You've been prudent with your finances up until now, and it has allowed you to save up little extra money -- let's say $5,000.
If you're on track with all your other financial goals (e.g., saving for a wedding, car or home), here are the best ways to invest that $5,000:
1. Save with an online bank
Online banks typically offer more interest than a traditional bricks-and-mortar bank. “For someone who is just starting out with savings, I would suggest building up that rainy day fund and invest it into a safe liquid account like an online bank,” says Michael Solari, CFP, Principal of Solari Financial Planning, LLC. “Before you can start building a mountain of wealth, it is important to protect yourself from falling into a ditch.”
While online banks offer more interest, the only downside is that they don't have physical locations, which makes it difficult to do things like talk to a teller or deposit cash.
See our list of Best Online Banks.
Here are the top online banks that have highest savings accounts rates and free interest checking accounts:
2. Think about certificates of deposit (CDs) or money market accounts
Again, it’s all about short-term access to cash. If you’re investing for less than five years, then consider placing your money in a CD with a maturity date that ends in five years.
CDs currently earn a small amount of interest, however, any interest does add up. The downside is that once you lock into a CD with a specific maturity date, you’re committed to that.
Money market accounts, on the other hand, offer more liquidity.
For people who are already experienced savers, Solari notes that there are more investment choices to consider. “I have a five-year rule when it comes to investing,” he says. “If you need the money within five years then you ought to invest it into a liquid savings account.”
3. Consider investing in a Roth IRA
A Roth IRA is a stable, long-term account in which you pay taxes ahead of time. “If time is on your hands, then I would strongly think about investing in a Roth IRA account,” notes Solari. “They have been great investment vehicles for young investors, and they have become a great tool for tax planning in the future.” Investment professionals suggest saving 30% of your $5,000 -- and your income moving forward -- in a retirement account.
4. Research online investment firms
Vanguard, Charles Schwab, and others allow you to manage your investment choices online.
Kalen Holliday from Covestor, a registered investment advisor, says, "There are many good options for people who want to start off investing with smaller amounts of $5,000 to $10,000. The important thing is to beware of high fees, which can eat away at less savings, and watch market volatility. Someone with a smaller amount of savings cannot weather rocky markets as well as someone who has built a more substantial portfolio.”
5. Invest in actively managed mutual funds
If you’re young and have a longer time frame, you can take some risks with your $5,000. Investing in mutual funds offers a simple way to diversify your exposure in the stock market.
There is such a wide selection of funds out there -- from equities and bond funds, domestic and international funds, emerging markets and target date funds.
Plus, with actively managed funds, you don’t have to do anything (unless you want to follow the various markets). Fund managers do all the heavy lifting, making all the investing decisions for you.
All you have to do is monitor the funds’ quarterly performance and see if you still want to be invested in the funds. One important note is that actively managed mutual funds charge fees for their services.
You can check on what each fund charges in the prospectus or on the Website. Many financial advisors suggest that you buy mutual funds with an expense ratio that is less than 1 percent.
6. Go for index funds
If you want to bypass the expenses with an actively managed mutual fund, then look at index funds. Again, it’s an investment vehicle that you simply have to set and let the fund do its business.
With $5,000 to invest, you’re not about beating the market every day, rather just keeping up with it.
Plus, there are questions whether portfolio fund managers can, over the long term, outperform their benchmarks, so index funds may be a good option. Take a look at Morningstar.com for a balanced view about all types of funds.
Exchange traded funds (or ETFs) are similar to mutual funds in that when you purchase one share of either fund, you are buying a small slice of that investment’s holdings.
The difference between the two is how they are managed. Since there’s no active management with an ETF, you will need to be the active manager and rebalance your portfolio at least once a year (don’t overlook your mutual fund portfolios either).
The advantage of ETFs are that there are lower costs associated with these investments, as apposed to actively managed funds.
Being smart about risk
Regardless of what type of investment you choose, there are certain intangible truths about investing.
“Strategic investing means taking on an appropriate amount of smart risk -- the kind that boosts return -- within a well-diversified portfolio of stocks, bonds, and commodities,” says Elle Kaplan, CEO and founding partner of LexION Capital Management LLC. “That way, your accounts can weather whatever the market throws at you over time and continue to grow and serve you.”
She points out that the real risk lies in not investing. “Diversification is a valuable tool that allows your portfolio, whether $5,000 or $5,000,000, to grow and work as hard for you as you did to earn it.”