Generating Income from Lending Investments - dummies

Generating Income from Lending Investments

By Eric Tyson

Besides ownership investments, the other major types of investments include those in which you lend your money. Suppose that, like most people, you keep some money in your local bank — most likely in a checking account but perhaps also in a savings account or certificate of deposit (CD). No matter what type of bank account you place your money in, you’re lending your money to the bank.

How long and under what conditions you lend money to your bank depends on the specific bank and the account that you use. With a CD, you commit to lend your money to the bank for a specific length of time — perhaps six months or even a year. In return, the bank probably pays you a higher rate of interest than if you put your money in a bank account offering you immediate access to the money. (You may demand termination of the CD early; however, you’ll be penalized.)

You can also invest your money in bonds, another type of lending investment. When you purchase a bond that’s been issued by the government or a company, you agree to lend your money for a predetermined period of time and receive a particular rate of interest. A bond may pay you 4 percent interest over the next ten years, for example.

An investor’s return from lending investments is typically limited to the original investment plus interest payments. If you lend your money to Skechers through one of its bonds that matures in, say, ten years, and Skechers triples in size over the next decade, you won’t share in its growth. Skechers’ stockholders and employees reap the rewards of the company’s success, but as a bondholder, you don’t; you simply get interest and the face value of the bond back at maturity.

Many people keep too much of their money in lending investments, thus allowing others to reap the rewards of economic growth. Although lending investments appear safer because you know in advance what return you’ll receive, they aren’t that safe. The long-term risk of these seemingly safe money investments is that your money will grow too slowly to enable you to accomplish your personal financial goals. In the worst cases, the company or other institution to which you’re lending money can go under and stiff you for your loan.