Wealthy people are very careful to make sure their money is put to work earning more money for them, and they never keep their money in a bank account. Keeping money in a bank account feels safe, you can log in to your bank and expect to know what the amount will be. But it’s also losing your buying power.
This article is going to convince you where you should put your money this 2020.
1. Savings Accounts
For this example let’s say that you put $50,000 in a high-yield interest savings account at the beginning of 2018, and it earned an average of 2 percent interest. At the beginning of 2019 you would have an extra $1,000. However, once you factor in inflation and taxes, your money might actually be losing buying power. That interest you earned is counted as income, adding to your total income amount when you’re doing your taxes. Even if you make under $100,000 a year you still could have to pay nearly a half of your interest income back to the government in taxes.
To make things even worse, inflation in 2018 was 2.44 percent meaning that your $51,000 has $1,244 less in buying power at the beginning of 2019, compared to the beginning of 2018. After including your $1,000 of interest income, but deducting $1,244 in inflation and $250 of tax, your original $50,000 now only has $49,506 in buying power.
2. Stock Market
2018 was a bad year for the stock market, but with the stock market, it’s all about averages. If you had invested $50,000 in Vanguard’s Total Stock Market Index Fund at the beginning of 2018 you would have lost 5.17% when including dividends, for a total loss of $2,585 (it would have been a decrease of 6.94% without dividends). Dividends are quarterly payments that some corporations pay as a return to their shareholders. Unlike interest from a bank account, dividends also receive special tax treatment.
However, if you look at the past three years you would have had a total return of 22.45 % and 28.63% when you include dividend returns, dividends averaged almost 2.1% per year over the last three years. If you had invested the $50,000 at the beginning of 2016 it would have increased in value by $14,315, when you include over $3,000 in dividends. These returns are almost exactly the same as the historical average of a 7% yearly return from the stock market.
When adding inflation and tax, the stock market is still a much better place to keep your money than a bank account. Inflation over those three years averaged closer to 2.15% and tax on capital gains is far lower than tax on income, which is how interest on a bank account is taxed. The capital gains tax is 0% for people who earn under $40,000; 15% for people who earn between $40,000 and $434,000; and everyone else pays 20%. To qualify for capital gains tax you have to have owned the stock for at least one year before you sell it. To get the capital gains tax on dividends you have to own the stock for at least 60 days in the period before the dividend is paid out.
Here is an example, $50,000 invested in 2016 would be worth $64,315 at the beginning of 2019. However, three years of inflation will have reduced the buying power by $3,923. Now, assuming that you make less than $250,000 but more than $85,000, your tax rate will be 46 percent. This means you’ll have to pay $6,584 in taxes, but only when you cash out your investments. This is another advantage over keeping your money in a bank account because your savings will keep earning more income instead of being taxed. In total, the $50,000 you invested in 2016 would have $58,245 in buying power in 2019 after inflation and tax. For a $2,750 increase in buying power on average per year.
Keeping $50,000 in stocks compared to a high-yield savings account would have earned you an average of $3,250 more in buying power per year over the three year period of 2016 through the beginning of 2019.
3. Property Investment
Meanwhile, the same research shows only 37 per cent of Australian investors holds any investment property.
Despite this, investment property is arguably a more straightforward concept. It’s simply commercial or residential real estate purchased and leased to yield a return. Take, for example, a rental home. You’ll buy a piece of real estate and list it on the property market either with the help of a property management agency or by yourself. A tenant will move in and make regular rent payments, which may go towards the mortgage or into your pocket.
You might later aim to sell the property in hopes of making a significant return due to appreciation or any capital improvements you’ve made.
Pros of investment properties
● Familiarity: Australians generally feel more confident investing in real estate, according to the ASX Investor Study. This may be because it’s a more familiar concept.
● Tax benefits: Negative gearing and significant capital gains discounts are available, however, this may change should Labor come into power in the 2019 general election.
● Inflation protection: Property may be used as an inflation hedge, protecting you against decreasing purchasing power of the Australian dollar.
● Security: As you’re buying a tangible asset, it’s often easier to feel secure in your investment. There is less risk of being defrauded as you can physically assess the property.
● Property ladder: Reinvesting can be an attractive option to help you get on the property ladder and own your first home.
● Equity: You can leverage the equity in a property much more safely than you might when borrowing might against existing stocks.
Considering the best investments for you
At the end of the day, the best investment for you comes down to a number of factors including:
Capital: Do you have access to enough money to make the investment?
Risk appetite: Does the investment meet the criteria of your risk profile? Are you comfortable making short-term losses for long-term gain?
Age: If you’re investing for retirement, the assets you choose should depend on how much time you have to make gains.
Goals: Outside of retirement saving, what do you hope to achieve with your investments and when do you want to have achieved that by?
Financial situation: Is now the right time for you to invest? Do you have debts that should be settled first?
Diversification: Are you putting all your eggs in one basket? It’s important to understand the risks of a non-diverse portfolio.
Sources: Medium and BusinessWeek