For those investors with a great deal of money to burn, perhaps riskier investments might make sense, but if $1,000 represents a significant chunk of the savings for you or your family, the tortoise approach to investing is probably the wisest course of action.
Starry-eyed dreams of massive returns is precisely what drove investors into the arms of Bernie Madoff or led them to think the subprime mortgage market was the way to go. So, for the investor interested in steady, slow, but most importantly safe returns, here are some simple, very broad, very general pointers that can help get you started.
Italian Treasury Bonds and Highly Leveraged Hedge Funds
Just kidding. Wanted to make sure you were paying attention. These would fall into the opposite category of high risk/high reward. If you have $1,000 you can afford to lose, maybe it’s worth doing some research, playing a hunch, and seeing if you can make money where MF Global’s (MFGLQ.PK) Jon Corzine failed. However, more likely than not, you don’t have the time, knowledge, money, or access to information that the people who play these markets professionally have, so it’s probably not worth it in the long run.
Ah, here’s something simple. Mutual funds are investment vehicles specifically designed for the consumer. In essence, mutual funds pool the funds of many different investors to buy a portfolio of equities, bonds, and money market instruments. Most mutual funds are typically geared toward being very low risk, providing the average small-time investor an avenue to invest his savings that will garner a better rate of return than a savings account while having lower risk for collapse. Because of the pooled money, mutual funds can feature a diversified portfolio that would be difficult to assemble for any individual investor. Picking a mutual fund can be tricky, but most funds have ample data on their historical performance.
Think of a mutual fund like long-term parking for your car at the airport. It isn’t necessarily the most economical place to park your car, but you can feel confident that your car won’t get broken into. If you’re primarily concerned about your car being where you left it when you get back, long-term parking is the way to go, and mutual funds are a relatively safe place to park your car…er, savings.
Exchange-traded funds are very similar to mutual funds in that they’re a collection of assets pooled together to provide a chance for an investor with limited funds to diversify his portfolio. Investing in any individual stock means taking a chance on a specific company, which can be risky. Just ask anyone who put money into Netflix (NFLX) last year. However, ETFs are a portfolio of investments designed to mimic the performance of a particular index or sector. This allows an investor to make fairly broad, fairly general bets about the economy without having to do the meticulous research required to find specific companies to invest in and also mitigates the risks of investing in individual stocks.
There are a dizzying array of ETFs available, including those that speculate on commodities futures, currencies, and specific sectors and subsectors (have a particularly strong feeling about the future of companies specializing in wind power? Well the First Trust ISE Global Wind Energy Index Fund (FAN) and the PowerShares Global Wind Energy Portfolio (PWND) are both specific to the segment!), but the casual investor should most likely avoid these specific ETFs.
Broad, index-based ETFs like the SPDR S&P 500 ETF (SPY) are fairly safe bets over a long enough period of time. The S&P 500 Index has returned 13.5% annually over the past 50 years against 11.8% for the average mutual fund. Of course, this is no guarantee. Anyone who thinks that 50 straight years of growth means that there’s no chance that things can change should ask anyone who was heavily invested in home prices continuing to increase in 2007. However, betting on the S&P continuing to increase at a similar rate over a long enough period of time is still a reasonable bet.
Blue Chips With Strong Dividends
Once again, investing in specific stocks presents an extra level of risk that isn’t as present in ETFs or mutual funds. Namely, you’ve pinned your hopes on one company rather than dozens, and who knows what might happen. However, there are certain massive corporations that have reached a point of relative inertia that makes it hard to see them completely collapsing. While they probably won’t offer big upward moves in share value either, they are safer than companies with smaller market capitalization (a number reached by multiplying the total number of outstanding shares by the price per share) and offer a major benefit: Dividends.
Dividends are how major companies with little room left to grow bolster their share price, essentially paying cash back to shareholders when big enough profits are turned. These companies are typically in industries with a set demand for their product and a history of performance, like food makers or telecommunications companies.
Dividends are typically expressed as a “yield,” which is essentially what percentage of your investment will be paid back in the form of a dividend over the course of the year (dividends are paid in four quarterly installments). Any dividend yield of over 5% is a strong return on investment, and this can further be bolstered by rising share prices over time. What’s more, dividends can also allow an investor to continue making money even if the share price drops. Dividends aren’t certain; companies can and do change them, but they can offer a path to increasing returns on a longer-term investment horizon for anyone willing to take on a little more risk.
No investment is completely safe, and even the lowest risk bets can ultimately prove a mistake. But any investor willing to forgo dreams of miracle stock-picking and crushing the market can find a number of simple, relatively safe investment vehicles that, with patience, can offer solid returns.
This article was written by Joel Anderson.
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How Team Owners made their Money No positions in stocks mentioned.