You've started your "Pay Yourself First Plan"; now what are your options?
Is this money going to be invested for the long term? Is it just short-term money you'd like to have available for emergencies? A down payment for a new car? Your first house? A vacation?
SHORT TERM - for the money you would just like to have available for an emergency; or a Christmas shopping fund; next year's vacation, etc., then a daily interest savings account makes the most sense. It doesn't pay a lot of interest but your money is guaranteed and available whenever you want it;
MEDIUM TERM - you would still have to start with a savings account until you have enough to put into a GIC (Guaranteed Investment Certificate) as it requires a minimum amount of money ($1,000 or more). This can be invested for terms of 6 months to 5 years and the interest rate increases accordingly. The interest rates are higher than a daily interest account, your money is guaranteed but you do not have access to your money until the term is up. It is very suitable if you are saving for a larger purchase such as a down payment on a house. Because this money is guaranteed, there are people who will invest all of their medium and long-term money this way. That's a choice but it definitely defeats the purpose of making your money work for you.
For example, if I had $10,000 (let's call it a gift from my parents), and I invested it in a 1-year GIC at 3% and kept renewing it every year, it would take 24 years for that money to double to $20,000. If I was lucky enough to get 6% on a GIC, it would only take 12 years to double to $24,000 (so it would be worth $48,00o in 24 years). If I invest it in good quality stocks and was able to average 12% a year, the $10,000 would double every 6 years (Year 6 - $20,000; Year 12 to $40,000; Year 18 to $80,000 and Year 24 to $160,000).
This is called the RULE OF 72 which basically means you take 72 and divided by the rate of return you are getting and you will have the number of years it takes money to double (72 divided by 3 is 24; 72 divided by 6 is 12 and 72 divided by 12 is 6). Feel free to try some other numbers to see where your money doubles.
BONDS
Companies issue bonds in order to raise capital for many reasons. The bonds are issued in larger amounts and the interest they pay is directly related to the financial strength of the issuing company. Bonds are rated so the higher the rating, the more financially secure the company is. Lower-grade bonds will pay a higher rate of interest, but the trade-off is they are not as secure.
Because of the larger face value of bonds, they typically sell out quickly to portfolio and mutual fund managers and are not available to us personally. By law, companies facing insolvency have to pay out bondholders before shareholders so they do come with less risk than the shares of the same company.
Just to recap all of the above-mentioned options, you are basically lending money to the bank (savings accounts and GICs) or companies (bonds). They, in turn, put that money to work and take the associated risk by doing so. The money is not left in their cash reserves waiting to pay you out. It can be used to expand the business to drive more profit; lend out to clients at a higher interest rate; buy stocks in good quality companies, etc.
To give you an idea of what happens with this money (and one of my favourite business stories), I was talking to a young, newly graduated person one day. They had gone to the bank to borrow $5,000 for their first car. Because they were newly employed - holding down more than one job - they had no credit rating. In order to get the loan, the bank needed to hold the car as collateral AND they needed a co-signer on the loan. That didn't sound like a lot of risk to me but they advised that they would have to charge a higher rate of interest because of the extra risk. At the time, they were paying you 2.5% for a one-year GIC (i.e. the money you were lending them) and the interest rate they were charging on this loan - make sure you are sitting down ...........
13.5% - a spread of 11% - I was shocked!
If you don't want to be a lender, allowing others to make YOUR money work for THEM (not you), then becoming a shareholder by buying stocks through a bank, a broker, or a mutual fund company is the next option providing you have time to make this money work for you. And time doesn't mean a month or a year or two; it should be a minimum of five years.
Perhaps you want to take a vacation in a year from now, and you've saved the $2,500 you need. If you invest this money in stocks and they happen to be down 20% that year, I suspect you wouldn't be very happy to see that investment at $2,000 when it comes time for your trip. In a savings account or 1-year GIC, you will have your $2,500 plus a bit of interest guaranteeing you will be able to enjoy the holiday you planned.
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