If you have $5,000 to invest, congratulations! It isn't easy to build up a sizable chunk of cash to put toward your future. There are many ways you can invest that money, and the right move for you depends on your financial situation. A person in their 20s will have a different risk tolerance than someone close to retirement.
We've highlighted five routes you might take, as well as when they might make most sense. Bear in mind these aren't either/or scenarios -- you can mix and match to suit your needs.
1. ETFs: Best for decent rewards at relatively low risk
Think of exchange-traded funds (ETFs) as pies containing a mix of securities. Buying even a small slice of that pie will give you a taste of all the securities inside. ETFs that track the S&P 500 are popular with investors because they give exposure to the largest 500 U.S. companies. The diversification across different industries reduces risk.
Many top brokerages don't charge commissions when you buy or sell ETFs. They also have lower expense ratios than other types of funds. Without factoring in inflation, the S&P 500 has generated average annual returns of over 10% over the past 30 years. There will still be years where the market performs badly. But on average, the good years more than outweigh the bad ones.
If you invest $5,000 today and get annual returns of 8%, you could have around $23,000 in 20 years. Even a few percent makes a difference. A $5,000 investment earning 5% would only be worth about $13,000 in 20 years.
2. A 401(k) or IRA: Best for your retirement money
Tax-advantaged accounts can considerably boost your retirement savings. Find out if your company has a 401(k) plan and will match the money you put in. If it does -- and you're not already maxing out your contributions -- talk to the human resources department. See how to put some of that $5,000 into your work retirement account.
If a 401(k) is not an option, a tax-advantaged account such as an individual retirement account (IRA) could help. Traditional IRAs reduce your taxable income now, while Roth IRAs let you put in after-tax dollars and make tax-free withdrawals when you retire. There's a limit to how much you can contribute each year. In 2024, it's $7,000, or $8,000 for those over 50.
Make sure you understand the different types of IRAs and how they'd impact your tax bill. You can put several of the assets listed in this article, including ETFs, into many IRAs and 401(k)s.
3. CDs or savings accounts: Best for money you might need in the near future
Savings and investments have different purposes. Savings vehicles like CDs and high-yield savings accounts usually carry less risk and make sense for money you might need in the near to medium term. That might include your emergency fund or cash you're saving for a down payment on a home.
Investing carries more risk than saving, but it can potentially generate higher returns, particularly if you let the returns compound over a decade or two. This makes it easier to wait out any dips and reduces the risk of being forced to sell at a loss.
Think about whether you'll need that $5,000 in the coming five years. If you will, the current APYs of 4% or 5% on some savings vehicles could make sense.
4. Bonds: Best if you're looking to reduce risk
Bonds are like a loan you make to the government or a company at a fixed rate. They tend to be less volatile than stocks, though they usually generate lower returns. Bonds and stocks often move in opposite directions, so they can balance one another. As you get closer to retirement, increasing the percentage of bonds you own is a popular way to reduce risk.
Bonds have been impacted by the recent high inflation and other unusual aspects of the post-pandemic economy. However, they can be a good source of fixed passive income. Plus, you won't owe federal taxes (and even state taxes in some situations) on the income from municipal bonds.
You can buy bonds through a broker or directly from the government. If you buy a bond EFT, you can invest smaller amounts and get exposure to a mix of bonds.
5. Pay down debt: Best if you carry high interest debt
Strictly speaking, paying down debt is not an investment. However, if you carry a balance on your credit card, you might be paying upward of 20% in interest. That's much higher than the potential gains of the stock market or the interest on a savings account. Put simply, there aren't many legitimate investments that can guarantee annual returns of 20% or more.
It often makes sense to prioritize paying off your credit card debt. You may have a 0% introductory APR on your card or be able to consolidate your debt into a loan. But if you're paying more interest on debt than your savings and investments might generate, use any windfalls to pay it down.
Key takeaway
There are many different ways to invest $5,000, and you don't have to put it all in a single asset class. Think about taxes, potential returns, and how long before you'll need to use the money. Most of all, look for ways to diversify your portfolio so if one industry or asset class performs badly, it won't derail your wealth-building plans.
