How to invest $5,000

How to Invest $5,000 Dollars

1. Invest in your 401(k) and get employer matching dollars

Many employer-sponsored retirement plans offer an employer matching contribution.

The common arrangement is a 50% matching contribution for up to a 6% employee contribution. That means the employer will contribute 3% of your salary to your plan if your own contribution is at least 6%.

If your employer does offer this arrangement, you should make a contribution that will result in the highest possible employer match. It's free money and should never be passed up.

One thing to keep an eye out for is fund fees, which can really eat into your 401(k). You can use Personal Capital to track your retirement fees.

2. Pay off high-interest debts first

This may sound like an oversimplification, but paying off high-interest debt is actually one of the best investments you can make. Think about it — if you're paying 22% interest on a credit card, paying it off locks in a 22% rate of return. And there are virtually no investments where you'll be able to earn anything close to 22% consistently.

By paying $5,000 on a credit card with a 22% interest rate, you'll be locking in a $1,100 annual “return” for life.

If you prefer a more direct way to invest that money, consider doing a balance transfer to a 0% annual percentage rate (APR) credit card to eliminate the interest charges. Then you can invest your $5,000 in one of the other options in this list. Several credit cards currently offer a 0% introductory APR for up to 18 months.

Even if you choose to invest your $5,000 nest egg elsewhere, you can still take advantage of a 0% APR to avoid the high interest. This lowers your monthly payment and helps you pay off your credit card principal faster.

3. Use a robo-advisor

Use a robo advisor if you don't feel comfortable creating and managing your own investment portfolio. Once it determines your risk tolerance, it creates a balanced portfolio for you and handle all the management going forward.

This management includes reinvesting dividends and rebalancing your asset mix to match your target allocations. The best part is that robo advisors usually charge around 0.25% of your account value. That means a $5,000 account can be managed for just $12.50 per year.

There are a lot of competitors in the field now, check out which ones we think are the best robo-advisors. Betterment and Wealthfront are two of the leading robo advisors today. Here's our comprehensive comparison between the two.

4. Invest in high-quality dividend stocks

One of the most successful investment strategies is investing in high-quality dividend stocks. This earns money on your investment from two directions: dividend income and capital appreciation on the stock itself.

There's something of a correlation between the two. A company that regularly pays high dividends is an attractive investment opportunity. And many of the same companies are also leaders in their industries and have successful long-term price growth patterns.

There's even a name for the most elite dividend-paying stocks: dividend aristocrats.

These are well-known companies that have been paying dividends regularly for decades. And they have also been increasing them steadily for at least 25 years. You can check out our list of Dividend Aristocrats to find companies that might be attractive to you. Some of them pay dividends in excess of 5% per year.

If you're going to invest in dividend aristocrats, you'll need to open an account with a broker that offers commission-free trades. A good choice is Ally Invest. They charge no fees on trades of stocks, exchange-traded funds (ETFs), or options. It's the perfect place to park your dividend aristocrats stock.

5. Create a diversified portfolio using buckets

Investment buckets are a strategy to match your investments with anticipated financial needs.

For example, one bucket may be your emergency fund. It's an account you'll need to cover short-term income disruptions and large, unexpected expenses. It will need to sit in a short-term bucket, which means an account where it will earn interest and be safe. A high-yield savings account will be the best place for this bucket.

Retirement can be another bucket and will require a long-term investment account that's likely to produce consistent capital gains over many years. Robo advisors or growth-oriented EFTs held in an investment brokerage account is an excellent location for this bucket.

You may have several intermediate-term buckets. For example, you may have a bucket set up for saving for the down payment on a house. Another may be saving for your children's college education. An intermediate bucket will include any future financial obligations that will be less immediate than an emergency fund but are needed well before retirement.

You could put medium-term buckets into a taxable investment brokerage account or even with a robo-advisor. It should have a relatively lower risk than you might have in a retirement account since the funds will be needed much sooner.

6. Fund a 529 plan for your child's (or other relative's) college education

529 plans are tax-favored investment accounts that let you save money for your children's college education. They work something like an IRA, except that your contributions are not deductible from your federal income tax. (Some states offer tax deductions for contributions to 529 plans.) But the income earned in the account is not federally taxed (though some states may tax it).

Money in the account can be withdrawn tax-free for education expenses. (However, if used for non-education-related purposes, withdrawals will be taxable — and subject to a 10% early withdrawal penalty.)

Theoretically, there's no limit to how much you can contribute to a 529 plan. But most people limit contributions to no more than $15,000 per year, which is the gift tax exclusion for 2020. If you contribute more, you may have to pay a gift tax on the excess. But each person can give that amount to each recipient. In other words, two parents can give twice that amount to each child.

7. Invest in international bonds with higher yields

U.S. interest rates are currently at an all-time low. So, getting a decent return on bonds is tough. But one way to get a better return is by diversifying your bond portfolio to include a position in international bonds.

Some countries have higher interest rates than the United States has. So, you may be able to increase your returns by adding bonds from those countries to your portfolio.

However, international bonds also carry higher risks because of currency exchange rates. Currency values between countries fluctuate on a daily basis. If the value of the currency falls in the country where you are holding your bonds, your returns could be reduced. Or you could even lose money.

Since this is a high-risk venture, it's best left to the professionals. Fortunately, most robo advisors will automatically include an international bond position in the bond allocation of your portfolio.

8. Buy commission-free ETFs

One of the big advantages of ETFs is that, unlike mutual funds, they don't charge load fees. These mutual fund fees can be as high as 3%. And they can be charged upon purchase or sale or both. Of course, such fees reduce your investment returns.

The better option is to go with ETFs. Not only are there no load fees, but they also have lower expense ratios than mutual funds. This is important because those fees are charged annually, even if you never see them since they're taken out internally.

But best of all, there are investment brokers that charge no trading fees on ETFs. Open an account with one of these brokers and invest primarily in commission-free ETFs. This will improve your long-term investment performance.

9. Take a risk with cryptocurrency

If you have a high-risk tolerance — and only if you do — you may want to take a chance and invest a very small percentage of your portfolio in cryptocurrency. But no more than 5% or 10% of your total portfolio value.

• Cryptocurrencies have been something of an investment phenomenon over the past decade. They started during the last recession. They languished for many years, but many began taking off in price after 2015.
• Bitcoin, the best known of all cryptos, even rocketed to almost $20,000 in 2017. It crashed after that but is rising again and is now over $11,000 (July 2020). It's the poster child for a high-risk/high-reward investment.

If you're going to invest in cryptocurrencies, you'll need to learn all you can about them. You will also need a brokerage account that lets you trade them. One example is Robinhood. It offers a limited selection of investments, but cryptocurrencies are one of them. It also enables you to hold cryptos in the same account where you hold stocks and ETFs. You can also use crypto exchanges like Coinbase if you don't mind having a separate broker and crypto exchange.

10. Fund a health savings account

Commonly known simply as an HSA, a health savings account is something like a medical IRA. You can contribute up to $3,550 per year for an individual plan or up to $7,100 for a family plan. Not only are your contributions tax-deductible, but the investment income will accumulate on a tax-free basis.

Funds withdrawn from the account to pay for IRS-approved medical expenses can be taken out tax-free. Any funds you don't withdraw for medical expenses can remain in the account. You can invest the funds in the account just the way you would an IRA — holding stocks, bonds, and mutual funds.

If you decide to open an HSA, you'll need to choose the right investment broker, one that supports these specialized accounts. Though you can open an HSA at a bank or credit union, a brokerage firm will allow you to grow your money through a portfolio of stocks and bonds.

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Think about the level of risk you're comfortable with

One of the most important considerations when investing is knowing your own personal risk tolerance. Basically, that's your ability to accept losses in the process of growing your investment portfolio.

Risk and reward have a complementary relationship: the higher the potential reward with an investment, the higher the corresponding risk.

• Low-Risk Tolerance — If losing money on your investments causes you to lose sleep at night, you may feel better investing mostly in fixed-income, fixed-value securities, like short-term bonds or certificates of deposit (CDs). There's virtually no chance you'll lose money on those securities, but you also won't earn anything more than, perhaps, 2%.
• High-Risk Tolerance — Toward the other end of the investment spectrum, investing in stocks have returned an average of about 7% per year going all the way back to the 1920s. But that's a long-term average. You could lose 10% or more in any given year. If you're willing to accept that short-term risk in favor of obtaining the longer-term rewards, you have higher risk tolerance.
• Mid-Risk Tolerance — Traditional investment advisors and robo advisors often begin the investment process by having you take a risk tolerance assessment. That's a list of questions that helps determine your attitude toward risk. Armed with that information, the advisor creates a portfolio that's allocated between stocks and bonds in a way that is within your comfort level. Visit Paladin Registry to get matched with a financial advisor.

You can find out what your risk tolerance is by taking the Vanguard Investor Questionnaire. It's free to take. And it will give you a basic investment allocation you can use in building your own portfolio.

Trade-up to better choices as your investment pot grows

If you're starting with $5,000, it will be best to choose only one, two, or maybe three of the options on this list. But as your portfolio grows, you should gradually expand into other areas.

For example, you may want to take advantage of a 0% introductory APR offer to stop paying high interest on your credit card debt. You should certainly begin contributing to an employer-sponsored retirement plan if your employer offers a matching contribution. And then you might allocate your $5,000 toward a robo advisor for long-term growth. Or maybe even open a brokerage account and invest in commission-free ETFs.

But once you get up to, say, $10,000, you may want to take a little bit more risk by adding small positions in aggressive growth stocks or even cryptocurrencies.

$5,000 is certainly enough to begin building a firm financial foundation. But as your portfolio and your investment experience grow, you should look at other opportunities to improve your long-term investment performance.

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Start investing today

Probably the biggest mistake most people make when it comes to investing is not getting started. The most common reason is a lack of investment capital. But in today's investment world, where you can invest in an entire portfolio of securities through exchange-traded funds or robo advisors, you can begin investing with just a few hundred dollars. That means $5,000 is more than enough to start.

If you've been delaying your investment journey due to a lack of funds but have at least $5,000 available, stop hesitating. One of the biggest secrets to successful investing is to get started as early as possible. Even if you've been delaying for many years, right now is the very best time to get started.

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