Where to put $5,000? Start smart
You have five grand in the bank, plenty of possibilities, and you want to make that initial investment a killer. But first you've got to build the right foundation.
NEW YORK (MONEY Magazine) - A few years into your working life, you probably have lots of ideas about where to put $5,000: a plasma TV, a blowout weekend in Vegas, a new wardrobe.
But you also have an inkling that it's time to get serious about money. Start by asking yourself these questions.
Four questions to get you started:
1. Do you have a cash cushion? You should have at least three months' worth of living expenses saved. If not, stop here: Use your $5,000 to build a rainy-day fund. You don't want to be one visit to the auto shop away from racking up thousands in credit-card debt.
2. Do you have credit-card debt? Each year a card balance lingers, the Mexico vacation you charged right after graduation becomes more costly. Chances are, your memories aren't growing fonder at double-digit rates. So pay off that balance. It's the equivalent of earning 13 percent (on average) risk-free.
3. Do you own a home? As long as you are paying for housing, you might as well spend on a house you own. Even if prices cool, a home has advantages like no other asset, including no taxes on the first $500,000 in gains (for a couple). And because mortgage interest is tax deductible, the cost may be lower than you think.
4. Are you doing what it takes to retire rich? It's not chasing a hot stock. It's getting into the habit of saving regularly. The easiest way to do that is to sign up for a 401(k) plan. The money comes out of your paycheck (pretax) and grows tax-free. Better yet, your boss will likely match your contribution.
(Having a hard time finding the money to invest? Invest in your earning power; see "Grad School" below.) Once you're saving, go for stocks. At your age, you can take sensible risks to get higher returns.
What you can do:
Stash cash Best $5k choice: HSBC Direct moneymarket account
The best place for your emergency fund is a bank account that's totally safe. In April, HSBC was paying 4.8 percent on its insured moneymarket account (888-404-4050; hsbcdirect.com).
Erase debt Best use of $5k: Pay off your high-rate cards first.
Pull out your credit-card bills to see what rate you're paying on each. Then put as much as you can toward the highest-rate balance. The psychic payoff too is double digit.
Save for a house Best $5k choice (if you're buying within five years): Vanguard Prime Money Market Fund 800-851-4999.
Best $5k choice (if you're buying later): Fidelity Balanced (Click here to see the table.) This balanced fund has 67 percent of assets in stocks now.
Out of the box idea: Grad school Your most valuable asset is your earning power. Invest in it. Anything you do to increase your salary early in your career can keep paying dividends as long as you work.
Take a class, pick up a certification, improve your computer skills. Earning a master's degree will bump up your pay by 19 percent. If you're willing to attend a state, lesser-known or online school, you can bring home an M.B.A. for about $5,000 a year.
Tough call: Pay off student loans or invest?
Why pay off the loan? If you have a private loan, chances are you have a variable rate of at least 7.5 percent - and rising. Paying down that balance keeps rate increases in check. You want happy memories of your college days, not debt.
Why invest? Long term, you should be able to earn a better return than the rate you're paying on a federal loan, especially if you're getting a tax break in your 401(k) or IRA. If you've consolidated those loans, you likely have a fixed rate of no more than 4.75 percent. Up to $2,500 in student-loan interest is deductible (if you're single with an income of $50,000 or less, or $105,000 if you're married and filing jointly). All the more reason not to pay it all off early.
Bottom line: If your interest is 7 percent or higher, pay off the debt. You can't count on doing better in the market. Otherwise, invest in stocks. If you absolutely can't stand the idea of debt - or have a huge loan balance - put half your $5,000 toward debt and invest the rest.