You certainly don’t want to work forever. The goal is to work for your money, and then let your money work for you. In other words, you want your money to generate passive income 24/7. This will enable you to retire early and achieve financial freedom. Now you might be wondering, where should you invest your money so it creates more money? Well, there are three primary “investment vehicles” that have generated money for investors over centuries. They are Stocks and Index Funds, Real Estate Investments, and “Lending Money”. Some of the most popular lending money mechanisms are Bonds, Certificates of Deposit, and Peer-to-Peer lending.
Words like “Bonds” or “CDs” might sound intimidating. Don’t be afraid! Conceptually, all you are doing is lending money to other people.
Lending money is actually a very old wealth-generating instrument. It is the main business model behind the banking industry. I am sure you’re very familiar with this concept. You probably have a big national bank such as Chase or Bank of America in your own neighborhood. These banks generally lend money for mortgages, car loans, business loans and charge interests on those loans.
Well, the main purpose of this article is to encourage you to take advantage of this money multiplier mechanism yourself! You can certainly use it to invest your money. It will help multiply your wealth, just like those big banks are doing as we speak!
I actually believe everyone should include “money lending” in their portfolio of investments.
This is because, in my humble opinion, lending money is perhaps the most “passive” of investment vehicles. Meaning it requires little to no work from your part, once the loan is established.
Lending money is also the most “secure” of investment vehicles. Meaning your capital is safe, and there is minimal risk of losing it. We can even take it one step further, not only is your capital safe, but your return is also safe. In other words, the monetary gains of your investment are clearly defined from the get-go. Very few investment vehicles have a fixed or guaranteed ROI (Return on Investment).
Another advantage of this investment vehicle is that you don’t need a large amount of capital to start lending it. You could typically start with as little as $1,000. Compare this to the capital you need to put down as a down payment for an investment property. You can easily see that the funds needed to invest in Real Estate are considerably larger.
Finally, if you already own Stocks and/or Real Estate, adding this mechanism to your portfolio of investments will help you diversify. Effectively, spreading out your risk over uncorrelated asset classes. Now let’s dive right into how you can lend money, and in essence, become a “mini bank” yourself!
Bonds – Lending Money to Governments or Companies.
When a Company or a Government needs to raise money, they issue out Bonds. These Bonds are basically “I owe you” notes. The bonds stipulate the amount of money of the loan, and what are the terms and conditions for repayment. If you have capital lying around, you could lend it to the government and “buy” a bond.
Typically, these bonds lock in your money for 2, 5, or 10-year terms. Once that term has expired, the bond “matures”. When this happens, the government repays you your money and then some (the stipulated interest rate).
Bonds are considered to be very safe. The only way an investor will not be paid back is if the Government or Company they obtained the Bond from collapses. Bonds are considered safer than stocks even in the case of catastrophe. The reason is because a bankrupt Company would pay its bondholders before their stockholders.
Certificates of Deposit – Lending Money to Banks
You can lend money out to banks as well. This is typically done through Certificates of Deposit, usually abbreviated as “CDs”. Essentially, CDs work very similar to Bonds. You give a specific amount of money to a bank and establish a deposit.
By doing this, you’re effectively lending the money you deposited to the bank for a specific timeframe. This timeframe can be tailored to your specific needs, so you have a lot of flexibility. Typically, the shortest timeframe is 3 months. The longest timeframe could be for several years. The most common CD duration is one year.
The longer the timeframe, the higher the interest rate you will be paid per year (sometimes called APY – Annual Percentage Yield). You have the possibility of choosing the timeframe you’re going to lend the money out. But, please keep in mind that once that timeframe is locked in, you shouldn’t ask for your money back. A penalty might be incurred if you ask for your money beforehand. Once the agreed-upon timeframe has elapsed, you get your money back (as well as an additional interest that the bank will pay you).
This is my preferred method of lending money because it is extremely easy to do, and extremely safe. CDs are considered the safest of all money lending mechanisms because they are usually FDIC insured for up to $250,000. I also consider it the most flexible way to lend money, since there are dozens of different timeframes available.
Banks also offer “Saving Accounts” where you can deposit your money, and gain interest.
Conceptually, they work similarly to Certificates of Deposit. The main difference is that savings accounts are liquid, meaning you can withdraw your money at any time.
However, the Annual Percentage Yields (compounded interest rates) offered in savings accounts are usually lower than the rates offered in Certificate of Deposit. In essence, they are more flexible (liquid), but they tend to pay less (lower interest rates).
Peer-2-Peer Lending – Lending Money to a particular person:
Another option is for you to directly lend money to another person. This can be done through a Peer-To-Peer lending platform. Sometimes individuals find themselves in the middle of a money crunch, and need a quick loan to take care of their financial issues promptly. These days, individuals have the possibility of easily obtaining this money online in a virtual marketplace. Loans of different sizes are available, so they can pick a loan depending on their needs.
Conversely, you can also sign up into these platforms to lend your money to individuals. That way you help them out, and also collect a lucrative interest in the process. The interests you can collect in this type of peer to peer loan are considerably higher than the interests offered in a Bond or CD.
So, this is by far the most lucrative option, but it is also the riskiest. In essence, individuals are not as financially robust as a Government or a Bank. Thus, lending money to “normal people” is considered riskier than lending money to an established institution. In other words, individuals are considered more prone to default on a loan. In simple terms, not paying you back.
The higher the risk, the higher the “interest” or “reward” that you should expect. This is true for any type of investment.
Generally, the better the “credit score” from the person borrowing the money, the lower the risk of default. But, the better the credit the lower the interest you will receive. Since there is less risk involved in that arrangement. More risk, more reward, always remember that!
That being said, a lot of these platforms provide you the capability of “screening” the loan applicants from a financial perspective. For example, you can consider factors like their credit score, education level, or employment history. So, you could try to mitigate or neutralize your risk in the “application” stage of the process. Similar to a landlord renting out a house.
A landlord has the possibility of screening a potential tenant’s credit history before renting out his property. Landlords do this a “risk management” protocol. Landlord-Tenant laws vary by state. But usually, landlords are in their right to consider financial factors of prospective tenants. For example, the landlord doesn’t have to rent out to someone that filed for bankruptcy. Or to someone that was evicted out of their last house.
All investments involve risk. The tenant might no pay rent. The stock might go down. The loan might not be paid back, etc. This universal truth also applies to peer-to-peer lending.
Money Lending Conclusion:
Currently, the United States Federal Reserve is printing a significant amount of money. Their goal is to minimize the impact of the Coronavirus in the economy. This money printing effort has been labeled as “Quantitative Easing Infinity”. The reason is that there is there is no limit to the number of dollars the Fed could print. Because of this money printing effort, the risk for higher inflation is increasing.
Inflation means that the acquisitive power of your dollars decreases. Or that your dollars will “depreciate”. Meaning you will have to pay more dollars to buy the same item in a few years. To hedge against that inflation, you should put your money to “work” in some sort of investment vehicle.
I understand that during uncertain times, investing in Stocks and Real Estate might seem like a risky proposition. But, you have other alternatives like I explained in this article. Lending money is a great strategy to shield yourself from inflation.
You can use this strategy to minimize the risk of having your money depreciate. I know that the interest rates that CDs pay are not that high. But, a CD is certainly better than nothing (it will help you mitigate a little bit of the inflation damage in a safe way). In difficult times, bonds and CDs are considered the most solid “safe haven” investment.
My ACTIONABLE Tips:
If you have $1000 or more sitting there, don’t hide them underneath the mattress and let your money rot away. Lend your money to somebody now! Put every single one of those dollars to work in your favor, and make you more dollars (don’t let those dollars get lazy). I think it is in your best interest (pun intended), to take a look at the following five possibilities:
If you want to play it “safe”, then check out a Certificate of Deposit from either of these two banks:
1.) Commercial Investment Trust (or CIT) has been in business for over a century, so the bank is solid. The bank is also FDIC insured, which means your deposit accounts are insured up to $250,000. Currently, they operate as an “online-only” bank, which has a lot of benefits for their customers. For example, they have less overhead than other brick-and-mortar banks. This allows them to transfer those savings to the people investing in their high-interest CDs and Savings Accounts.
CIT offers some of the best CD interest rates in the industry, and some of their CDs don’t have a penalty if you withdraw your money early.
2.) Barclays is a British Banking empire, with a history dating back to 1736. They have more than 48 million customers worldwide. They currently offer online Savings Accounts and CDs in the USA. You should take a look at their Savings Accounts since the interests are extremely high. Barclay claims it to be 21 times higher than the national average. Their savings account interest rates are actually higher than most CDs in the nation. Even their own CD! Enabling you to withdraw your money at any time! They don’t have a minimum balance to open a savings account, so you could start with whatever funds you have available. There is no monthly maintenance fee either. Finally, their savings accounts are also FDIC insured up to $250,000.
You could also lend your money on peer-to-peer platforms.
This is the best option if you like the feeling of directly helping others, and have a higher risk tolerance. Remember, this is by far the most lucrative proposition:
3.) Upstart.com is a great option to use as peer-to-peer platform. Upstart is one of the leading online marketplaces. It evaluates a significant number of factors from the individuals trying to get a loan. Meaning Upstart attempts to mitigate the risk for investors. Aside from credit score, they consider other factors such as education, area of study, experience, years of credit history. With this approach, investors get a “holistic” overview of the creditworthiness of loan applicants. Upstart has excellent reviews and ratings from both sides of the coin (borrowers and lenders).
4.) LendingClub is the largest online peer-to-peer lending marketplace in the United States. Lending Club is the industry leader. The platform has helped over 2.5 million individuals with their loan rates and appealing investment returns. Generally, borrowers use this platform when they are looking for personal loans, business loans, education-related loans, or even “elective” medical procedure loans.
5.) Prosper is another leading peer-to-peer lending marketplace that started back in 2006. It connects borrowers with investors that want to invest in consumer credit. In this platform, borrowers generally apply for loans that range between $2,000 and $40,000. The loans have fixed terms that are healthy for both borrowers and lenders. Prosper provides an opportunity for investors to earn attractive returns.