To use your money to make more money, you first need to habitually save. For example, you might save 10% of your paycheque every month. What you do with the savings will determine how much you make from it.
Will you lend out your money or invest in great businesses?
Lend your money for interest
Money in your savings accounts earns interest. If you have $1,000 in the savings account and you earn a 1% interest, you’ll get $10 in a year.
In essence, you lend your money to the bank. In turn, your bank lends your money to someone else for a higher return; for example, the bank could earn a rate of 3.5% for a mortgage. So, while you get $10 of interest, your bank will earn $35 of interest for a gross profit of $25.
Buying a corporate bond is similar, but you’d get a higher interest rate than you would by putting money in a bank. The company borrows your money and attempts to generate a higher return than the interest rate it pays out.
The company could be using the borrowed money to invest in a project, make an acquisition, or even pay down previous debt which has a higher interest rate.
When you lend money out, you expect to earn interest and get your principal back, but it’s not guaranteed. For example, if a company goes bankrupt, there’s a chance you won’t get your money back. Typically, the riskier the business, the higher the interest rate it offers.
Buying businesses for dividends and growth
By buying shares of a business, you’re essentially buying a piece of it. Certain businesses, such as the Big Three telecoms, including BCE Inc. (TSX:BCE)(NYSE:BCE), generate lots of cash flows and are happy to share generous dividends with their shareholders.
Since 2013, BCE has consistently generated operating cash flows of at least $6.2 billion. Even after accounting for capital spending, from 2013 to 2016, the telecom leader generated enough free cash flow cumulatively to cover the dividends paid out with ~10% left over.
At ~$59 per share, BCE offers a yield of ~4.8%. On top of the income, shareholders can get some growth as well. Analysts estimate the company will grow its earnings per share on average by 3.4-4.7% per year for the next few years.
So, the dividend-growth stock of eight consecutive years should generate income for shareholders that would at least keep pace with inflation.
You’ll probably put money in savings accounts or GICs to ensure you have enough saved for a rainy day. At the same time, you’ll probably have some other investments in great businesses to keep peace of mind and ensure your money will make you more money to maintain or even beat inflation for the long haul.
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Fool contributor Kay Ng has no position in any stocks mentioned.