Asking where you should invest $5,000 is a bit like asking what car you should buy. It depends. What’s your highest priority for the car? Safety? Economy? How long do you plan to keep it?
The best way to invest $5,000 for one person might be entirely different for someone else.
When asking yourself about investing, one of the biggest factors to consider is when you will need the money. You should keep money that you need within five years in a low-risk investment. Money that you can part with for more than five years can be invested in a higher risk investment vehicle that offers potentially higher rewards.
Investments for under 5 years
Certificates of deposit (CDs). If you need to access your money in fewer than five years, placing it in a CD is a safe, short-term investment strategy that allows you to earn more than you would in a traditional savings account. CDs can be issued in any denomination, and they offer fixed interest rates, fixed maturity dates and FDIC insurance for up to $250,000 per person.
However, if you withdraw your money before the maturity date, you’ll receive a stiff early withdrawal penalty. Once the CD matures, the principal and earned interest are available for withdrawal.
Let’s say you purchase a $5,000 CD at an interest rate of 2 percent compounded annually with a five-year term. At the end of five years, your CD will be worth $5,520.
Money market accounts. If you may need that money in the near future, money market accounts allow you to access it at any time in exchange for a slightly lower interest rate than CDs, but a higher interest rate than traditional savings accounts. Like CDs, money market accounts are safe investment vehicles, offering fixed interest rates with FDIC insurance. However, they provide limited check-writing ability and require a higher minimum balance. If your account goes below the minimum balance, you may be subjected to a service fee.
If you were to place $5,000 in a money market account for five years at 1.5 percent interest, your investment after that time would be worth $5,386.
Money market accounts and CDs don’t always keep up with the inflation given their low yields. Because of this, they make better short-term investments.
Higher risk, higher reward investments
Investors who have more time to invest are in a better position to take on more risk and achieve potentially higher returns by investing in the stock market. There are several vehicles you can invest in to get stock market exposure.
Stock index fund. Warren Buffett, one of the most famous investors of all time, has made the case for stock index funds. In planning his estate, he directed the trustee of his wife’s inheritance to invest 90 percent of her money in an S&P 500 index fund and the other 10 percent in bonds. That may not be the best asset allocation for everyone, though.
Index funds are passively-managed mutual funds that track the markets. The S&P 500 index, for example, is composed of 500 large companies. Index fund earnings are identical to the market they track. Because these funds track an index, there is no manager actively managing the fund and analysts aren’t needed to continually evaluate companies. This results in lower fees. Conversely, actively managed funds have a difficult time outperforming index funds because they have higher fees.
Most exchange traded funds, or ETFs, also track an index and so have low expenses. Shares of ETFs fluctuate in price throughout the day like stock shares. Mutual funds, on the other hand, are only priced at the end of each trading day.
Actively managed mutual funds. While index funds have been found to outperform most actively managed mutual funds, some mutual fund managers consistently produce outstanding results. Mutual fund managers make the decisions regarding what sector of the economy to invest in and analyze which companies are currently undervalued and expected to grow.
It’s important to keep in mind, however, that mutual funds charge higher fees and these fees cut into your profit. If you do select an actively managed fund, experts recommend buying globally balanced funds and avoiding funds that have expense ratios of more than 1 percent.