If you’re just an average income earner, earning less than $80,000 a year (or less than $120,000 a year in expensive areas like Los Angeles, San Francisco, Chicago, and New York) you may find it difficult to invest money that you don’t quickly turn around and spend. Here are a few suggestions on investment options that entail limited risk in exchange for reasonable liquidity (the ability to “cash out” quickly without paying interest or penalties).
An Emergency Cash Envelope This is the simplest and easiest way to save money. Although it does not earn interest and is not protected by insurance, the emergency cash envelope is easy to get to. You should keep it in a safe place in your home, hidden where a burglar or untrustworthy house guest is not likely to find it. By adding $5-20 a week to this envelope, within a year you can save up as much as $260-$1040 to keep close by in case of emergencies.
You should never leave a large amount of money in your home. Instead, you should periodically deposit about half your emergency cash into a savings account, or use it to buy savings bonds.
Savings Accounts All banks and credit unions offer savings accounts. The idea behind a savings account is that you will not make many withdrawals from it over time. The account will earn a little bit of interest as time passes but you should not think of this as a wealth building plan. A savings account is a safer place to keep your money than an envelope because it is insured by the Federal Deposit Insurance Corporation or a similar program. This Federal insurance protects your deposits against bank failures.
Resist the urge to tie your savings account to a credit card or checking account (for “overdraft protection”). Banks encourage customers to use these options either to build credit or to limit overdraft fees. However it is your responsibility to manage your money well. The more difficult you make it on yourself to spend the money in your savings account, the longer your account will be able to flourish.
When you are building credit and need to open a savings account to obtain a credit card, go ahead and do so. Just don’t agree to automatic payments for a regular credit card.
Money Market Accounts A money market account acts like a checking account and savings account combined. Many investment companies offer money market accounts. You are usually required to keep a minimum amount of money in the account (anywhere from $1000 to $2500). You should view a money market account as an emergency fund. You can make as many withdrawals from a money market account as you need to, whereas most normal savings accounts are limited to a small number of withdrawals per month (or locked because they are tied to secured credit cards).
You should not attempt to open a money market account until have enough liquidity in your savings account and checking account that you can do without the money. You should not use a money market account except in emergencies or to save up for large purchases that you do not want to finance (such as appliances, home renovations, etc.). It does you no good to open a money market account only to drain it within a few months.
Savings Bonds Government-backed savings bonds allow you to help finance the government while earning interest for the future. Savings bonds do not accumulate much value but they are relatively inexpensive and easy to obtain. By purchasing a few savings bonds each month (for $50-100) you will gradually build up a pool of bonds that may come in handy down the road. Keep the bonds in a safe place, such as a bank deposit box. You should also record the bond serial numbers and store that information in a separate location.
Certificates of Deposit Banks issue certificates of deposit that may earn competitive rates compared to savings accounts and savings bonds. However, you usually have to buy certificates in large amounts ($1000 or more) and you will be required to wait several years before you can cash out the certificates. Some investors “roll over” their CIDs, reinvesting the money in new CIDs, but you cannot know in advance what interest rates will be 1, 2, 3, 4, or 5 years in the future.
Certificates of Deposit are good investments for people who already have other easy liquidity options such as savings accounts and/or money market accounts. You may be able to sell a CID on a secondary market but do not expect to make a profit. Selling CIDs before maturity is a way of raising cash quickly but at a cost.
Universal Life Insurance Although insurance policies are not good investment options for creating wealth they do provide easy liquidity and also protect your assets (home, vehicles) and income against an early death. Since you probably need life insurance anyway you should consider investing in a Whole Life or Universal Life policy, especially if you are under the age of 35.
Employer Stock Plans If you work for a publicly traded company you may be offered stock options or the ability to purchase company stock at a discount. These employer stock plans make it possible for you to enter the stock market but don’t expect to get rich playing the market. Your company’s stock depends on its quarterly performance to maintain its high trading value. A stock may pay dividends, which is how a publicly-traded company distributes its accumulated wealth among investors.
Many people reinvest dividends in stock purchases through so-called DRIP plans. You never see the money so you never miss it. Employer stock plans are good vehicles for creating short-term wealth but you should never allow the bulk of your savings to lie in your employer’s stock plans. Employees of the failed energy company ENRON found to their horror that their investments were destroyed when the company was caught cheating on its accounting practices. In reality, they probably never had much wealth in that stock plan anyway.
Think Carefully About How You Will Manage Your Investments
Saving money is not as easy as the financial institutions and advisers make it sound. These companies and professionals make money by persuading you to let them use your money. Of course, it’s all good if they use your money well and earn you back great rewards. But that doesn’t work out if you make investments that you cannot afford to keep. Whether you are buying a house or simply depositing extra cash into a money market fund, every type of investment entails some sort of risk. That risk may be realized at the worst possible time for you if you find yourself deprived of income and you have little to no quick liquidity.
You should always buffer your large, long-term investments with short-term investments that are easy and inexpensive to cash out. The less often you dip into your home’s equity, your 401(k) plan, or even your Certificates of Deposit to cover small emergencies or personal entertainment, the better.
Create a budget that allows you to set aside money for:
- Emergency cash
- Rainy day spending
- Short term entertainment goals (purchases within the next 6-12 months)
- Long-term investments
- Life insurance
- Special large purchase
It won’t be easy to do all of that and the best way to do it is to start out by budgeting for one “savings expense” at a time. When you have become accustomed to living without the money you’ll be in a better position to start budgeting for your next “savings expense”.
In reality these savings expenses are investments in your future, both long-term and short-term.