What to Invest In: What Is the Best Investment?

The goal of investing is clear - to have our money make more money in the safest way possible. The only thing to do is find the "best" investment that satisfies these requirements.

As a general rule, the lower the risk, the lower the return. One of the main challenges in selecting the best investment is determining the optimal balance between risk and reward. The ideal trade-off is a personal decision and depends on your financial goals and risk tolerance.

Let's go over the most popular investment options, see how risky they are and what kind of returns you can expect from each one.

Savings Accounts

Savings accounts may not offer high-interest rates, but they offer some returns and can be considered an investment. So let's go over them briefly. Savings accounts are a safe and stable way to earn a small return. They are also highly liquid, meaning you can easily access your money when you need them.

The national average annual yield for savings accounts is 0.20%, and this investment option may look only slightly better than stuffing your mattress with cash. Some banks offer high-yield savings accounts paying up to two percent, but the rates constantly fluctuate depending on economic conditions and, in most cases, wouldn't let you catch up to the inflation. While savings accounts can be a safe place to keep your emergency fund, they are not ideal for long-term goals.

Certificates of Deposit (CDs)

Certificates of deposit or CDs are another financial product offered by banks and credit unions. They typically come with a higher interest rate than savings accounts, but in exchange for a higher rate, you have to lock your money away for a set time. The time you can't touch your money is called a term. A typical term ranges from three months to several years. If you need to withdraw your money before the term is up, you will have to pay a penalty. This penalty can be a percentage of the interest you earned or a set number of months' worth of interest.

This means that CDs are not as liquid as savings accounts. But they are just as safe. As long as the bank is still in business, you can count on getting your money back with the promised interest.

Certificates of deposit typically pay between one and three percent in annual yield, but even with this higher rate of return, you would barely catch up to the inflation. However, a CD might be a good option if you are saving up for a big purchase, such as the down payment on a house in a few years, and don't want to involve risk at all.

Savings Bonds

Investing in Savings Bonds is a way to lend money to the U. S. government in exchange for interest payments. Savings Bonds are backed by the U. S. government and are a very low-risk investment. But a trade-off for that safety is a relatively low rate of return.

The interest rates for savings bonds are set by the U. S. Department of the Treasury and are subject to change. There are two main types of savings bonds: Series EE bonds and Series I bonds. The interest rate for Series EE bonds is fixed at the time of issuance and does not change over the life of the bond. Series I bonds have an interest rate that is a combination of a fixed rate and an inflation rate.

You need to hold Savings bonds for at least one year from the date of issue before you can redeem them, but there is a penalty for cashing them in before they reach five years of age. If you cash in a savings bond before it has reached five years of age, you will lose the last three months of interest that has accumulated on the bond.

Savings bonds are a long-term investment and are generally best suited for people who are saving for a specific goal at least five to ten years in the future. If you need to access the money sooner, it may be better to consider other investment options that offer better liquidity.

So far, the presented options are not going to make you rich. Where to get better returns? You will have to consider more risker options like public markets.

Public Markets

Public markets are financial markets that are open to the general public and where securities, such as stocks and bonds, are bought and sold. Public markets may offer the potential for higher returns compared to other types of investments, but there are no guaranteed returns. Unlike savings bonds, the value of Treasury, Municipal and Corporate bonds can fluctuate due to various factors, and investors in these markets may experience gains and losses.

The bonds traded on public markets can be considered a middle ground between guaranteed investments like savings bonds and riskier investments like stocks, as they offer the potential for higher returns than guaranteed investments but generally carry lower risk compared to stocks.

The income from bonds can vary greatly, depending on various factors such as the type of bond, the issuing entity, the length of time until maturity, and the prevailing interest rate environment. For example, the average income earned from a Treasury bond may differ from that earned from a Municipal bond.

Publicly traded bonds can be a good fit if you are looking for better returns and relative stability and predictability, approaching retirement, hedging against inflation, or saving for something in a five to ten-year timeframe.

The Stock Market

A stock market is where people buy and sell shares of publicly traded companies. Companies raise money by selling shares of stock to the public, and when you buy a share of stock, you become a part-owner of the company.

A stock market is a volatile place, with prices fluctuating based on a myriad of various factors. However, the stock market also presents the possibility of building wealth over the long term.

The returns on the stock market are inherently unpredictable, making selecting individual stocks a futile strategy for the majority of retail investors. Instead, financial experts recommend adopting a more diversified approach, such as investing in a broad range of stocks through mutual funds or exchange-traded funds (ETFs).

The S&P 500 is an index of 500 large publicly traded companies listed on the New York Stock Exchange and the NASDAQ. The average annual return for the S&P 500 has been 10.67% since the inception of its modern structure in 1957.

This return is significantly higher than any other investment option we previously examined. Why doesn't everyone invest in the stock market given its growth rate?

Well, the S&P never has a consistent return year after year. If you had invested in the S&P 500, 2018 would have been a rough year for you with a loss of 6.24%. However, just a year prior, you would have seen a handsome return of 19.42%. And let's not forget about the infamous year of 2008 when the S&P saw a staggering drop of 38.49%. In 2011, the returns were a flat 0%.

The stock market's wild ride of ups and downs makes it an unsuitable option for short-term investing. But if you have the patience and fortitude to ride out the ups and downs over a decade or more, the stock market may provide a rewarding investment opportunity and could be a great way to grow your wealth.

So, What's the Best Investment?

The best investments depend on your goals and risk tolerance. It all boils down to what you're comfortable with and what you're hoping to achieve. If you need your money to be safe and easily accessible, earning a modest 1-4% may be just fine. But if you have a longer time horizon and are willing to take on a bit more risk, aiming for an average return of 5-10% over ten years or more is a reasonable goal. Of course, it's possible to achieve even higher returns, but be aware that it may require taking on additional risks.

Before making any investment, it's essential to develop an investment strategy. Determining your financial goals, risk tolerance, and time horizons can help you choose the best investment.

Related: Developing Your Investment Strategy

Of course, you don't have to choose just one investment option. Mixing and matching is a good way to tailor the risk and potential returns to your circumstances. Spreading your investments out among a variety of assets is called diversification. Investing in a diverse range of options can potentially reduce the impact of any one investment underperforming, as unrelated investments may perform differently under various economic conditions.

Related: Diversification: Important Concept in Investment Management