6 Important Financial Instruments to Make Your Financial Plan a Success
Decades ago, investors primarily relied on limited financial instruments like bonds and stocks to constitute their portfolio. However, with the advancement of time, investing options have amplified manifold. Today, there is no shortage of financial instruments. But with multiple options, the complexity and confusion have also heightened. In such situations, finding the right investment instruments is critical. A strong and well-balanced portfolio helps you earn higher returns, mitigate risk, and substantially accumulate wealth over time to achieve your monetary goals.
Here are six important tools to make your financial plan a success:
1. Individual stocks
A stock represents your ownership in a company. Stocks offer one of the highest potential returns on your money, while simultaneously exposing you to the highest level of risk. But when placed adequately in a portfolio, stocks can help provide the much-needed boost to your savings in the long-run. Stocks are the perfect option for you if you have a well-diversified portfolio but can potentially take on some risk to increase returns. However, as a good rule of thumb, it is advisable to reduce your allocation into stocks with age. Age-based equity allocation helps you to balance risk and reward with each stage of life.
Ideally, the best way to know the adequate percentage of equity allocation is to subtract your age by 100. For example, if you are 40 years old, you could allocate 60% in equity and the rest in more stable market instruments. That said, as you approach the age of retirement, you would need to restructure your portfolio to include approximately 35% in stocks and the remainder in more stable return-producing investments.
Bonds are one of the safest investment options in the market. Bonds, especially government and municipal bonds, offer more security of earnings at a reasonable risk, as compared to equities. Investing in bonds can be beneficial for your financial plan, irrespective of your age or risk appetite. But it is important to be critical of your bond allocation. It is wise not to invest too heavily in these instruments since they also offer lower returns as compared to many other instruments like stocks, mutual funds, etc.
The right mix of bonds with other money market instruments can help you earn better. A portfolio dedicated 100% to bonds can likely hit hard on your retirement savings and long-term goals. Thus, it is good to invest more in such fixed-income securities with increasing age. For instance, to ensure that you have a regular stream of income in your post-retirement years, you can buy bonds that have a different maturity date.
3. Exchange-traded funds (ETFs)
An important investment tool to make your financial plan a success is an ETF or exchange-traded fund. ETFs comprise a mixture of securities traded on a recognized exchange. The combination of investments in ETFs usually include stocks, bonds, commodities, currencies, or a mix of them all. As an investor, when you buy an ETF, you purchase a basket of assets, without targeting each security separately. In this regard, your interest in the total number of assets is proportional to the shares you own. That said, ETFs closely mimic mutual funds but differ on several grounds too.
ETFs offer ease of purchase. ETFs also have low administrative costs and diversified index fund management. Including ETFs in your portfolio allows you low-cost access and much-needed diversification into a definite area of the market. The popularity of ETFs as an investment has grown considerably over the years. As per recent reports, there were more than $530 billion in ETFs in 2008, but in May 2020, the number of U.S. investors in ETFs was above $4 trillion. Considering all factors, this type of market instrument is perfect for you if you have another 10 or more years until retirement.
4. Mutual funds and index mutual funds
Another great market investment tool that you can consider to improve your monetary returns is mutual funds. Mutual funds include a pool of cash from different investors into bonds, stocks, and other assets. You can use mutual fund investments to diversify across investment instruments and hedge against potential market volatility. These are best suited for you if you have an expensive long-term goal or retirement plan in mind. You can also consider allocating into index mutual funds, which are a more secure version of mutual funds.
Index funds hold stocks in a specific market index such as S&P 500 or Dow Jones Industrial Average. These investments offer returns equal to that of the associated index’s performance. In comparison to mutual funds, index funds are more cost-effective and less volatile. They are beneficial for young or mid-age investors.
5. Certificates of deposits (CDs)
A certificate of deposit is a federally insured account with a fixed interest rate over a specified period. CDs are offered by trusted financial institutions like banks and credit unions. CDs help you preserve an optimum level of liquidity in your portfolio. Some of the top-paying CDs offer higher returns than specific money market and savings accounts. They are ideal for you if you are a more conservative investor, and desire stable returns on investments.
Even though CDs offer lower growth than bonds and stocks, they offer non-volatile, guaranteed earnings. This is appropriate for retirement planners who wish to secure a stable income during their golden years of life. However, it is important to not invest in CDs with reserves you might require shortly. These financial tools are sold based on tenure – one, three, and five years. Hence, you should consider investing in CDs only if you can spare capital and allow it to grow within a predetermined time frame.
6. Real estate investment trusts (REITs)
As opposed to traditional real estate investments, you can consider REITs that allow you to invest indirectly in a property and get high earnings. Real estate investment trusts function like mutual funds, which own real estate. These funds combine real estate holdings like apartments, malls, vacation homes, hotels/motels, commercial spaces, etc. and manage them end-to-end. These companies provide regular dividend payments. You can choose a publicly-traded REIT or a private REIT, where an authorized representative works for you for a commission.
REITs are optimal for you if you already have a well-diversified portfolio in stocks, mutual funds, bonds, etc. and wish to spread further or are willing to chase higher returns. That said, before investing in real estate-linked tools, you must understand that these assets are not liquid. Hence, access to money is not so quick. So, you should only invest in REITs, if you do not need funds in the near term.
To sum it up
Apart from these six most significant monetary instruments, you can also consider assigning assets in immediate and variable annuities, money market mutual funds, or savings and cash management accounts for stable returns in the future. However, the right mix of assets will depend on your timeline, age, risk tolerance, availability of money, investment knowledge, and ultimate monetary objective.
For expert guidance on financial instrument selection, you can consider engaging with a professional financial advisor. Wise decisions of today will lay strong foundations for the future. So, invest smartly.