If you are fortunate enough to find yourself with an extra $10,000 in your savings account, you may realize that each year it is worth 2%-3% less due to inflation. If you find yourself in this situation, I have some suggestions for you to make the best decision with your money!
If you’re anything like me, you have trouble trusting people when it comes to money. Early on in my financial journey, my wife and I saved up a sum of money and we found ourselves in the same situation. I met with several investment professionals and wrote a related blog post on my experience: My Dave Ramsey Endorsed Local Provider Experience.
In my quest to figure out what to do with money sitting in a bank account, I was able to uncover several great options for different scenarios.
Before You Invest, Do This:
Before you make the decision to empty your bank account and start investing, you need to set yourself up financially. Obviously, you are a good saver (or you scored an inheritance), but you still need to protect yourself from unknown financial issues.
Before you invest, go through this sequence to see where your current financial plan is:
- Save $1,500 – $2,000 for emergencies
- Pay off all debt (excluding mortgage)
- Save 6 months of monthly living expenses
- Start investing
The Argument To Pay Off Your Debt First
Debt in the form of credit cards, vehicle loans, student loans, or other debt should be paid off before you invest. The best decision is to keep $2,000 in your emergency savings and apply the remainder of your savings toward your debt.
The process of paying off vehicle and student loans before investing is fiercely debated. The reason for this is due to interest rates. According to Credible.com¹ , the average federal student loan interest rates are:
- 4.81% for undergraduates
- 6.38% for graduate students
- 7.44% for parents and graduate students with PLUS loans
According to Bankrate.com², the average auto loan interest rate is 4.73% for a 60-month new car loan.
Average Investment Returns
Those who oppose paying off “low-interest debt” first cite historical stock market returns. According to Investopedia.com³, the average annual return for the S&P 500 over the past 92 years has been approximately 10%. From a mathematical perspective, it may appear that investing first would make more sense due to the higher return than the debt interest rate. However, if you factor inflation into the stock market averages, the return is closer to 7%.
We Need To Change Our View Of Debt
As we look further at debt, we need to make the distinction to what a liability is and what an asset is.
What Is A Liability
Our society views debt in a more positive than negative light. People use the term “good debt” for low-interest loans and suggest you should “leverage your debt” to make more money. These people view debt as an asset rather than a liability. Unfortunately, this thought process is inherently flawed. All debt is a liability because you must pay it back with interest within a certain period of time.
If you do not pay back debt as described in the initial agreement, you can be sued and suffer other financial consequences.
What Is An Asset
A financial asset is something that generates income but does not leave you indebted to someone else. An asset would be an investment such as stocks or bonds or paid off rental property.
An asset provides equity, or money, without the liability aspect.
Save 6 Months Of Living Expenses
If you have emergency savings and do not have debt, the next step is to make sure you have 6 months of living expenses in a savings account. The purpose of this cash on hand is to act as insurance against life. It protects against a serious unplanned financial disaster. It could be a medical issue that prevents you from earning an income or the loss of employment. The 6-month buffer will help you to avoid declaring bankruptcy and plunging into debt.
I have a 6-month buffer and it hurts to leave it in the bank. I know I could be making interest on that money by investing it, but this money is not an investment – it is insurance. Insurance costs you money and investments make you money. Without the proper amount of insurance on vehicles, your home, or life, you can end up losing all your investments. Insurance is necessary but not a fun way to spend money.
How To Invest $10,000
First and foremost, you need to decide how long you can be without this money. If you are going to invest in the stock market, you should plan on leaving the money alone for a minimum of three to five years. The stock market is not a get rich quick scheme unless you are willing to risk losing everything quickly.
Here are some guidelines for what you should invest in depending on when you may need access to your money.
If You Plan To Invest For 5 Years Or Less:
- Invest in a Money Market Account (2% – 2.25% return)
- Money markets are great if you want to make more on your money than if you left it in a savings account. You also have quick access to your money if you have an emergency.
- Certificates of Deposit (CD) (2.7% – 3%)
- Certificates of Deposits are good at protecting your money from yourself. Money in a CD needs to be left alone in order to avoid early withdrawal fees and penalties.
- Treasury Bills (T-Bills)(2%-3%)
- T-Bills are short term securities that are usually issued to mature in 4, 13, 26, or 52 weeks. These are backed by the Federal Government.
- For instance, you purchase a $10,000 T-Bill for $9,700 ($10,000 – 3%) and when the time frame is up, you get the full $10,000 – making $300 dollars.
There are not many great investment options if you may need your money in less than five years. If you may need access to your money in a short amount of time, you can not afford much risk. Low-risk investments are tied to lower returns and rewards. The more you are willing to risk, the higher your potential return (and loss).
If You Plan To Invest For 5 Years Or More:
With a longer time horizon, you can afford to be more risky with your money because time protects you.
Fund Your Retirement Account At 18% Of Your Income
Before you invest this money, ensure you are putting 18% or more of your income away for retirement. You should be invested in a 401(k) and/or a Roth IRA before you invest in any other avenues. If you have not started investing for retirement, I would put your first $6000 in a Roth IRA (current Roth IRA contribution limit in 2019) and the remainder of the funds in a 401(k) or employer-sponsored retirement account.
Time is your best friend when it comes to retirement funding. Compound interest needs time to start snowballing into considerable wealth. The sooner you get started, the better off you will be!
Investing Extra Money
If your retirement accounts are funded and you have extra money, do you have children? If you do, you may want to start saving for their college education. Investing in a 529 plan may be the right choice for you.
Education Savings Plans (529 Plans)
A 529 plan is a tax-advantaged savings plan used to save money for education. When you contribute money into these plans, it grows tax-free – similar to a Roth IRA. When you withdraw the money to use for educational expenses, including room and board, you are not taxed on the money. Win-Win!
If you don’t need any of the above-mentioned investment ideas, then index funds may be perfect for you. I invest heavily in S&P index funds because of the minimal fees and advantages they have over mutual funds. Index funds have much lower fees than mutual funds and they beat mutual fund performance in the long run over 90% of the time. This is a secret that brokers and portfolio managers don’t want you to know. For more information, refer to my related article: Exposing The Mutual Fund Industry.
You can take your money and sign up for an account like E-Trade, Charles Schwab, Vanguard, TD Ameritrade, or any other company where you can make self-directed trades. From there, pick an index fund with a low expense ratio. I personally love the S&P 500 index funds and the funds I buy have expense ratios of .04% or less.
On average, the S&P 500 index fund has historically provided an annual return of just under 10%. This averages in the years when the returns were negative and the years when the returns were much higher than 10%. With index funds, the proper way is to invest it and forget it. When the market drops, DO NOT SELL! Market drops are the perfect time to buy because that is when stocks are cheaper.
Custodial Accounts For Your Children
If you want to start putting money away for your children that they can later use on whatever they want, a custodial account may be right for you. I opened custodial accounts for my three children so all their birthday and Christmas money is invested and growing.
Custodial accounts are investment accounts for children that a guardian manages. In Arizona, I am in control of the investment account in my child’s name until they turn 21 years old. I take their money and invest it in index funds to teach them the power of compound interest and investing.
Custodial accounts also have tax advantages that I wrote about in my related article: Kids And Money: Why Your Kids Need A Custodial Account.
Pay Down Your Mortgage
If you are putting 18% or more of your income into retirement and you have 6 months of expenses saved in a money market or savings account, paying down your mortgage may be your best option.
Currently, I am putting every extra penny towards paying off my mortgage early. So far I have been able to cut 10 years off of my mortgage and have saved a ton of money in interest. Check out my related article: Should I Pay Off My Mortgage Or Invest?.
However you choose to invest your extra money, make sure you do not put all your eggs in one basket. I would strongly recommend you DO NOT buy stock in any one individual company. Individual companies go up and you don’t want to be the last one holding the stock when the company goes under. By investing in index funds, you are invested in a large number of companies that will offset poor performance over time.
I applaud you for thinking of investing and for your ability to save! You are well on your way to becoming wealthy and being able to help others through charity. Keep educating yourself and if you have any questions feel free to send me a message!
Do you have any other favorite investing ideas for $10,000? Leave a comment below with your suggestions, I would love to hear them. Also, if you have not signed up for my weekly newsletter of all my best posts, please enter your name and email below. Keep learning my friends, you work too hard to be this broke!