Investing: Four Options to Consider

by Adam on December 10, 2010

Today’s post about investing is a guest post by long-term reader, Alban.

He outlines 4 different investment options that might be worth considering.  There’s lots of great stuff  here,  but, as with most things when it comes to investing,  some of the details are likely to be different from country to country.  That said, it’s a great primer for helping you consider your options and, when it comes to investing, knowledge is everything.

Take it away, Alban.


It is not enough to have a good job, and earn good money.

You need to also make sure you are planning for your future, and investing a good portion of your income into an investment strategy which will match your goals.  There are so many investment options available to you, and everyone’s income, cash flow and future financial needs are different.  This article assesses four of the most popular investment options, to help you decide which one suits your lifestyle.

1 – Real estate

Property investment is not a new phenomenon and you are probably aware that if you own your home – even if you are repaying a mortgage – your property has experienced capital growth, giving you equity in your property. However, this does not make you a property investor and to choose real estate as an investment option you need to consider the pros and cons.

Benefits of investing in real estate:

It is safe as a long term investment.

Mortgage brokers are keen to point out that historically property prices double every 10 years. Even when there are down times, these are evened out in the long term by property booms. This makes real estate a relatively safe place to invest your money as capital growth means you can’t lose.

Tax deductions.

When you invest in property which is not your primary place of residence, you are able to claim the costs of owning and maintaining the property, back at tax time. You can also claim back any losses you make on the property, if for example the rental income doesn’t cover the loan repayments and maintenance, this is known as negative gearing. This makes property a good investment if you are in a high tax bracket.

Editors note: ‘real estate’ and landlord tax rules vary considerably by country.

Leverage for new investments.

In the space of just a few years you can accumulate equity in your investment property which you can then very easily leverage into another property and then another, or you can use your equity to diversify your investments with other strategies.

Property beats inflation.

Inflation costs can quickly eat into the returns on your investments as you need to be making returns at a higher rate than inflation, so your investment is of value when you go to access it. Property will tend to rise at a fast rate than inflation because real estate is in relatively limited supply, compared to other goods and services.

Editors note: Over the long term in many countries like the US and the UK this has been the case although this isn’t a universal truth, with places like Germany seeing property values stagnant in real terms for a number of years. A reminder that when it comes to investing nothing is guaranteed.)

Cons of investing in real estate:

You can be waiting a while for a return.

It can be difficult to find a positively geared property, where the rental income covers the costs of the property, and affords you a profit. Therefore, to see a return on your investment you will need to wait for the property to increase in value, and profit from capital growth.

The rental market.

When your investment relies a lot on other people, it can add risk to your strategy because there is the chance you will have a bad tenant who doesn’t pay, or damages the property. You may also experience long vacancy periods if there is an oversupply of rental properties at any point.

Time consuming to liquidate your investment.

If you need cash quickly you will be hard pressed to get it from your investment property as real estate can take some time to sell, and if you need to sell in a hurry, you won’t be getting the best price.

Ongoing costs.

Maintenance and repair costs will always be there – as you probably already know from your own home. Plus, you’ll need to pay your investment loan repayments each and every week, regardless of whether you have rental income coming in.

2 – Stocks

Investing in the share market is seen as an exciting and high flying option, however, even if you are choosing stocks as your investment strategy, the chances are slim that you will ever see the Wall Street trading floor. Excitement aside, you need to carefully consider both sides of stock investment.

Pros of investing in stocks:

Greater returns over time.

Over the long term, stocks can outperform almost any other investment option because as the companies you have invested in grow, so too does the value of their shares, and your portfolio.

Dividends.

You can choose to invest in stocks which pay dividends which means you receive a return on your investment as a payout from the companies in which you are invested. You can use these dividends to supplement your income or other investments, or you can set up a dividend reinvestment plan with your stockbroker.

Reinvesting your dividends can see your investment compound quickly because the dividends go on to earn dividends themselves and those new dividends are reinvested, and so on.

An accessible investment.

There are thousands of different companies listed on the stock market for you to choose from and if you take the time to research your options, and you have enough cash to invest, anyone can be a part of the market.

Good liquidity.

If you need to liquidate your stocks quickly, you can often easily find a buyer for your shares by selling to other traders looking to increase their own portfolios.

Tax benefits.

By investing in stocks you are able to reduce the amount of tax you pay on capital gains by offsetting the capital gains from the losses you incur with your stocks.

Cons of investing in stocks:

Risk.

When you invest in stocks you are investing in the success of a company and the growth of your portfolio depends on how capable your chosen company is financially. If the company goes bankrupt, investors who have stocks in the company lose their money. The state of the economy can also determine the success of your stocks because if a company is suffering because of a recession, stock prices go down.

Management costs.

Unless you have the time and to monitor the market and constantly update your information, you will need brokerage services. Having a stock broker can help you find the best deals on the market, but their fees will eat into your returns.

Editors note: Whilst investing in individual stocks can be costly, there are also some great low cost ways to invest in the stock market that Magical Penny will be exploring in the coming weeks and months. Be sure to join Magical Penny to not miss out.

Liquidity time.

Sometimes it can be hard to liquidates your stocks at certain times of the day, or over the weekend.

3 – Savings account

Cash is an easy investment anyone can make by opening a high interest or easy access savings account, but that doesn’t necessarily mean it is the best investment option for you.

Advantages of investing in a savings account:

Security.

Cash is a safe investment because there is no chance that you will lose your principal investment amount if you make sure to research the security of the financial institution you invest with.

Earn high interest.

High interest savings accounts are a competitive market, and financial institutions want your deposits to fund their own business operations. Therefore, if you shop around you can find very competitive interest rates. You can also choose an account which pays you bonuses or rewards you with higher interest rates when you make certain transactions.

At call access.

A high interest savings account gives you at call access to your funds, so you can transfer them out to your transaction account instantly if you have an account with the same institution. Otherwise you’ll have access to your funds after one to two days of transfer time.

Disadvantages of investing in a savings account:

Struggles to beat inflation.

While a 7% return on your investment each year might sound impressive for your savings account, you need to consider that the inflation rate is usually 3% per year and after taxes and fees, cash doesn’t always come out in front of inflation.

Interest income is taxed.

The interest your savings earn is deposited directly into your savings account to continue to compound, however, at tax time you need to declare how much you have earned from your savings account, and you will be taxed according to your tax bracket.

Editor’s note: In the UK you are automatically taxed on your savings account interest before you see it so the actual rate you see advertised is not what you get, unless you are saving in a Cash ISA, which is tax-free.

Fluctuating interest rates.

Interest rates for savings accounts appear high right now, but that is because official interest rates are rising. The interest rates paid on high interest savings accounts are influenced by the official cash rates, and if official rates go down, so too will your investment returns.

4 – Gold

Gold is an investment in a physical product. You need to choose a type of gold to invest in, as each has a varying quality and value:

Raw gold.

This is the most common form of gold but is not always the safest, and can be hard to maintain. This makes raw gold unsuitable if you are planning on investing large quantities, and if you choose to invest in raw gold you will need to secure it in a bank locker.

Jewellery.

Just about everyone has gold jewellery in some form, and most people are always interested in acquiring more. Therefore, investing in gold jewellery can ensure the liquidity of your investment. At the same time, gold jewellery requires a lot of maintenance, and is usually only considered by full time gold investors.

Gold coins.

Gold coins are easily portable, but are specific to national boundaries, therefore, before trading them you need to make sure you are clear on their value to get a good deal. You can also convert gold coins to other forms, or sell them for cash.

Benefits of investing in gold:

Diversify your investments.

Gold is a very stable investment and a good way to diversify your portfolio because when the value of the US dollar is falling, the value of gold is often rising. While gold prices fluctuate too, it will always have some value.

Increasing value.

History has shown that gold maintains its value and is expected to continue to rise in value.

Safety.

When the economy falters and the stock market suffers as well, investors will utilise the safety of gold investments to offset low interest rates and a weak dollar. Gold investments also benefit from the fear associated with uncertainty in other markets because
when investors full out of stock, cash and mutual fund investments, gold becomes in demand. This means that as a weak economy increases the demand for gold, the price goes up.

Not affected by inflation.

When inflation is high, investments such as stocks can suffer as returns are lower. However, gold prices will also rise in times of inflation.

Disadvantages of investing in gold:

Does not produce an income.

Gold is held as an investment for its value, not for its returns and is more suitable as savings for the future, rather than increasing your income now. If you invest in gold, you will need to either keep it in your possession, or with a third party, rather than trading it because then your asset is gone.

Government emergencies.

Be aware of the type of gold you are investing in because the quality and the type can affect the security of your investment. For example, some forms of gold coins can be confiscated by the government in emergency situations such as a war.

Gold is a possession.

Like any other possession your investment in gold can be damaged, lost or stolen.

This was a guest post by Alban, a long time reader and a personal finance writer at Home Loan Finder, a home loan comparison website.

{ 3 comments… read them below or add one }

Monevator

Good summary of many of the basics for the average investor. 🙂 Like Adam though, I’d stress new investors are far better off looking towards index funds and ETFs than individual stocks. You can still get the opportunity to use your capital gains tax allowance with these vehicles, though of course the average private investor should be using their £10,200 Isa allowance anyway, and avoiding CGT that way.

I don’t like “you can’t lose” with property though. I agree it seems stubbornly to be the case in the UK, but there is no rule that says property will always double every ten years. Not saying it’s a bad investment, but if I ever find a “you can’t lose” opportunity I’ll invest everything in it and borrow to invest more. Which is exactly what many bankrupt property investors in the US did on the “can’t lose” mantra, and even a few BTL-ers here in the UK.

Of course, I don’t expect to *ever* find a “can’t lose” investment. Everything has a risk!

Adam

Definitely, index funds are awesome and it’s a shame the common perception of “investing in the stock market” is that it involves owning shares in indvidual companies. It can be fun (http://stocktickle.com/ comes to mind) but for the bulk of us, investing in index funds captures the wealth creation of the world economies and spreads your risk around (and with less fees).

The good/bad thing about property is the leverage it provides -you can see some big increases considering the amount of money put down, but you can also get stuck “underwater” owing more money than the house is worth, and finding it costly and difficult to sell should circumstances change.

Laurie Allen

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