How to Invest Money
Beginners should stick to the three main productive asset classes
In most cases, the best place to launch your foray into investing is to decide which asset classes you want to own. Real estate, stocks, and fixed income all have unique risks, opportunities, pricing structures, market customs, valuation models, legal structures, jargon, and tax rules. While building a complete portfolio might seem an impossible task, rest assured the dividends, interest, and rents can be worth it.
You likely will gravitate toward specific asset classes based on your own personality, but it also is important to understand that different asset classes meet different needs at different times in your life. If you're 70 and retired, it doesn't make a lot of sense to hold huge stock positions unless you plan on passing a decent-sized estate to your heirs or charity. Instead, you'd likely be better off enjoying the relative safety and stability of interest income from high-quality bonds. That way, if the country were to descend into a depression, your odds of maintaining your standard of living would be much improved.
Almost all major assets you are likely considering when investing money fall under the categories of business ownership, lending money, or real estate.
Acquiring an Ownership Stake in a Business
Historically, ownership of a successful business has been the greatest source of wealth accumulation for self-made men and women, surpassing the next highest asset class, real estate.
There are several ways to invest your money into business ownership:
- Start your own company, often by establishing a sole proprietorship, general partnership, limited partnership, limited liability company, or corporation. If you have the talent, skill, discipline, and luck of an excellent operator, it is often the most lucrative path to investment riches because you can buy into the firm at book value with your compounding rate equal to the return on equity, or ROE.
- Buy into someone else's privately held company or partnership, often in exchange for cash or labor, on terms privately negotiated. Some investors specialize in so-called private equity, restricting themselves to specific sectors of the economy where they feel like they have an advantage, such as technology or manufacturing.
- Buy a stake in a publicly traded business, most often by purchasing common stock in a corporation traded on the over-the-counter market or on one of the stock exchanges such as the NYSE, Nasdaq, Toronto Stock Exchange, London Stock Exchange, Tokyo Stock Exchange, etc.
Most people are going to fall into the last category because they have a day job and are interested in learning how to invest money they have built up in their brokerage accounts, 401(k) plans, IRAs, direct stock purchase plans, and mutual fund accounts.
Lending Your Savings
Money lending in all of its derivations and forms is as old as civilization itself. An investor saves up his or her wealth and then lets others borrow it for their own purposes upon the promise of repayment plus interest based on the perceived risk, projected inflation rate, and length of the loan.
There are many ways you can invest your money in this asset class:
- Making a direct, private, negotiated loan with a borrower based upon a written or verbal contract detailing terms, conditions, a repayment schedule, and interest rate.
- Making peer-to-peer loans through market platforms such as Lending Club or Prosper where you bid on a small percentage of a given loan and fund a piece of it
- Purchasing bonds issued by sovereign governments—including Treasury bonds or savings bonds—municipalities, corporations, nonprofits, or other entities.
- Acquiring an FDIC insured certificate of deposit at a bank or other financial institution.
Just like investing money in a business, the compound annual growth rate you can earn when lending money depends on your skill.
In one case, an 80-year-old retiree, in a world of near zero-percent interest rates, carefully, shrewdly, and wisely acquired homes that she rented out on lease-to-own terms to struggling families who otherwise couldn't qualify for a mortgage. After adjusting for various factors, her equivalent cap rate is north of 13 percent per annum.
Nobody advertises such investments. She creates them out of thin air. She sees an opportunity and with a pen, a lawyer, a notary, and her savings finds a way to solve other peoples' needs.
Investing Money in Real Estate
Behind lending money, making a profit from owning real estate is among the oldest recorded financial activities in all of the recorded human civilization. From ancient Egypt to modern-day New York City, if you own a property—be it a residence, an office, or a plot of land—you can make money by charging rent.
Certain types of investors prefer real estate ownership over all other asset classes due to its enduring nature. By way of illustration, the aristocracy in Great Britain is so concentrated in real estate that a mere 0.6 percent of the entire country owns 50 percent of all rural real estate in the nation.
In the modern economy, there are several ways to acquire real estate for your investment portfolio:
- Buying a home for your family, which is more of a cost mitigation and less of an investment but falls into this category nonetheless.
- Buying a property outright and renting it to tenants.
- Buying a property, improving and/or developing it in some way, and selling it.
- Funding lease/buyback transactions.
- Pooling money with other investors to buy real estate through special tax-advantaged businesses exempt from corporate taxes under most circumstances. These businesses are known as Real Estate Investment Trusts (REITs), and often can be acquired just like any other stock through a brokerage account. There are even ETFs and mutual funds that specialize in REITs.