A question I am often asked is:
“How do I invest small amounts of money and make a LOT of money?” I always smile and say, “Wouldn’t it be nice if it were that easy?” Investing money for high-yield returns usually requires significant research, due diligence, resources and capital. Some (or all) are often outside the reach of us mere mortals.
So, what should you do when you have a few extra hundred dollars or maybe even a couple of thousand dollars? I recommend that people go through a 4-tier investment waterfall. This methodology applies to both personal balance sheets and small business balance sheets.
1. Pay down high cost debt
The easiest way to earn money is to stop spending money. Evaluate outstanding debt and determine which debt bears the highest interest/cost structure. By utilizing excess cash to pay down high cost debt (I usually don’t include mortgages in this analysis), you accomplish three goals.
- You get an immediate and known return on your investment equal to the amount of interest/fees you would have paid on that debt had you not paid it down.
- You reduce the outstanding debt and therefore create credit availability should you need to access such for a future need.
- Paying down debt can improve future credit/FICO scores which directly correlates with the cost of future debt. Ultimately, you will pay less for future credit.
Ensure you have at least a 90-day rainy day fund. You should aim to have 6 months of living expenses in an interest-yielding savings account that is liquid, in the event you’re hit with one of life’s challenges. The last thing you want in an economic downturn is to find you not only lost employment/your business had cashflow shortages, the market value of your investments also suffered a serious blow at the exact time you need their liquidity to deal with the life event.
3. Retirement Account
Every employee and/or business owner should aggressively fund the ultimate insurance policy. The great thing about the human spirit is our incredible ability to be optimistic about our future; however, one should not count on optimism being the sole source of future financial stability. These accounts can be invested in a multitude of ways and earn tax-deferred returns (you get to invest your money and the tax man’s money, earning a return with no taxes due until you start to take distributions out of your retirement account). This tax-deferred investment vehicle, depending on your tax bracket, can generate substantially greater returns than traditional investments in the after-tax market. Maximize your retirement contributions as much as you can.
4. Marketplace Investing
If you cleared the first three tiers, you have done a great job putting your personal business capital to work, establishing a short-term rainy day fund, and are appropriately funding your future financial stability. You are now in a position to go into the market and make small investments. The two critical areas I ask all individuals to assess are how much time do you have, and what level of experience evaluating investments do you have? If either one of those is limited, I encourage them to open simple brokerage accounts and invest in diversified mutual funds with low-cost fee structures. You can ask your brokerage for recommendations, or there are many lists like this one that identify low-cost funds.