Originally published by James Royal on Bankrate.com.
To enjoy a comfortable future, investing is absolutely essential for most people.
As 2020 showed, a seemingly stable economy can be quickly turned on its head, leaving those who haven’t prepared scrambling for income. But those who could hold on to their investments may have done quite well, as the market registered new all-time highs in the second half of the year.
But with some stocks at what seems like astronomical valuations, what moves should investors consider taking in 2021? One idea is to have a mix of safer investments and riskier, higher-return ones.
Why invest?
Investing can provide you with another source of income, fund your retirement or even get you out of a financial jam. Above all, investing grows your wealth — helping you meet your financial goals and increasing your purchasing power over time.
Or maybe you’ve recently sold your home or come into some money. It’s a wise decision to let that money work for you.
While investing can build wealth, you’ll also want to balance potential gains with the risk involved. Markets can become volatile quickly, and 2020 rang up some of the biggest daily declines ever, but those were soon followed by new all-time highs, despite a majorly challenged economy.
Regardless of the overall climate, you have many ways to invest — from very safe choices such as CDs and money market accounts to medium-risk options such as corporate bonds, and even higher-risk picks such as stock index funds.
That’s great news, because it means you can find investments that offer a variety of returns and fit your risk profile. It also means that you can combine investments to create a well-rounded and diversified — that is, safer — portfolio.
What to consider
Risk tolerance and time horizon each play a big role in deciding how to allocate your money. The value of each can become more obvious during periods of volatility.
Conservative investors or those nearing retirement may be more comfortable allocating a larger percentage of their portfolios to less-risky investments.
These are also great for people saving for both short- and intermediate-term goals. If the market becomes volatile, investments in CDs and other FDIC-protected accounts won’t lose value and will be there when you need them.
Those with stronger stomachs and workers still accumulating a retirement nest egg are likely to fare better with riskier portfolios, as long as they diversify. A longer time horizon allows you to ride out the volatility of stocks and take advantage of their potentially higher return, for example.
If you’re looking to grow wealth, you can opt for lower-risk investments that pay a modest return, or you can take on more risk and aim for a higher return. Or you can take a balanced approach, having absolutely safe money now and still give yourself the opportunity for long-term growth.
The best investments for 2021 allow you to do both, with varying levels of risk and return.
Best investments in 2021
1. High-yield savings accounts
Just like a savings account earning pennies at your brick-and-mortar bank, high-yield online savings accounts are accessible vehicles for your cash.
With fewer overhead costs, you can typically earn much higher interest rates at online banks. Plus, you can typically access the money by quickly transferring it to your primary bank or maybe even via an ATM.
A savings account is a good vehicle for those who need to access cash in the near future.
Risk: The banks that offer these accounts are FDIC-insured, so you don’t have to worry about losing your deposit. While high-yield savings accounts are considered safe investments, like CDs, you do run the risk of earning less upon reinvestment due to inflation.
Liquidity: Savings accounts are about as liquid as your money gets. You can add or remove the funds at any time, though your bank may legally limit you to as few as six withdrawals per statement period, if it decides to do so.
2. Certificates of deposit
Certificates of deposit, or CDs, are issued by banks and generally offer a higher interest rate than savings accounts.
These federally-insured time deposits have specific maturity dates that can range from several weeks to several years. Because these are “time deposits,” you generally cannot withdraw the money for a specified period of time without penalty.
With a CD, the financial institution pays you interest at regular intervals. Once it matures, you get your original principal back plus any accrued interest. It pays to shop around online for the best rates.
Because of their safety and higher payouts, CDs can be a good choice for retirees who don’t need immediate income and are able to lock up their money for a little bit. But there are many kinds of CDs to fit your needs, so you can still take advantage of the higher rates on CDs.
Risk: CDs are considered safe investments. But they do carry reinvestment risk — the risk that when interest rates fall, investors will earn less when they reinvest principal and interest in new CDs with lower rates, as we saw in 2020.
The opposite risk is that rates will rise and investors won’t be able to take advantage because they’ve already locked their money into a CD.
Consider laddering CDs — investing money in CDs of varying terms — so that all your money isn’t tied up in one instrument for a long time. It’s important to note that inflation and taxes could significantly erode the purchasing power of your investment.
Liquidity: CDs aren’t as liquid as savings accounts or money market accounts because you tie up your money until the CD reaches maturity — often for months or years. It’s possible to get at your money sooner, but you’ll often pay a penalty to do so.
3. Government bond funds
Government bond funds are mutual funds or ETFs that invest in debt securities issued by the U.S. government and its agencies.
The funds invest in debt instruments such as T-bills, T-notes, T-bonds and mortgage-backed securities issued by government-sponsored enterprises such as Fannie Mae and Freddie Mac. These government bond funds are well-suited for the low-risk investor.
These funds can also be a good choice for beginning investors and those looking for cash flow.
Risk: Funds that invest in government debt instruments are considered to be among the safest investments because the bonds are backed by the full faith and credit of the U.S. government.
However, like other mutual funds, the fund itself is not government-backed and is subject to risks like interest rate fluctuations and inflation.
If inflation rises, purchasing power can decline. If interest rates rise, prices of existing bonds drop; and if interest rates decline, prices of existing bonds rise. Interest rate risk is greater for long-term bonds.
Liquidity: Bond fund shares are highly liquid, but their values fluctuate depending on the interest rate environment.
4. Short-term corporate bond funds
Corporations sometimes raise money by issuing bonds to investors, and these can be packaged into bond funds that own bonds issued by potentially hundreds of corporations.
Short-term bonds have an average maturity of one to five years, which makes them less susceptible to interest rate fluctuations than intermediate- or long-term bonds.
Corporate bond funds can be an excellent choice for investors looking for cash flow, such as retirees, or those who want to reduce their overall portfolio risk but still earn a return.
Risk: As is the case with other bond funds, short-term corporate bond funds are not FDIC-insured.
Investment-grade short-term bond funds often reward investors with higher returns than government and municipal bond funds. But the greater rewards come with added risk.
There is always the chance that companies will have their credit rating downgraded or run into financial trouble and default on the bonds. To reduce that risk, make sure your fund is made up of high-quality corporate bonds.
Liquidity: You can buy or sell your fund shares every business day. In addition, you can usually reinvest income dividends or make additional investments at any time. Just keep in mind that capital losses are a possibility.
5. S&P 500 index funds
If you want to achieve higher returns than more traditional banking products or bonds offer, a good alternative is an S&P 500 index fund, though it does come with more volatility.
The fund is based on hundreds of the largest American companies, meaning it comprises many of the most successful companies in the world. For example, Amazon and Berkshire Hathaway are two of the most prominent member companies in the index.
Like nearly any fund, an S&P 500 index fund offers immediate diversification, allowing you to own a piece of all of those companies. The fund includes companies from every industry, making it more resilient than many investments.
Over time, the index has returned about 10 percent annually. These funds can be purchased with very low expense ratios (how much the management company charges to run the fund) and they’re some of the best index funds.
An S&P 500 index fund is an excellent choice for beginning investors, because it provides broad, diversified exposure to the stock market.
Risk: An S&P 500 fund is one of the least-risky ways to invest in stocks, because it’s made up of the market’s top companies. Of course, it still includes stocks, so it’s going to be more volatile than bonds or any bank products.
It’s also not insured by the government, so you can lose money based upon fluctuations in value. However, the index has done quite well over time.
The index closed 2020 near all-time highs after a strong rebound, so investors may want to proceed with caution and stick to their long-term investment plan, rather than rushing in.
Liquidity: An S&P 500 index fund is highly liquid, and investors will be able to buy or sell it on any day the market is open.
6. Dividend stock funds
Even your stock market investments can become a little safer with stocks that pay dividends.
Dividends are portions of a company’s profit that can be paid out to shareholders, usually on a quarterly basis. With a dividend stock, not only can you gain on your investment through long-term market appreciation, you’ll also earn cash in the short term.
Buying individual stocks, whether they pay dividends or not, is better-suited for intermediate and advanced investors. But you can buy a group of them in a stock fund and reduce your risk.
Risk: As with any stock investments, dividend stocks come with risk. They’re considered safer than growth stocks or other non-dividend stocks, but you should choose your portfolio carefully.
Make sure you invest in companies with a solid history of dividend increases rather than selecting those with the highest current yield. That could be a sign of upcoming trouble.
owever, even well-regarded companies can be hit by a crisis, so a good reputation is not a protection against the company slashing its dividend or eliminating it entirely.
Liquidity: You can buy and sell your fund on any day the market is open, and quarterly payouts are liquid. To see the highest performance on your dividend stock investment, a long-term investment is key. You should look to reinvest your dividends for the best possible returns.
7. Nasdaq-100 index funds
An index fund based on the Nasdaq-100 is a great choice for investors who want to have exposure to some of the biggest and best tech companies without having to pick the winners and losers or having to analyze specific companies.
The fund is based on the Nasdaq’s 100 largest companies, meaning they’re among the most successful and stable. Such companies include Apple and Facebook, each of which comprises a large portion of the total index. Microsoft is another prominent member company.
A Nasdaq-100 index fund offers you immediate diversification, so that your portfolio is not exposed to the failure of any single company. The best Nasdaq index funds charge a very low expense ratio, and they’re a cheap way to own all of the companies in the index.
Risk: Like any publicly traded stock, this collection of stocks can move down, too.
While the Nasdaq-100 has some of the strongest tech companies, these companies also are usually some of the most highly valued. That high valuation means that they’re likely prone to falling quickly in a downturn, though they may rise again during an economic recovery.
Liquidity: Like other publicly traded index funds, a Nasdaq index fund is readily convertible to cash on any day the market is open.
8. Rental housing
Rental housing can be a great investment if you have the willingness to manage your own properties.
And with mortgage rates hitting all-time lows recently, it could be a great time to finance the purchase of a new property, though the unstable economy may make it harder to actually run it, since tenants may be more likely to default due to unemployment.
To pursue this route, you’ll have to select the right property, finance it or buy it outright, maintain it and deal with tenants.
You can do very well if you make smart purchases. However, you won’t enjoy the ease of buying and selling your assets in the stock market with a click or a tap on your internet-enabled device. Worse, you might have to endure the occasional 3 a.m. call about a broken pipe.
But if you hold your assets over time, gradually pay down debt and grow your rents, you’ll likely have a powerful cash flow when it comes time to retire.
Risk: As with any asset, you can overpay for housing, as investors in the mid-2000s found out. With low interest rates and a tight housing supply, housing prices ran up in 2020, despite the struggles facing the economy as a whole. Also, the lack of liquidity might be a problem if you ever needed to access cash quickly.
Liquidity: Housing is among the least liquid investments around, so if you need cash in a hurry, investing in rental properties may not be for you (though a cash-out refinance is possible). And if you sell, a broker may take as much as 6 percent off the top of the sales price as a commission.
9. Municipal bond funds
Municipal bond funds invest in a number of different municipal bonds, or munis, issued by state and local governments. Earned interest is generally free of federal income taxes and may also be exempt from state and local taxes, too, making them particularly attractive in high-tax states.
Muni bonds may be bought individually, through a mutual fund or through an exchange-traded fund. You can consult with a financial adviser to find the right investment type for you, but you may want to stick with those in your state or locality for additional tax advantages.
Municipal bond funds are great for beginning investors because they offer diversified exposure without the investor having to analyze individual bonds. They’re also good for investors looking for cash flow.
Risk: Individual bonds carry default risk, meaning the issuer becomes unable to make further income or principal payments. Cities and states don’t go bankrupt often, but it can happen, and historically muni bonds have been very safe — although a rough 2020 has challenged that safety a bit.
Bonds may also be callable, meaning the issuer returns principal and retires the bond before the bond’s maturity date. This results in a loss of future interest payments to the investor.
A bond fund allows you to spread out potential default and prepayment risks by owning a large number of bonds, thus cushioning the blow of negative surprises from a small part of the portfolio.
Liquidity: You can buy or sell your fund shares every business day. In addition, you can typically reinvest income dividends or make additional investments at any time.
Bottom line
Investing can be a great way to build your wealth over time, and investors have a range of investment options, from safe lower-return assets to riskier, higher-return ones.
That range means you’ll need to understand the pros and cons of each investment option to make an informed decision. While it seems daunting at first, many investors manage their own assets.
But the first step to investing is actually easy: opening a brokerage account. Investing can be surprisingly affordable even if you don’t have a lot of money. (Here are some of the best brokers to choose from if you’re just getting started.)
Learn more:
Editorial Disclaimer: All investors are advised to conduct their own independent research into investment strategies before making an investment decision. In addition, investors are advised that past investment product performance is no guarantee of future price appreciation.
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