3 Great Ways to Invest $5,000 Whether you've managed to save $5,000 on your own or somehow ended up with $5,000 from an overly generous aunt, you can invest your money in a plethora of good (and bad) ventures.

By Melissa Brock

entrepreneur daily

This story originally appeared on MarketBeat

Depositphotos.com contributor/Depositphotos.com via MarketBeat

Whether you've managed to save $5,000 on your own or somehow ended up with $5,000 from an overly generous aunt, you can invest your money in a plethora of good (and bad) ventures. Consider investing your $5,000 in your 401(k) or 403(b), through index funds or in a 529 for college.

Let's go into detail on these three ways you can invest your money.

Option 1: Invest in your 401(k) or 403(b).

What type of retirement account does your employer offer? If you work for a nonprofit organization, your employer may offer a 403(b). If you work for a for-profit organization, you may have the opportunity to invest in a 401(k).

When you contribute to a traditional 401(k) or 403(b), contributions get taken out of your paycheck before federal income taxes get taken out. Doing so lowers your taxable income so you might owe less in income taxes. You can contribute up to $19,500 to either a 401(k) or 403(b) in 2021. If you're 50 or older, you can contribute an additional $6,500 and bring your total to $26,000 for the year.

The most exciting part of investing in a 401(k) or 403(b) involves compound interest. When compounding interest accumulates, interest builds on interest. Compounding adds up over the years and the money grows tax-deferred until you withdraw your money in retirement.

The other exciting part about retirement investing involves the employer match. Your employer may kick in money to match half or all of your contributions, up to 3% to 6% of your salary. Talk about a guaranteed return!

How do you earmark your $5,000 for your retirement account? Simply go to your human resources office and make sure money gets deducted from your paycheck each month. Since the deduction gets taken out before you get paid, you won't miss even a single cent. Try your best to max out your retirement savings, up to $19,500 or $26,000, depending on your age.

Option 2: Buy index funds.

Index funds aim to match the performance of a particular market index, such as the S&P 500, which measures the performance of about 500 companies in the U.S. You can also choose to "follow" other indexes as well, such as the Dow Jones Industrial Average and the Nasdaq 100.

How do you invest in index funds? You want to choose the right percentage of stocks versus bonds for your portfolio based on your appetite for risk and investing timeline. Next, open an account directly with the mutual fund company that offers the fund. You can also open a brokerage account with a broker that lets you buy and sell shares of the index fund you want.

Quick tip: You can also invest in index funds through an IRA or your 401(k) or 403(b) plan through your employer.

Option 3: Save for college.

Do you have a college-bound child? You might want to choose to invest in a 529 plan with your $5,000.

Why this approach to investing $5,000 when you can invest in so many other things? One really powerful reason: Your child will more likely to go to college, no matter the actual amount you've saved.

A study by the Center for Social Development at the George Warren Brown School of Social Work at Washington University in St. Louis said that students end up seven times more likely to attend college than children who don't have an account.

The study found that a college savings account was a better predictor of whether a child would attend college than race or parents' net worth.

Investing in a 529 plan means you:

  • Won't pay federal taxes and you may get a break on your state taxes. As long as you use the money for qualified higher education expenses, vocational school and/or fees or expenses, you don't have to fork money over to Uncle Sam. These qualified expenses include tuition and fees, room and board, books and computers or computer equipment. Your state might offer you a tax deduction for contributions to 529 plans but may impose limits per beneficiary and per taxpayer.
  • Can choose investments based on the age of your student. You can also choose investments based on how much exposure to risk you want your investment to have. In other words, you can choose more conservative investments if you don't want to risk losing money or more risky investments if you want the potential to earn more returns.
  • Can choose another state's 529 plan. If another state offers options you like better, you can choose that state's plan instead. Don't forget to find out whether plans from other states still qualify you for the income tax deduction.
  • Can change investments. Don't like your initial selection? No sweat. Federal tax law lets you change investments twice a year or when there's a change in your beneficiary.

Ideally, you want to start saving for college as soon as you possibly can. Ideally, you'll start saving for college immediately — right when your child turns a month old (or before!).

Consider Other Ways to Invest $5,000

Chances are, you can think of other ways to invest $5,000. However, remember that you want to take care of your own retirement first and should pursue these three options in the order presented. First, invest in your retirement plan through your employer to get the match your employer offers. Then, invest in index funds. Finally, once you've done that, then save for college. You can always borrow to fund your child's college education but you can't borrow for your own retirement!

In addition, remember that with any investment, the earlier you get started on your savings, the more you can save in the long run. However, don't think it's ever "too late" to get started, whether you start saving for retirement at 50 or for college when your child turns 16.

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