February 21, 2019
Think of investing as casting a vote with your dollar. Your investments directly support the companies in which you choose to invest.
For those new to investing, getting started can seem daunting. But at heart, investing is simply a means to move toward the life you want. It’s making a plan with your money so you can pursue both your big dreams and everyday improvements.
If you’re considering getting started with investing, let’s first consider your financial goals. Where would you like to be in the next five years? How about 10 to 20 years?
Working remotely from a wi-fi connected beachfront cottage in Aruba?
Opening a bakery or microbrewery?
Paying off your student loans, once and for all?
Once you’ve got a few scenarios in mind, let’s consider the practicalities: Are your finances working as hard as they can to help you get where you want to go?
This is where investing comes in. Investing can enable your money to grow over time, faster than, say, a standard savings account. Investing can give you more capital and flexibility as you pursue the life you want.
Which means those far-flung goals may actually turn into any-day-now accomplishments.
Sounds great, you may be thinking, but I don’t know anything about investing!
No worries, newbie! Every investor has to start somewhere. Let’s dive right into the basics of investing.
So, what exactly does investing mean? Merriam-Webster defines investing as committing “money in order to earn a financial return.” But how exactly does that happen?
First, you have to decide how you want to invest your money. Many people consider the following investment options:
Equities: Equities refer to stocks or other shares that represent ownership. Simply put, when you become an investor, it means you’re buying the stock of a public company. You’re literally buying a part of a business. When you buy a stock, you’re not just tucking your money away in a bank like with a savings account. You’re buying an ownership stake in a business, also known as becoming a stakeholder or a shareholder. Think of it like casting a vote with your dollar. Your investments directly support the companies in which you choose to invest.
Equities can typically provide strong returns, but know that they’re also considered the most risky investment of the options listed here. Nevertheless, it’s worth noting that, even within this relatively risky investment class, some stocks are considered safer than others. Remember that the potential for loss always exists.
Bonds: Bonds are a type of investment that provide a fixed income over a fixed period. Federal, state, and local governments, as well as private companies, can issue bonds. With a bond, you’re essentially loaning your money to the government or private business, and you’ll get your investment back at the end of the fixed period. Additionally, you’ll receive interest payments throughout the life of the bond.
Bonds are generally considered less risky investments compared to equities/stocks, but note that their value generally rises and falls with market interest rates, so it is possible to lose money. Additionally, there’s a chance the organization that issued the bond could default, meaning it misses payments on the interest or principal within the bond’s specific time period. Taking some time to research the bond-issuing organization can provide clarity on its financial health and potential default risk.
Mutual Funds: Mutual funds are a professionally managed collection of investments, generally stocks and/or bonds, chosen by a fund manager. Investors can purchase one or many shares of a mutual fund. Mutual funds pool your money with other investors, so you’re essentially joining a group of shareholders when you invest your money this way. Because the risk is spread out over many investments, mutual funds are generally considered less risky than an investment in a single equity or stock.
Cash: Cash investments, such as money market accounts (MMAs) and savings accounts are typically a shorter-term, lower-risk investment method that offer an opportunity for a specific return. Investopedia notes that the temporary structure of cash investments can be especially appealing to investors “who need a temporary place to keep their cash while researching other investment products” because “an investor can have access to his or her money within a short period of time.”
So, we’ve gone over the typical options for investments. Next, let’s delve into some basic investment concepts, strategies, and personal factors to consider when making investment decisions.
When it comes to investing, every investor needs to understand how interest works.
Interest is the price you pay to use someone else’s money.
If you have a credit card or student loan debt, you’re already well familiar with how interest can add up over time. But with investing, you’re the lender, not the borrower, and interest works in your favor. All investments have the potential to earn interest, but there are no guarantees.
Here are two ways you can earn interest:
- Coupon payments on bonds: This interest refers to a percentage of a bond’s face value. Let’s say you have a $10,000 bond with 5% interest. This means you’ll get $500 in coupon payments every year until you sell it or the bond matures. Remember, though, that returns are not guaranteed.
- Cash interest: This is interest paid on short-term securities like a traditional savings account. Note that short-term securities tend to be considered lower risk, so their returns tend to be lower than other types of investments. (You can read our Saving for Beginners blog post to learn more.)
Note that the amount of interest paid, how often interest gets paid, and whether returns are guaranteed will vary by the type of investment account you choose. Depending on the type of account and its terms and conditions (e.g., the fine print), interest may compound over time. Compounding interest lets you earn interest not only on your original deposit, but also on any interest you earn on that deposit. It means your original deposit grows much faster than it would with simple interest!
Risk, in terms of investing, refers to financial losses and can vary with investment type. If you save $1,000 in a savings account, for example, your $1,000 won’t really fluctuate over time: You’ll likely earn interest, but that initial $1,000 won’t budge. But if you took $1,000 and invested it instead, there’s a chance that amount could be lower in the future. It all depends on the category of investments you choose and the state of the market.
As such, it’s important to understand the risk you’re taking on with any investment, as you’re never guaranteed a positive return. But if you’re careful in spreading out your risk, you can minimize your chances of loss.
Many investors manage their risk exposure through diversification: They allocate their money across many different investment types, pairing options that may be risky with those considered safer, so they’re more protected overall. The old adage “don’t put your eggs in one basket” is a simple way to think of this strategy.
So, you’re now familiar with the different ways to invest, how you can earn interest, and the risks involved. You’ll next want to figure out which investment options make sense for you. There’s no one-size-fits-all determination, and how you allocate your investments will depend in part on your investment goals, time horizon, and risk tolerance. If you’re investing for retirement down the road, for example, the risk of your portfolio will most likely be different compared to an investment for a goal you’d like to reach in the next five years.
Remember, with investing, you’re not limited to any one option. You can invest in stocks, bonds, mutual funds, cash, or any combination of the four!
Still not sure which investment options are right for you? Speak with a fiduciary (e.g., a licensed financial professional dedicated to working in your best interest) to get the lay of the landscape.
As you start your investment research, keep in mind:
- Interest allows you to earn money on your deposit.
- You can invest in equities, bonds, and mutual funds, and also make cash investments.
- Different investment options have varying features and returns.
- Always understand the risk associated with any investment decision.
- Investing may be a faster way to reach your short- and long-term goals.
Remember those goals you thought about earlier? A tailored investment strategy may take them from idea to reality.