When it comes to investing, the term “diversify” comes to mind pretty quickly. If you’re new to investing, it means don’t put all your eggs in one basket. Simple enough. And if you’re an expert, it means every good investment decision is likely a compromise of sorts. However, before you begin to invest, you need to ask yourself an important question. 

Can I afford to invest at the moment?

A few months ago, friends of mine saw an enticing advertisement for savings bonds with guaranteed rates of return. A good idea right? In the eyes of middle to low income families who know little about investing, the word “guaranteed” is pretty alluring, especially when you’re making lots of monthly car, house, and loan payments. For some reason, when people see the words “guaranteed” and “investment” together, they associate it with making lots of money (which isn’t really the purpose of savings bonds). But before you decide to invest, you need to ask yourself the following: is the interest I’d make on the investment greater than the interest I’m paying on my debt, over a given period of time?

For a lot of my middle income friends with considerable debt loads, the answer is no. If you have substantial high-interest credit card debt, then work on paying that off before you invest elsewhere. Investments like savings bonds are a nice way to save money for a rainy day, but what good is it if you still haven’t paid off your credit card when that day rolls around!

How to diversify between different types of investments

Next, you need to ask yourself, “Am I looking to invest in things that more or less set money aside for the future with a small rate of return, like savings bonds or GIC’s (guaranteed investment certificates)?” or “Am I interested in making greater returns on my money (albeit more risky) through things like stocks or mutual funds?”

Choosing to do both is one way of diversifying, but the rule still applies to each on their own. In the case of bonds or GIC’s, you might be asking why you need to diversify when there’s virtually no risk? The risk to you is whether or not you might need that money along the way before it matures. You may loose your job or come across some other financial hardship, in which case drawing upon that money early could suffer some penalties of its own. When saving, invest in a variety of options that give yourself more flexibility, e.g., bonds that mature over different periods of time. Shop for investments that deliver a combination of the highest rates of return, with enough options to suit your lifestyle.

When it comes to investments with potentially more fruitful returns likes stocks or commodities, it’s important to consider a few things first. While it’s possible to make bigger returns in the stock market, there’s often a lot of irrational behaviour driving them. For example, people buying or selling based on fear, speculation, or poor information which leads to uninformed decisions. This creates a great deal of volatility. So unless you’re able to devout considerable time and effort into researching which companies or commodities show the greatest signs of return, I’d suggest leaving it to the people with a little more disposable income to play around with. But if you do decide to give it a go, diversifying is still the key… don’t hitch your entire cart to one horse, because it might turn out to be a bucking bronco!

Which brings us to mutual funds. They have been known to take a few hits, but they’re a better way to diversify your portfolio (rather than buying individual stocks) because they’re diversified themselves. They also aggressively defend the fund holder’s interests by keeping a close eye on the market. Like the investment strategy for savings bonds, you can diversify yourself by choosing mutual funds with varying rates of returns. However, the strategy differs slightly in that you’re now dealing with different levels of risk. A mutual fund with potentially high rates of return is considerably more risky than a more conservative fund offering lower rates of return. The right investment choice for you will be a compromise between the rate of return you’re looking for and the amount of risk you’re willing to take.

Invest in education

A third investment option would be to invest in education, be it for yourself or your children. Investing in yourself, or increasing your “human capital” as an economist would say, could offer you one of the best rates of return out there. You need to ask yourself, “what marketable skills do I have?”. If you lost your job tomorrow, could you get a job in today’s changing economy? Experience is good, but today’s fast paced world is putting greater demands on marketable skills and clever new talent. If you can barely manage to use a computer, watch out, because kids and young adults like me can do things with them that would make your head spin! Diversifying your talent-set undoubtedly casts a bigger net for finding a job, or a better one.

The tough thing about increasing your level of education is that it can take a long time and tons of hard work. You might not have the money on hand to invest with either. However, deficit spending (a.k.a., a loan) is okay, so long as it fuels future potential growth and earnings. Students accrue substantial debts going to university, but research consistently shows that the long-run benefits outweigh the costs.

In any event, diversifying will continue to be a sound strategy wherever you choose invest.

…As some of you probably noticed, I didn’t touch on RRSP’s or real estate as potential investments, but they’ll be separate topics for discussion in upcoming posts!