Okay, so you’re 20 thousand dollars richer, and you want to know the best way to invest 20k. No problem. I’ve got you covered.
One problem: the best way to invest 20k is relative. It depends on what you want. I mean, you could take that money to Vegas and bet it all on lucky number 13. You might 35x your money.
But 98% of the time, you’ll just lose it all.
Same with putting your money in something speculative like bitcoin or oil futures.
On the other side of the spectrum, you could invest all your money in treasury bills. This is about the safest investment possible, but it has commensurately low returns–less than 3% annual yield as of this writing.
In investing money, the amount of interest you want should depend on whether you want to eat well or sleep well.
These two examples illustrate the risk-return tradeoff. The higher the return you need, the more risk you need to take on.
Why is this so?
Consider a concrete example: working on an oil rig. Why do these sort of jobs pay so well?
Because they must. If the owners of the rigs tried to pay less for labor, no one would work their. It’s too risky to justify the price.
The same is true of investment securities. If you buy stocks, there’s some risk that the company will go bankrupt and you’ll lose all of your money. Thus, you’re going to demand to be compensated for your risk.
This is the reason why investing your money in the stock market will have a greater payoff than buying bonds. The risk is higher, so the return must be, too. Otherwise, you wouldn’t invest.
With that background out of the way, you’re now in a position to figure out the best way to invest 20k. If you want a high return, invest in a risky asset. If you’re comfortable with a lower return for more peace of mind, pick something lower risk.
How do you do this?
The most straightforward way is to decide on allocating some of the money into bonds and some into stocks. The more you allocate into stocks, the higher the return and the higher the risk.
So, a high-risk, high-return portfolio might allocate 90% of the 20k into the stock market, with the other 10% in bonds.
On the other hand, a low-risk portfolio would allocate 50% of the portfolio into stocks, with the other half in bonds.
You need to decide on the amount of risk you want to take on, and choose your asset allocation accordingly.
For more on choosing a risk tolerance, check out these graphs.
Okay, so let’s assume that you have some idea about your risk tolerance and the kind of asset allocation that you’d prefer.
How do you choose what stocks and bonds to invest in?
You could painstakingly research each company and only invest in those that you believe are a good deal, but who has time for that?
Luckily, there’s an easier way.
You can use index funds. Index funds are broad slices of the stock and bond market. When you buy one, it’s like buying a tiny slice of everything.
For your stock allocation, for instance, you might buy shares of Vanguard’s Total Stock Market Index Fund (VTSMX). For you bond allocation, you might choose Vanguard’s Total Bond Market Index Fund (VBMFX).
That’s it. That’s the best way to invest 20k. Determine you risk tolerance, decide on an asset allocation, and then fill it via index funds of your choice.
If you want to read more, I go into this a little more depth on a similar article I’ve written on where to invest 50k.