I have made my final mortgage payment this month and will have extra cash. I would like to invest rather than get used to spending. I'm a bit skeptical with the stock market. I was thinking a CD, but they want you to invest a lump sum all at once. I've heard of tax-free bond funds that pay dividends monthly, which sounds good. Are they worth the time? I want something with little risk and that I can add to every 2 weeks (each pay period). I'm 35 years old, so time is still somewhat on my side to take advantage of compounding.
First off, congratulations on paying off your mortgage! That’s a huge step! I think you’re on the right track by asking these tough questions. However, at your age, assuming that these assets are going to be used for retirement purposes, the investments you are mentioning could prove to hurt you in the long run due to the loss of potential upside of utilizing the stock market. CD returns are next to nothing and tax-free bond funds aren’t much better. But, if you’re sold on using one or the other, I would also look into taxable bonds as well. If you aren’t in a high tax bracket, it may be better to utilize taxable bonds instead of a tax-free municipal bond fund. In fact, if you are below the 25% tax bracket, then qualified dividends from taxable bond funds are not taxed at all.
Historically, bonds have certainly experienced less volatility than stocks, but returns have also been much lower. And, given the fact that interest rates are near all-time lows, that could provide adverse circumstances for the bond market in the coming years. If interest rates rise, bond prices will go down. This will cause your bond funds to lose value as rates increase. Be sure to check the duration of the bond fund if you want to limit that. For example, longer term bond funds will be more affected by a change in rates than shorter term funds. Also, be sure to check the credit quality. “High-yield” doesn’t always mean “better.” High-yield funds have lower credit quality, which means there is a higher default risk associated with the underlying bonds. I would encourage you to get advice from a qualified investment professional so that he/she can cover these important things with you. Making efficient and effective decisions with your money can make a huge difference over time.
If you are 35, it’s encouraged, but not required, to take a little risk with your investment. Like you said, “time is on your side.” Not only you have the time, but also resources (stability of your employment, steady pay check, good health, no mortgage, etc.) to offset any possible losses from the stock market. One quick note, owning a bond is different than owning a bond fund, which includes many individual bonds. Individual bonds usually offer semi-annual coupon payments, which is why they are called fixed-income. Retirees like fixed income because they can count on them to supplement their other income. Bond funds, on the other hand, can have variable payment times and amounts. Tax-free muni bonds are used for people who are in high tax brackets. Talk to a financial planner, who may guide you to a better approach after learning your individual needs.
Congrats on paying off the mortgage, especially at such a young age! The answer to your question is yes, there are investments that have very low risk. The problem with them is that they tend to also have a very low return. For example, 1-year CDs are in the 1.0% range at the moment, and the longer the CD, the higher the return, but you are also locking your money up for that period unless you want to potentially incur early redemption penalties. Savings accounts at online only banks seem to be in the 0.90% to 1.05% range and you aren't locking your money up.
One thing to keep in mind though is that cash (whether CDs, savings accounts, money markets, etc.) do carry risk. The principal will not fluctuate like with stocks, and potentially with bonds, but cash is subject to inflation risk. Basically, if you are getting 1.0% on your cash, you are losing purchasing power after accounting for inflation. The really bad thing about inflation risk is that you probably don't even notice it over a 1, 3, or even a 5-10 year period. But given the fact that you are only 35, if you kept all of your money in "low risk" cash until retirement, while the principal would not fluctuate on a daily basis like stocks do, you would find that the money did not have as much purchasing power at 65 as it does right now when you are 35.
You can look to bonds, which will tend to have better long-term returns than cash, but they have risks too. A few risks that bonds are subject to are Inflation risk, interest rate risk, and default risk.
Essentially, the point is that even investments that people perceive as "safe" or "low risk" (such as cash, CDs, bonds, etc.) still have risks. They are just different risks than stocks and they tend to "take their toll" over longer periods of time. For example, a stock could fluctuate 2, 3, 5, 10%+ up or down in a single day, which can be pretty scary; while the price of a bond can fluctuate, but it will usually not do so wildly over a short period of time. So you don't want to equate a lack of price/value volatility with low or no risk, because that is not the case.
Furthermore, it is worth keeping in mind that if you are going to invest exclusively in things with very low risk, they will usually have low(er) rates of return, which means that to meet your goals, you will tend to have to save larger amounts of money to make up for the return that you are foregoing by taking more risk. Conversely, if you invest in stocks/mutual funds/ETFS that will tend to have higher returns over time (when compared to bonds and cash), you can "afford" to save a bit less because, in theory, the higher returns will make up for a lower savings rate. So as long as you are okay with the prospect of having to save more if you stick to low risk/return investments, that is fine, but you don't want to find yourself in a position in 25+ years where you have been saving diligently over the years, but you find yourself coming up short because your "investments" were all low risk/low return.
I would strongly suggest that you look into options that include at least some exposure to stocks, because over time (especially when we are talking 3-4 decades) stocks have historically outperformed cash and bonds by substantial amounts. For example, if you are truly very risk averse, you could invest in a portfolio of 50% equities (i.e. stocks) and 50% fixed income (i.e. bonds and cash). Assuming this portfolio was well diversified, it would still be subject to some ups and down since there would be exposure to stock, but your long-term return prospects would likely be much higher over time than sticking to cash or bonds only. That is not to say that past performance indicates future success, but I think it is pretty safe to assume that stock will outperform bonds and cash over the next 30-40 years (though by how much is anyone's guess).
Given your age, the fact that you are mortgage free, and you want to start utilizing those funds toward investments, it might not hurt to speak with a fee-only financial planner who can look at your overall financial picture and make some recommendations on a portfolio that will help reduce risk, but will also generate higher returns than cash and/or bonds alone over the next 3-4 decades.
Hope that helps some and best of luck.