Many investors think of investing as a competition between investing in the stock market, interest earning investments and real estate. Too many people take a strong stance for or against one of these three broad categories rather than embracing the advantages that each one can bring to their portfolio. A well balanced portfolio should include some of all three with each serving a very different purpose.
All three categories will have their day in the sun depending on the investment climate. Due to low rates, interest earning investments such as CDs, bonds and savings accounts aren’t getting much love right now. Despite the current low rates of return, interest earning investments provide a relatively safe place to keep your short term money. This is money needed to cover living expenses or emergencies over the next several years. Interest earning investments provide a buffer against more volatile investments in the stock and real estate markets. Keeping a portion of your portfolio in safer, fixed income investments can give you greater peace of mind and help you stick to your long term plan when the stock market gets rocky. However, avoid putting too much in interest earning investments; this can make it difficult to keep up with inflation and earn the growth needed to support your retirement goals.
On the other hand, when the stock market is doing well everyone wants to get a piece of the action. Avoid overloading your portfolio with stock when the market is skyrocketing. Investments in the stock market can provide you with long term growth and a hedge against inflation. Historically, the stock market has trended upward and over long periods of time has outperformed other investment categories. However, in the short term the stock market can be very unpredictable and volatile and should only be used for long term needs – money that isn’t needed for five to ten years. Keep your short term money in interest earning investments.
Real estate serves a dual purpose for most investors, it gives us a place to live and it provides us with an asset that usually appreciates over time. In addition to your home, as your portfolio grows, you may want to consider additional real estate investments in mutual funds or rental property. Like the stock market, real estate should be treated as a long term investment. The real estate market can experience extreme downturns and commonly lacks the liquidity needed to cover short term needs.
These three categories of investments have their advantages and disadvantages. Focus on the role the asset plays in your financial plan and avoid becoming overly comfortable and confident with a single category – it’s all about balance. The appropriate amount in each category will vary over time and is dependent on your age, your financial goals, your cash flow needs and your risk tolerance.