I’m a firm believer in making sure every dollar I have is working full time on my behalf. Money sitting idle is a bad thing in my book. If it’s not invested then it’s depreciating.
You should adopt this philosophy. Make sure every last dollar you own has a job to do. You’re the CEO of You, Inc. Your investments are your employees. As CEO it’s your responsibility to organize your employees for maximum growth of your little enterprise.
Here are six fundamental strategies you should use to ensure each and every dollar is invested in the most optimal way.
- Municipal bonds – Interest in municipal bonds, or munis, are tax-exempt. If you can buy them either directly or in a fund that specializes in munis from your home state, you will not have to pay state taxes on the interest either. I used to buy these directly for my accounts. Now there are so many ways to purchase munis via mutual funds and exchange-traded funds it’s easy to buy a basket of munis and achieve a properly diversified portfolio of bonds, which minimizes security risk. And speaking of minimizing security risk.
- Diversify your investments – You may really feel good about the prospects of the company you work for, or about some class of investment, or about a particular industry segment; but don’t fall into the trap of investing too much of your hard-earned money in one place. Spreading your savings around minimizes your risk of anyone’s security or any one class of security impacting your portfolio negatively in the event of a downturn. Diversification will generally have the effect of doing more to reduce risk than to reduce return. Diversification is a sound investment strategy.
- Save into tax-advantaged accounts – Are you maxing out your IRA contributions each year? How about your 401(k) or your 403(b)? Contribute as much as the limits allow to these accounts. Tax deferral allows you to hold on to every last penny of gains, which can, in turn, be invested to generate gains of their own. The effect of compounding is well documented, and it applies equally as well to money you would have paid out of your pocket to the government. Take maximum advantage of tax-advantaged accounts and your savings will grow faster.
- Make the right investments in the right accounts – Look at what you’re investing in for your tax-advantaged accounts. You won’t pay taxes on them until you retire at the very least, so it makes sense to be as aggressive with the tax-disadvantaged investment types as possible. Buy stocks and mutual funds that generate as much income and capital gains as possible for your IRA and other retirement accounts. Go ahead and buy bond mutual funds and bond ETFs which generate plenty of taxable interest. Conversely, you should buy investments that appreciate in value and/or generate tax-free interest for your taxable portfolio. I like growth stocks and growth stock ETFs for these accounts. They typically do not pay large dividends, which are taxable, and they have maximum appreciation potential – especially over the long term.
- Make your cash work harder – Cash in your checking account will generate little or no interest. Set up an electronic transfer process between your brokerage account and your bank checking account and use it to move money out of checking and into a higher return money market account whenever possible. If you consider the cash you keep in your checking account and in your money market account as your emergency fund, you should think about adopting my two-step strategy for emergency funds. Your emergency fund will still be there waiting for the day you hope never comes, but while it’s waiting for it’ll be working as hard as possible on your behalf.
- Health Savings Accounts – I have become a believer in these little tax savers. Look into your budget and figure out how much after-tax money you spend per pay period at the drugstore and for all things medical. You should ask your employer to take that much money out of your paycheck before you pay taxes on it. There is a little paperwork involved, but it’s worth the extra time to cover all these medical expenses with tax-free dollars.
There you have it. Six savings fundamentals which will ensure every dollar you earn and save works as hard as it possibly can for you. Get the most out of your savings. It will help you to get the most out of life.