There are a million things you can do with $1 million – pun definitely intended! You could buy a nice house or car, go on vacation, or buy some stocks. But what are some of the best ways to invest $1 million?
Before we dive in, it’s important to remember that no amount of money is eternal, especially if it is used unwisely. There are more than enough rags to riches and back to rags stories, so it’s important to not add our name to the list. It is very easy to get caught up in the amount that you have and choose to spend it rather than save or invest it wisely.
So, what are the best ways to invest $1 million? I have listed the options below, in order from safest to riskiest. Even though I mention “riskiest”, please note that all of these are reasonable investment options. Nobody is talking about betting it all on a night out in Vegas!
You also won’t find me talking about buying $500,000 cars and sipping on $10,000 bottles of champagne! However it’s also important to remember that once you have earned your financial freedom, you then have all the flexibility to spend away on the luxuries of life! There’s no point in just saving money endlessly and not having any fun!
Take a read and do let me know what you think!
Payoff Debts
Before thinking about where to invest the $1 million, I strongly recommend paying off any debts you may have – especially credit cards or personal loans. Consider that the average interest rate on credit cards in the US is well over 20%. This is significantly higher than any after-tax rate of return you can generate consistently over the long term from investing. Therefore the single best investment you can make is to wipe out credit card debt and other high interest rate debts. Time to streamline, and once you are free from all high interest debt, it’s time to look for some interesting investment opportunities!
Build up Your Emergency Fund
We’ve all heard the advice before and sometimes it’s just too damn difficult to save up the extra money to put aside in a rainy day fund – no matter how important it is! Well, now that you have $1 million in cash, there’s no better time than the present to put some cash aside for your emergency fund.
How much should you save for your emergency fund? Having between 3 to 6 months equivalent of your income is a great place to start. If you plan on saving beyond 6 months of expenses, you may want to examine options to generate a little higher returns on your emergency fund than simply putting it in a bank account.
Buy Your House
If you don’t already own your own home, then this would be the perfect place to start deploying your capital. Over the longer term home equity is a great way to build up stable wealth. There are of course numerous costs associated with home ownership, but make no mistake, even as a tenant you are paying for those costs through your rent. So it’s better to pay yourself instead of your landlord.
If you already own your home, you might similarly want to consider paying down your mortgage. Whether to pay down your mortgage or invest is not a simple decision, so its best to give it some thought.
For now though, if we focus on investing, the decision depends on the mortgage rate you are actually paying, term remaining, and whether you’re likely to get a better after-tax return from investing. As a general rule, if your interest rate is low, then it probably does not make sense to pay off your entire mortgage just yet.
Perhaps you could chip away at it a little bit if that makes you comfortable. However at this stage, you could likely generate higher returns from other investment opportunities, so it might be worth considering those first.
Deposit the Cash in a Savings Account
Ah yes, the good old savings account – nowhere better and safer to stash your cash than a savings account! Of course you would make lower returns in a savings account compared to other opportunities, but nevertheless, you will never have to worry about losing your capital. The same cannot be said when you invest your money in any other manner – whether in a home (home prices go up and down) or in stocks and bonds (both can be volatile)!
So how much interest can you generate on your $1 million in bank? Well, as interest rates are now ticking up, it’s a tidy sum. Read my dedicated article on the topic to learn more about how much interest you can make from $1 million.
Invest
This is where things start getting tricky. Before proceeding further, take a stock of your life situation and determine what is the best asset allocation for you. I have provided a framework for asset allocation and also discussed my personal financial assessment and asset allocation to provide an example.
Once you have decided what is the proper allocation for you, the next step is to look for investment ideas. There are a few different core asset categories one can think about:
- Real estate
- Stocks & Bonds
- Physical Commodities
- Alternative Investments
Finally, it’s about which are the best investment methods and accounts to look at: whether you’re saving for retirement, or for your children’s education, or a trust fund!
Real Estate
When we talk about real estate investment, the most common thought that people have is residential real estate. However there’s a whole world out there in the commercial real estate segment. Commercial real estate covers office space, retail space – stores or restaurants, hotels, motels, self-storage units, RV storage lots, etc. However as commercial real estate is a huge topic, and probably not a good starting point for beginners, I focus here on residential estate.
No matter what is happening in the world, people always need a place to stay, live, work, host events, etc. There are multiple benefits to owning properties other than your own home, one of which is using them for rental income. Renting a property will require some work on your part but will nearly always guarantee a steady income for you.
This is a great way to invest money in yourself without having to rely on something over which you will have very little control, such as the stock market. It’s a great semi-passive source for cash.
As an investor, your job will be to find the right locations, build or buy the properties, and make sure that they are always up to standard. Depending on what they are being used for, that could mean investing in cleaning services, a maintenance team, etc. However, whatever you invest will be returned to you with a profit. It may be worth hunting down a property management specialist to help you along the way.
How Much Can You Expect to Make in Real Estate?
It’s a difficult question to answer as there are many variables involved beyond just the property price and rent. There are factors like location, property type, renovation costs, operations and maintenance costs, your skill in operating and maintaining the property, occupancy rates, your luck with tenants, and taxes.
There are also two types of rentals – long term or short-term nightly rental (Airbnb). There are of course big similarities, but also huge differences in how the properties are identified, operated, and managed. Depending on the location of the property (are you in a touristy location?), the local rules (any limits to how many rooms you can rent out?), and competition, one type of rental operation may deliver better returns. It’s best to scope out the options with someone who has experience in your market.
At the very minimum, you should be looking to break even on cash flow. This means that you should expect to generate enough to cover your mortgage payments, any other operating and maintenance expenditures, and taxes. If you are unable to cover these expenses, you may end up having to pump money in to your rental property on a monthly basis indefinitely. Not a very appealing investment!
You also have to ensure that your tenants have solid credentials and income sources. Often landlords use an informal rule of asking tenants to prove that they earn three times the rental payment. This ensures that they have a sufficient buffer to pay you on time and in full.
In terms of numbers, if you purchase a property for around $400,000 with a down payment put down a of 15% (typically the minimum for investment properties), you only have to deploy $60,000 in cash. This still leaves a huge chunk of cash for you to pay off debts, build up your emergency fund, and invest in the financial markets!
The target for your annual rental yield (total annual rent/total value of the house) should be around 0.5% to 1% higher than your mortgage to cover for other operations and maintenance costs. With current mortgage rates of around 6.6% APR for a 30-year term, your rental yield should ideally be in the 7.1% to 7.6% range. This means for a property costing $400,000, your ideal target for rent should be $2,367 to $2,533 per month. This might be tough to achieve in the current environment, so although I’m not a fan of market timing, it might make sense to wait till home prices fall a little so this equation fits for you.
Obviously rates are a little crazy right now, so one could consider opting for a 15-year fixed term loan where interest rates are around somewhat lower at around 5.5% APR. A shorter amortization period has a higher mortgage payment, so the only way to equalize the monthly payments with the above option would be to put down a 30% down payment, or $120,000 in this case.
If you only put down the minimum 15% deposit on the value of the house, the return on your equity would in reality be much higher – well over 20% in the first several years! Of course, this does not take in to account any changes in house prices (which could go up or down). As your equity starts to build up, this return on equity would gradually start trending down, but should remain very respectable for a good portion of the life of the loan.
Stock & Bond Markets
This is my favourite topic and I’m sure many people also enjoy investing and trading in the stock markets. Before investing in the market, it’s important to remember this rule: You are more likely to lose your money overnight in the stock market, rather than to make it big overnight.
The key to making money in the stock market is to invest systematically and have a good investment process and focus on the long term. It is important to be honest with yourself and figure out what your skill level and capabilities are before diving in fully with your money. Of course, we all like to have some fun, so it makes sense to have a small pot of “play money”, but it should only be a very small proportion of your total assets.
How Much Can You Expect to Make in Financial Markets?
The key to making good returns in the stock market is to have a disciplined investment process and to stick with it through thick and thin. General return guidelines for a 100% equity allocation account would be in the 7-9% range over the long term. Note however that recent returns have been higher, which has driven annualized 10-year return figure to over 10% compounded.
As you go in to more conservative investments, such as the standard balanced fund with 60% equity and 40% bonds, your returns will likely be in the 5-7% range over the longer term.
If you pick money market funds or ETFs that hold short-term securities, your returns will likely be in the 2-3% total returns range.
Growth vs Income: Which is Better?
You may have heard about investments funds that are tailored for growth or for income and might have found yourself wondering – which is better? It can get confusing quickly, but I feel that some of this confusion has been deliberately created by the industry to confuse the customer!
The growth vs income debate in my mind is misplaced. From a purely financial perspective, one should opt for a portfolio that maximizes total return, which is inclusive of capital gains (rising share prices) and dividends, while minimizing risk. In simple terms, what this means is that your portfolio should be allocated in such a way that you are not concerned about whether your returns are coming from dividends or stock prices going up – you just want the best returns overall.
In fact, since capital gains are typically taxed at a lower rate, it is more tax efficient to “generate your income” by selling down units of the fund that have gained in value rather than to receive an equivalent amount in dividends.
If you want to see what difference this can mean, even when investing in an index fund that focuses on dividend paying stocks in the S&P 500, consider the example of the SPY vs SPYD. Just over the last 5 years (as of Aug 31, 2022), the dividend focused ETF (SPYD) underperformed the SPY by 2.75% annualized on a total returns basis. It may not sound like much, but $1,000,000 invested in the SPY 5 years ago would have been worth $1.74 million now. On the other hand, the $1 million invested in the SPYD would have been worth only $1.53 million. That’s a gap of just over $200,000 in 5 years, or equivalent to 20% of your initial investment!
My message here is simple: Please focus on total returns. Do not get caught up in the growth vs income debate.
Financial Markets for Beginners
Whether you are taking your first baby steps to financial literacy or just diving into the world of investing, it is to learn. This means reading a few books and perhaps even taking some courses. Here are some of my articles that I feel would be useful in this process of education:
- Rich Dad, Poor Dad: One of the foundational books on financial literacy along with its very valuable and underappreciated board game Cashflow 101.
- Best Investing Books for Beginners: A look at 11 different books which would be useful in your investment journey.
If you are a beginner in the markets or you simply just don’t have the time to manage your portfolio properly, then your best bet is to go with an advisor who can handle the nitty gritty of investing and asset allocation for you. You can sit back and relax and watch the returns flow in!
For Intermediate Investors
Intermediate investors have a great deal of choice in how to invest their $1 million. For the purposes of this discussion, I would classify intermediate investors as those who have a good degree of knowledge of finance, economics, and business; plus they have some time to devote to managing their portfolio.
For intermediate investors, I believe ETFs and Index funds are the way to go as they allow you to get good diversification at a very low cost, but still also target specific niches such as sectors or geographies where you may have some more conviction.
What are some options that you can look at for investing in 2022? Well, I’ve got you covered with a monster article on the topic: The Ultimate Guide to Investing in the Market Correction of 2022. I have discussed 14 different ideas – spread across equities and bonds – with loads of ETF options for each idea.
If you are ready to open an account, M1 Finance or eToro are great places to get started.
Physical Commodities
The rationale for investing in physical commodities is a bit different than all of the other options. The most common physical commodities to own would be gold or silver as these are easily tradeable. Of course you can buy ETFs that own these assets on an underlying basis if you purely want some financial allocation to those assets.
I however own a small quantity of physical assets mainly from an emergency fund/insurance perspective and store them in a locker close to my home. Firstly, gold and silver coins and bars are easy to liquidate, so they serve well for the purposes of emergency fund. Secondly, in an inflationary environment, gold and silver prices should go up which helps to insulate my emergency fund from inflation. Pure cash loses value in an inflationary environment, so it’s important to not hold too much cash either.
Now, for the doomsday part: In the event of a major hacking of financial systems or an outright global war, I do know how digital assets will behave. I therefore prefer the security of knowing that, in the absolute ultimate worst case, these gold and silver assets can be easily traded as currency to procure food, water, and protection. I also believe, these assets will benefit from the anti-fragile effect, which means that when all other asset prices are crashing, my gold and silver values would be soaring. There are many flaws in that plan – I know! But a little gold in your pocket can solve many of life’s problems!
How Much Can You Expect to Make in Physical Commodities Like Gold and Silver?
Honestly, I don’t think anybody has a good answer. These commodities trade on a variety of factors and it is therefore difficult to generate a consistent or predictable return from them over the long term. As I outlined above, in my mind, the purpose of owning these assets is to generate own some non-digital assets, get some inflation protection for my emergency fund, and in the worst case – benefit from the anti-fragile effect. My goal in holding them is not necessarily to generate a good financial return over time.
Alternative Assets
Private Equity and Venture Capital
For even the high net worth retail investor (anyone less than a couple million bucks), directly getting in to alternative assets like the best private equity funds, venture capital funds, or infrastructure funds may be difficult. The best bet would be to invest directly in stocks and ETFs that provide exposure to such assets via the stock market.
Collector’s Items
Other alternative assets include collector’s items such as luxury watches, fine wines and whiskeys, classic cars, luxury purses, artwork, vintage furniture, etc. It goes without saying that you should really know and understand what you are buying as it’s easy to fool the uneducated!
It’s also important to remember that when buying physical assets, you have to include the costs of storing them appropriately and securely in your return calculations. Additionally, the market for such products is not liquid as these assets may not trade as regularly as gold, silver, or stocks and bonds. This means your expected price may differ from the realized price when you go to buy or sell them. Finally, in a recessionary environment, you may find that buyers for your products may simply disappear; so you may not be able to liquidate them when you need.
On the flip side though, many of these products are great inflation hedges and their prices usually appreciate with time. Plus if you really love and understand the products, it’s a great way to build up a valuable collection and spend your time as well!
Digital Assets
As for other digital assets like cryptocurrencies or NFTs – my advice is to proceed with caution. I’m sure this message resonates a lot more now that these assets have plunged in value. At best, investing in these would be purely speculative and so in my books would not qualify as an “investment”. It could work out great or it could end up in disaster – there’s no way to take an educated position and align the risk/reward in your favour here. One can always play here with a small token amount, but I would strongly urge against putting a big chunk of your money here.
Start or Buy A Business
If you have the entrepreneurship bug inside you, and always wanted to have your own business, the $1 million would go a long way towards starting or even buying a business. While this is a very broad topic, and one that I have not covered at all, it is a very interesting opportunity.
One excellent and underappreciated idea is to acquire a business, rather than start your own. Buying an operating business lets you skip past the difficult start-up stage where many businesses often fail. Existing businesses have met the product-market fit, have a ready list of customers, brand recognition, and cash flow. All of this takes time to develop and if you can buy, this lets you jump past the stage where there is tons of effort and input to the business, but very little rewards!
There’s a big movement towards buying small businesses now, and as the baby boomers continue to retire, they will be selling their businesses. Typical small business deals are in the range of 3x to 4x of EBITDA.
The SBA is a great source of financing for new entrepreneurs as they provide up to 90% deal financing – although I don’t recommending doing that on your first deal! But just for fun, let’s look at what you could do: with your $1 million in cash plus a $9 million SBA loan from the bank, you could easily be the owner of a business valued at $10 million. This business would likely bring in around $2 to 2.5 million in EBITDA annually (deals of this size would have a higher multiple – probably 4 to 5x EBITDA). Even at today’s very high loan rates (8.5% for 7 years), your annual pre-tax income would be around $250,000 to $750,000. That’s massive return on your equity!
Again, I don’t recommend putting down all your money on buying a business and never ever with so much leverage! One of the leading causes for failures of operating business is running simply with too much debt. High debt levels sap your cashflow through principal and interest payments and leave you with minimum flexibility in the event that your revenues decline.
The amazing thing about buying a small business is that the returns on total capital (25-30%) and return on your equity (>50%) are amazing. These rates far exceed what you can attain in the financial markets. More importantly, these are cash flowing assets. I strongly feel that one of the best ways to building solid wealth over your lifetime is to buy and operate small businesses. Small businesses will help you build wealth at a fast clip, and the financial markets can help you maintain and grow it gradually over time.
If buying a business interests you, there are some fantastic books to whet your appetite:
- Buy Then Build by Walker Deibel
- HBR Guide to Buying A Small Business
On Twitter, following people like Codie Sanchez would be a great starting point.
Conclusion
You’ve got a great problem on your hand – how to invest the $1 million that’s burning a hole in your pocket. Whether you earned it or won it in a lottery, I firmly believe that your ultimate goal should be to improve your financial well-being: this means eliminating debt first.
The next steps then include buying your own home (if you don’t already have one), and finally it is to look at the various investment and entrepreneurship opportunities that are out there!
Once you have earned your financial freedom, you then have all the flexibility to spend away on the luxuries of life!
