7 Ways to Invest Some Extra Cash

7 Ways to Invest Some Extra Cash

Last month I received a small bonus from work and after the initial excitement of having some extra money as well as the appreciation and recognition for a job well done, I needed to decide what to do with it, as I didn’t want to blow everything in one go.

How could I make the most of it and allocate it in the best way possible to get bigger long-term results from it? Should I save it, use it to pay off debt, invest it or invest it in myself or my company to generate more income with it?

Here I’ve put together some key points that I hope will be of use to you for when you too find yourself with a little bit of extra money – maybe due to a (small) pay rise, a present or just because you’ve perfected your budgeting skills.

Here are some of the advantages and disadvantages of what you can do with some little extra cash:

Build an emergency fund

What: Save together $1,000 (or the equivalent in your country).

Pros: An emergency fund will allow you to pay for unexpected events without having to go into debt or eating into your savings. I also recommend to build a 6 months living fund with time to cover your expenses for up to 6 months if you find yourself without a job for a prolonged period of time.

Cons: Don’t put more than needed in this savings account, as it will likely not be making you any money due to low interest rates, so once you’ve hit your target amount, put any extra money elsewhere.

Pay off debt

What: Make an extra payment towards your debt, such as a credit card, mortgage or student loan, especially if you have any debts with an annual interest rate over 5%.

Pros: By reducing your outstanding principal, your interest charges go down and so will the long-term effects of compounding interest. The long-term goals of becoming debt-free also means more independence and peace of mind.

Cons: Paying off debt reduces your expenses in the long run, it doesn’t create more money. If you only have outstanding debts with a fairly low interest rate (4% or less), you might get a higher return-on-investment in other ways, such as investing it or generating another income stream with it.

Save

Save money

What: Put the money in a savings account to generate interest.

Pros: It gets you a little closer to your savings goals and it will make you some extra money over time due to interest and most importantly: compounding interest.

Cons: Interest rates are extremely low at the moment and below most inflation rates which means that not only will that money sit idly without making you much money, with time it will also lose value.

Contribute to you pension

What: Make an extra contribution to your private or workplace pension plan.

Pros: By adding more to your pension you’ll not only increase your pension fund, it also allows for it to grow even faster due to increases in returns and its compounding effects.

Cons: Any money invested in your pension plan will not be available until your retirement, you essentially lose access to that money for a long time (or you might be able to take it out before but will need to pay hefty fees.)

Invest in a brokerage account

Invest in the stock marketWhat: Invest the money in your own private investment account to generate interest and dividends.

Pros: Increase your investment funds, as well as the amount of dividends and interest generated to compound without losing access to this money.

Cons: You likely won’t benefit from the same tax advantages that pension funds give and you have to manage your own investments.

Invest in yourself

What: Invest in your individual capital by spending the money on a course, attending a conference or buying books to gain new knowledge or develop your skills.

Pros: Can be tailored to your needs and interest, and can have a long-term effect on your employability, professional development and / or earnings.

Cons: This strategy can be time consuming and prove difficult to see direct financial effect.

Invest in another income stream

Generate another income streamWhat: Set up a company, write a book, buy a property-to-let or find a different way to create another income stream with time.

Pros: Can provide you with a reliable, steady stream of income on the side.

Cons: Can be expensive, hard work, uncertain and unsuccessful.

Which of the above options you ultimately choose depends on your current circumstances: your dreams, plans, job, how much money you have to spend, the risks you want to take, how much time you can and are willing to invest, your family situation and many more. I hope however that the above helps in giving you a better idea of the various options to help you make a decision!

In addition to using your money wisely, if you feel you want to also enjoy a little bit of that extra money now and not just invest it in your future, consider sticking to the 50% rule: invest 50% and keep the rest to spend freely on whatever you want now. Or adapt this to whatever % you want: invest 70% and keep 30%, invest 20% and keep 80%..Whatever you feel happy with!

Step 97: Sequence of Return

Step 97 of the 100 Steps mission to financial independence: Sequence of Return
Step 97: Sequence of Return

Sequence of return – or sequence risk -can pose a serious threat to you portfolio and is a factor to be very aware of and take measures against when you are planning your retirement. Sequence of return can hamper a secure retirement, whether you plan to retire when you are 40, 65 or 80 and it can seriously increase your chances of outliving your portfolio, meaning you might be left with no income towards the end of your retirement.

So what is sequence of return?

Sequence of return is the risk of your portfolio being hit by bad market returns early on in retirement when you start making withdrawals from your portfolio. Like for anybody a bad market return affects the value of your portfolio, but whereas you have time to recover from a few bad years if you are still building up your portfolio, once you start withdrawing you no longer have this time to recover. The value of the portfolio can be affected (i.e. decreasing) by it so much that it threatens its own chances of survival. Not only does your portfolio reduce in value from your withdrawal but also from the market drop.

Let’s have a look at how devastating this effect can be by looking at the portfolio of a retiree who is hit by this phenomenon Let’s say they have $1,000,000 and that the market returns an average of 8% over the first 20 years. This retiree takes out $40,000 (4%) in their first year and then adjust for inflation by 3% each year. Below is the chart with how well they do.

market returns start portfolio take out Total left over
-10% $              1.000.000 $           40.000 $         864.000
-15% $                  864.000 $           41.200 $         699.380
-25% $                  699.380 $           42.436 $         492.708
5% $                  492.708 $           43.709 $         471.449
0% $                  471.449 $           45.020 $         426.429
-15% $                  426.429 $           46.371 $         323.049
5% $                  323.049 $           47.762 $         289.051
20% $                  289.051 $           49.195 $         287.827
10% $                  287.827 $           50.671 $         260.872
25% $                  260.872 $           52.191 $         260.852
30% $                  260.852 $           53.757 $         269.224
15% $                  269.224 $           55.369 $         245.932
-10% $                  245.932 $           57.030 $         170.012
15% $                  170.012 $           58.741 $         127.961
25% $                  127.961 $           60.504 $           84.322
30% $                    84.322 $           62.319 $           28.604
-15% $                    28.604 $            28.604 $                     0
15% $                              0 $                     0 $                     0
30% $                              0 $                     0 $                     0
25% $                              0 $                     0 $                     0

Despite the average 8% return, as you can see, this portfolio takes a big hit at the start of retirement with big negative returns and therefore a big decrease of value early on. Unfortunately after 16 years this person has run out of money and is no longer able to draw anything out of their portfolio. Of the $1,000,000 they started with, they were only able to take out just over $806,000. Continue reading “Step 97: Sequence of Return”

Step 88: Annuities

Step 88 of the 100 steps mission to financial independence: Annuities
Step 88: Annuities

Let’s look at one more pension option before we round off the pension series: Annuities. Sounds like something complex (and they certainly can be when they want to be!) but this step will break down their characteristics and benefits, as well as some of their disadvantages.

What are annuities?

Annuities are a financial product somewhere between an insurance and an investment option. Like any insurance, you buy annuities – in this case it insures you against living too long. Yes, you read that right. Whereas a life insurance insures against dying too early, an annuity insures you against living too long. An annuity provides a set monthly income that you get for the rest of your life after a certain age. If you are fearful that you might outlive your pension, i.e. that you might withdraw too much from your investment and / or pension fund and end up without any money at some point in your retirement, an annuity is a good solution as it gives you a guaranteed monthly income.

How do annuities work?

There are many different types of annuities with many different characteristics. First of you normally buy an annuity from an insurance company, pension provider or broker who then reinvests your money. It very much works like a mutual fund and the company you buy the annuity from will add in a profit margin of course so your money won’t grow very much over time due to the fees you pay. You can buy an annuity with all of your pension savings just before you retire or you can buy several smaller annuities over time. Annuities differ in the way that they are set up and some of the key variables include: Continue reading “Step 88: Annuities”

Step 85: Plan your Money Allocation Strategy

Step 85 of the 100 steps mission to Financial Independence: Plan your Money Allocation Strategy
Step 85: Plan your Money Allocation Strategy

A difficult question that many people on their mission to financial independence quickly encounter is “where they should get their money to work for them”: You’ve managed to cut down a little on your expenses, or to up your income or earnings from a side hustle. But the question as to what to do with the extra money you now have remains. Let’s review some of the avenues on how to “make money with your money” that we have looked at on this mission:

  • Paying off debt – saves you money on interest and compounded interested paid over the years.
  • Saving – generates money due to interest received and the power of compounding interest over the years.
  • Investing – generates money due to capital gains, interest received or dividends.
  • Pensions – builds up the income you’ll receive after your retirement age
  • Personal capital – increases your earning potential as a professional or entrepreneur.

These are the most common strategies to pursue in order to leverage what your money can do for you.

But where to start? Say you saved $100 this month and that you are happy to invest this money into your future and future earnings, where do you actually put this money? Which of the above options do you choose? And how do you mix these strategies?

If you haven’t yet fully read the previous steps on the above mentioned strategies, I invite you to read those first before continuing reading this step, to better understand all the pros and cons of each strategy. Just come back once you’re done!

Money allocation

The question of where to allocate your money doesn’t have to imply an “either …or…” situation. You can start investing whilst still having a mortgage. You’ll want to save an emergency fund together whilst still paying off credit card debt. And once you start investing in your personal capital, you’ll likely want to keep that up on a fairly regular basis and the fact that you are investing in the market doesn’t rule out this option. Continue reading “Step 85: Plan your Money Allocation Strategy”

Step 73: Lifestyle Investing Option

Step 73 of the 100 steps mission to financial independence: Lifestyle investing option
Step 73: Lifestyle investing option

In the previous step we’ve looked at asset allocation and using the yearly rebalancing technique to keep the right balance between your various assets in your portfolio, even if some of your assets grew more than others, thereby taking up a bigger percentage of your portfolio. In step 73 we’ll look at how rebalancing your portfolio can also help to readjust your portfolio when you get closer to your goals. In the examples below I mainly use retirement as a goal, but it can of course be other goals too that you might have in mind for your investments, such as a college fund for a (grand)child, a down-payment for a house etc.

Lifestyle option

Let’s assume that you have a 70/30 shares / bonds allocation to start off with in your portfolio and that the main goal for that portfolio is to use it as (an addition to) your pension provision. With time when you start nearing retirement, you might become a little nervous about the possible volatility of this portfolio however. What happens if there is a sudden crash in the market and you lose a big chunk of the money in your portfolio right before or after you were planning to retire? It means you suddenly wouldn’t have the same amount of money available that you maybe planned to have, which would probably compromise some of your pension plans. Of course when you’re 30 or 40, having a portfolio with a bigger risk factor doesn’t matter as much as your portfolio still has time to recover after a possible crash before your retire. But when you’re close to retirement age, you don’t have the same luxury of time and you probably don’t want that same volatility anymore as when you were younger. Continue reading “Step 73: Lifestyle Investing Option”

Step 45: Calculate your Desired Pension

Step 45: Calculate your desired pension
Step 45: Calculate your desired pension

Although it is nearly impossible to predict how your pension will develop over time and how much pension schemes will change, especially if you are still many years, if not decades, away from your retirement, calculating your pension regularly and setting pension goals is a key habit to develop and establish if you don’t want to be taken by surprise when you finally get to retirement age and start needing to rely on your pension.

It’s easy to think that our pensions will work their way out for us and that we will be able to retire comfortably after 40 or 45 or even 50 years of working. Yet with fewer and fewer young people carrying the burden of paying for an ever-increasing aging population, not just in numbers but also in years living after retirement as saw in step 42, we don’t know exactly how the pensions will develop. Already many countries are increasing retirement age and this might happen again in a decade a two.  Continue reading “Step 45: Calculate your Desired Pension”