Investing 101: Real Estate, Stocks, and Bonds
- Consider your risk tolerance and investment goals when developing your investment strategy.
- The pros and cons of real estate and stocks–appreciation, rental income, and dividends, with a side of risk.
- High-rated bonds work well for minimizing risk and increasing your returns.
There are many options to invest and grow your cash flow, from real estate and real-estate-related investments to more traditional assets such as stocks and bonds. It can feel overwhelming as a first-time investor, so let’s break it down.
Three Questions to Answer Before You Invest
Any well-balanced portfolio should comprise a mix of assets rather than just one type. Answering these three questions can help you determine the investment mix that works best for you:
1. What is your risk tolerance?
Your risk tolerance is how comfortable or uncomfortable you are with risk in exchange for a chance to increase the value of your investment.
A traditional bank savings account is a very low-risk asset, and consequently, the return is also quite low. In contrast, buying shares of stock in a large, global bank carries the risk that you could lose some or all of your investment, but also comes with a higher potential return.
Risk and return tend to be correlated. Low-risk investments generally have a lower return than high-risk investments.
2. How long will you leave the investment alone?
There are two basic options: long-term or short-term investments. Funds invested at least a year, like your retirement or real estate, are considered long-term. On the other hand, an investment or savings fund focused on building up cash for a vacation or the holidays tends to be invested for a few months and is considered a short-term investment.
3. What are your liquidity requirements?
Liquidity is how easily and quickly you can sell your investment. For example, real estate investments are illiquid because it could take weeks or months to sell your property. Stocks, on the other hand, are very liquid because they can be sold in fractions of a second at the click of a button.
Investing in Real Estate
There are two simple ways to make money from your properties: appreciation and rental income.
As you’ve probably seen, real estate appreciation varies with inflation and the economy, market supply and demand, and any significant changes in the condition or perceived value of a house or neighborhood. You’ll make money as the property grows in value.
Rental income is typically earned by renting the property to a tenant through an annual lease. However, with the advent of the short-term rental market, the ability to slice and dice a property into rentable chunks (a couch, a room, a backyard, or the whole house) and rentable periods (evenings, weekends, and special events) have greatly increased the potential rental value of properties.
Despite the many advantages of real estate, a property investment comes with its share of challenges and risks. One of the biggest drawbacks is that real estate investments are illiquid, meaning they can’t quickly be offloaded or converted into cash.
Real estate investments work particularly well for the following types of first-time investors:
- Investors who are considering the property as a means to home ownership.
- Investors who are able to renovate the property as a DIY project and thus save on third-party contractor costs.
- Investors who are buying an affordable or below-market property that has low vacancy risk, such as properties near a desired public school or university.
Investing in Stocks
Stocks have become increasingly accessible to the general public thanks to trading platforms that bypass brokerage firms. In addition, trading platforms vary in the minimum amount that must be deposited to begin investing, so it pays to shop around.
Stocks represent an ownership interest in a company. When you purchase stock, you own a share of that company. Stocks can be purchased in one company, several companies, or even a whole class of companies, called mutual funds.
Stocks, like real estate, offer the two key benefits. The first is from the appreciation of the asset when the stock price increases. The other is the benefit from returns on the asset in the form of dividends. However, it is important to note that not all companies offer stock dividends, which are paid quarterly and thus have less month-to-month fluctuations in payment versus rental income.
Stocks work particularly well for:
- Investors who are looking for a 1-5 year investment term.
- Investors who are establishing a diversified retirement plan. In such cases, your financial advisor, accountant, employer (if your company offers a retirement plan), or a personal finance investment platform can serve as great sources of information in formulating your strategy and making your first investment.
If stocks and real estate still feel a little too risky for you, you might want to look at bonds.
Investing in Bonds
A bond is essentially a loan taken out by a company, and in return, the company promises to repay the loan amount, plus interest. In that regard, bonds are similar to bank deposits in terms of providing interest. However, unlike most bank deposits, bonds come in a range of risk ratings. They range from exceedingly low-risk, such as a bond issued by the U.S. Treasury, to a much higher level of risk, such as bonds issued by municipalities, states, or companies in tough times.
High-rated, low-risk bonds will have a very low-interest rate (called yield) and a very low default rate. Conversely, low-rated, high-risk bonds generally have a higher return and default rate. Investors who prefer to purchase a basket of bonds issued by numerous government or corporate entities can purchase a bond fund.
Bonds work particularly well for:
- Investors who prefer a lower level of risk and predictable returns.
- Investors who want a diversified portfolio that includes both high- and low-risk assets.
The Money Wrap Up
Now that you’ve figured out an investment approach that works for you and understand a few of the major investment options, it’s time to research your first investment.