can lead to losses: on one hand, the user-friendly nature of P2P platforms combined with the ability to view borrower profiles makes for a convenient investment process. But it’s not unheard of for more gung-ho lenders to get carried away by the simplicity of it all and invest more than they should.
Is it worth it?
No red tape is a definite plus with P2P lending, and although the default risk is high, you can avoid this completely by only investing in loans secured by collateral. And for the more adventurous, by breaking your investments into smaller amounts to dilute the default risk. It’s a simple and rewarding way to invest your money.
The Bottom Line
Recent inventions like robovesting and P2P platforms are great for first-time investors looking to invest in user-friendly products that don’t require a hands-on approach. Particularly P2P platforms that secure loans with collateral that’s easily liquidated should the borrower default.
While robovesting’s low fees and potential for strong returns are attractive, it can limit your options. More traditional fixed-rate products like CDs require more research and paperwork. You’ll also need to touch base with a bank to open an account. CDs are suited to people who have savings they can lock away for a long time.
The stock market has the highest potential yield, but the market can be volatile and if you want to be more aggressive in your investments you’ll need to spend time figuring out how it all works.
Investing in bonds is less risky but the returns won’t be as high. Index funds are also an option if you’re happy to pool your resources and would prefer someone else to manage your affairs for you — but you’ll need to pay them to do it.
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