Real Estate
Long before people knew about investing in stock market, people would make their money work for them through investing it into a business or real estate. Real estate investing denotes buying and selling of land and all its fixtures for a profit. While stocks certainly have their place in any diversified portfolio, real estate poses several ways to make money that are simply not available to the average stock investor.
There are four advantages to investing into real estate. One is that if this is a rental property, the rental income will generate a steady cash flow. Two is the leverage you receive by investing your money into real estate. Typically, banks will lend up to 80 percent of the appraised value of a property. By leveraging the bank’s money, an investor can increase the cash on cash return. While some investors use leveraging in buying options and futures, leveraging real estate carries much less risk. Three is the appreciation of the property value. If the real estate property is carefully selected, this asset should increase in value yearly as rent prices go up. In addition, each year you are reducing your debt through your mortgage payments, thereby increasing your equity in the asset. Four is the tax advantages of owning a real estate property.
Investing in real estate is attractive for several other of its key features. A feature particular to investing in real estate is financing. It is useful when you have owned a property for a while and have built up significant equity. Instead of selling the property and paying significant taxes on the capital gains, you go to the bank and refinance the property and pull out your equity tax-free. Other real estate characteristics include:
Replacement value: Under certain circumstances, you can purchase real estate for less than its replacement value. In most circumstances, investors purchase stock for multiples of not only the book value, but also its future earnings. Given this comparison, real estate would be a better value.
Depreciation: An investor can take depreciation of a property as a tax-deductible expense. And certain types of properties depreciate faster and provide more of a write-off than others.
Lack of volatility: Real estate by its very nature is much less liquid than stocks or bonds. While that can be a disadvantage, it also can be an advantage in the fact that illiquidity causes less volatility in pricing.
Savings
We’ve all often heard of the most traditional form of ‘investing’ your hard-earned cash, and that form is called savings. Whether its having a savings account at the bank or burying cash underneath the porch, saving cash for future use is an investment method used as long as money has been in use. Most are also familiar with an expression “it is never too late to start saving”.
Savings means something different to everyone. To many, it means a stash of money they are putting aside for a particular investment, such as a car, a home or an education. It could even just be savings put away to buy the new car or fancy suit you've been eyeing that could not be bought at the time. In these cases, you know exactly how much you need to save and when you need to have saved it by. To others, it is a stash of money being put aside for a particular date or event. Most commonly this event is retirement. In this case, you should have a target date and amount you'd like saved, but in general this type of savings is listed as "the more the merrier" kind. There are also people who save just to know that they have a pile of money that they can depend on in the case of a job loss, death or other unforeseen circumstances. And then there's just the rainy day fund - money put aside for special events or items that you hadn't planned on but find you'd like to have. Most of the people probably have savings accounts with ATMs to access their hard-earned cash and be able to store away any extra cash in a place a little safer than a mattress.
Saving provides funds for emergencies and for making specific purchases in the relatively near future (usually three years or less). Safety of the principal and liquidity of the funds (ease of converting to cash) are important aspects of savings dollars. Because of these characteristics, savings dollars generally yield a low rate of return and do not maintain purchasing power. The rate of returns and risk for savings, in fact are often lower than for other forms of investing. Return is the income from an investing your money. Risk is the uncertainty that you will receive an expected return and preservation of capital.
Investing, on the other hand, focuses on increasing net worth and achieving long-term financial goals. Investing involves risk (of loss of principal) and is to be considered only after you have adequate savings. The benefits associated with investing vs. savings are that investments may produce current income while you own the investment through the payment of interest, dividends or rent payments. When you sell an investment for more than its purchase price, you can also earn profit from the sale of the stock or other asset.
Bonds
Just like people need money, so do companies and governments. A company may need funds to expand into new markets while governments need money for everything from infrastructure to social programs. The problem large organizations run into is that they typically need far more money than the average bank can provide. The solution is to raise money by issuing bonds (or other debt instruments) to a public market. Thousands of investors then each lend a portion of the capital needed. In a nutshell, investing in a bond is nothing more than issuing a loan of which you are the lender.
The indebted entity issues investing members a certificate, or bond, that states the interest rate (coupon rate) that will be paid and when the loaned funds are to be returned (maturity date). Interest on bonds is commonly paid every six months (semiannually). Bonds are also called fixed-income securities because the cash flow from them is fixed. The main types of bonds people are investing in today are the corporate bond, the municipal bond, the treasury bond, the, treasury note, treasury bill, and the zero-coupon bonds.
The higher rate of return the bond offers, the more risky the investment. There have been instances of companies failing to pay back the bond (default), so, to entice investors, most corporate bonds will offer a higher return than a government bond. It is important for investors to research a bond just as they would a stock or mutual fund. The bond rating will help in deciphering the default risk.
A common risk with investing in a bond is the risk that a bond’s total return will not outpace inflation. Because the "coupon" or interest payment is fixed until maturity, an inflationary environment will cause these payments to lose value relative to other investments. When interest rates rise in the economy, a bond’s price will usually drop, and vice versa. Interest-rate risk is common to all investing in bonds.
It is more appropriate to look at bonds as a contributor to portfolio’s diversification. Because bonds generally may not move in tandem with stock investments, they help to offset some of the volatility risk involved in investing in stocks and provide diversification in an investor’s portfolio. They also seek to provide investors with a steady income.
