The Financial Pyramid

There are a lot of ways to save and invest your money. Which option is best? That depends on what you’re saving your money for, how long you have to save or invest, and how much risk you can stomach and still sleep at night. The best option is probably not one of these things at all, but a combination of two or more options. Store the largest portion of your savings in low risk, predictable options, then put money you can afford to wait for (or lose) into higher risk options toward the top of the pyramid.

You’ll note that the financial pyramid below shows higher risk and higher return on the same end of the pyramid. In general, that’s true: safe, low risk investments usually have a lower rate of return. However, high risk really means the possibility of higher returns, but also the possibility of bigger losses.

Cash

Throwing all your spare money in a piggy bank or a mason jar on your dresser is very low risk. But it’s also very low return. In fact, all you’ll gain from these savings options is, well, dust. If you’re going to need the money tomorrow for lunch, by all means, throw it on the dresser. If your timeframe is much longer than that, you could do better stashing that money elsewhere.

Savings Accounts - Certificates of Deposit - Money Market Accounts

These options are all very low risk (assuming your financial institution is insured), but also offer lower returns than the higher risk options on the financial pyramid. They are a good place to keep money you will need - or may need - in the near future, as well as a rainy day fund with enough in it to tide you over for two to six months in an emergency. In Save Your Money, we discuss when and how to choose each of these options.

T-Bills

Treasury bills, or T-bills, offer a guaranteed return, backed by the US Treasury. Minimum purchases are usually between $1,000 and $10,000. They usually mature in anywhere from three months to thirty years.

Government Bonds

When you buy a bond, you are making a loan to the company or government issuing the bond. You loan the money and receive a fixed interest rate for that money at the maturity date. Before the maturity date, though, the market value is not guaranteed and can change because of interest rates and the credit rating of the bond issuer. That means your bond could be worth more or less than the guaranteed amount at any given time before they mature. Government bonds are generally fairly low risk, low yield instruments.

Mutual Funds

Mutual funds aren’t a specific investment. They’re a pool of money from many investors used to buy a wide variety of stocks and bonds. Mutual funds offer a number of advantages over investing individually. One is that, since a lot of money is available, the money can be "spread out" over many stock and bond options. Another is that, once you’ve chosen a mutual fund, you don’t have to do the thinking about every purchase or sale. Mutual funds are managed by professionals who do that for you.

Corporate Bonds

Like government bonds, corporate bonds are based upon loans. You, as the purchaser of a bond, are loaning money to the bond issuer. Like any loan, they can be risky. Be as careful in buying bonds as a credit union or bank would be in lending money to you. Check the financial standing of the company, whether the bond is backed by collateral, and how the bond is rated by a professional bond-rating service.

Stocks

When you buy stock, you are buying part of a company. It’s as simple as that. If the company earns money, you earn money. If it doesn’t, you don’t.

All stocks are not created equal. Any investment in the stock market is a chance to make money. It’s also a chance to lose all or part of your money. Some stocks are more risky than others: the best way to protect yourself and realize a profit from stocks is to diversify. Buy shares of a variety of companies in a number of different fields. That way, if one company or industry stumbles, you won’t fall. Many people invest in mutual funds in order to avoid the hazards of having all their eggs in one basket.

Blue Chip Stocks

Blue chip stocks are named after the poker chip with the highest value. These are shares in high-priced, dividend-paying companies like General Motors or DuPont. The companies that offer blue chip stocks are those that have a solid, proven track record and strong management. The value of their shares is not likely to skyrocket or crash, but to make slow, steady movements.

Penny Stocks

Penny stocks are very speculative stocks. They usually cost less than other shares, but are also more risky.

Commodities

Commodities are actual materials or things like oil, wheat, or pork. When you buy a commodity, you are actually purchasing a specific amount of oil, say, for a specific price. When you do, you hope that the price will rise so you can sell your oil to another investor for more money. The risk, of course, is that the price will fall and you will lose some or all of your money. Commodities are considered a very risky investment.

Collectibles

Collectibles are speculation, not an investment. If you could retire off of your baseball card collection, working men all over the country would be quitting their jobs and living the high life. The same goes for your Barbie dolls, Beanie Babies, and the "classic" car you’re planning to restore. If collecting something makes you happy, you should collect them: just don’t make the mistake of thinking they will make you rich.

The Lottery

Two words: No way.  

You’ve finished the guppy class. You know enough to get your feet wet, and you have a healthy respect for the dangers that await the unwary. For more advanced lessons, check out "Other Resources" at the top of the page.