You may be new to the world of finance and have heard the terms “investing,” “stock market,” or “retirement account” and wondered what are these things? While there are many ways to invest, the goal of investing is always the same—a desire to grow your money.
What is Investing?
Investing is the act of using money in a manner that will cause your initial investment to increase in value (hopefully). While you can put your money safely in a savings account and your money can grow there with no risk of losing value, it will grow so very slowly. Investing involves some level of risk, dependent upon your investment, but can also yield returns much greater than the very safe savings account. You might invest in real estate hoping the value of the property will rise. You could invest in other valuable assets such as gold or silver with the expectation the value will increase over time. A common type of investment is to purchase stock in a company that is publicly traded on the stock market or invest in a mutual fund (a collection of investment products bundled together. Any of these options are no guarantee that your money will increase in value, you could very well lose some of all of your money, but you could also grow your money exponentially as well. It’s a traditional risk-return proposition.
Considerations When it Comes to Investing
When investing, it’s a good idea to only use money that you will not need in the next five years, so as not to compromise your current financial situation. Investing can seem scary with market crashes and dips, but for the most part, the market tends to grow more than it shrinks. When you invest, you can put your money to work for you with the measured expectation that you will be able to receive profit after a certain period of time.
Before you begin investing all your extra cash into stocks or bonds (we’ll get to those in a minute), you should take a moment to decide what you are comfortable with, what your overall goal/outcome should be, and how often you can or want to put money towards your investments. Choosing the right types of investments as a beginning investor can help you build a collection (or portfolio) of investments that will allow your money to go to work for you. Even if you have an extra $10 at the end of the month, using that cash to start investing now can help you have a healthy financial future.
Risk Tolerance
Every investment comes with some level of risk, as there is always a given amount of uncertainty in the world. Always be prepared for the potential of a negative financial outcome when investing. The value of your investment(s) will rise and fall based upon on the conditions of the market. The market can be affected by a variety of factors, but the main driver is typically the current economy. There is a chance that you can end up losing money and your level of comfort with this uncertainty is the risk tolerance you are willing to accept when investing your money.
While it is impossible to predict the economic upturns and downturns that will happen in the future, carefully look over the risks associated with each investment. You may want to vary your investments (known as diversification) as you invest over the years and with different goals in mind. No matter what kind of investment you choose, all come with some degree of risk.
Investment Goals
Many people begin investing aiming toward a particular financial goal or plan for their future. Common investment goals are:
- Saving for college
- Creating an emergency savings fund
- Buying a home
- Having and raising children
- Changing a career
- Retirement
- Or any other decision that may require a large amount of money in the future
When you are looking to create investment goals, you may want to use the following SMART goals outline to help you create a more specific vision for your goal:
Specific: have a clearly defined goal
Measurable: give yourself a specific target for when you know you’ve achieved the goal
Achievable: make sure your goal is something that you can realistically accomplish
Relevant: your goal should be applicable to the life you’re living and creating
Timely: lay out a realistic timetable that enables you to track your progress
Hold yourself accountable for your goals, but also be willing to understand that sometimes circumstances might require your goals to change. Life doesn’t always happen the way we think it should and your goals may need to be flexible.
Consistency
When you decide to begin investing, it’s a good idea to consistently build up your investments. Whether it’s through your employer’s 401(k) program that you make contributions to each pay period, or if it’s just $5 that you are able to put towards your investment portfolio, the intent is the same—what you are doing today is putting money towards the future for you.
Depending on your type of account, you might be able to set it up so money will automatically be deposited into an investment account by your employer right out of your paycheck. Other accounts require you to choose what stock or fund you want to invest in. However you choose to do it, creating a habit of investing a portion of your income creates the opportunity for your money to grow.
Best Beginner Investments
401(k)s, Roth IRAs & Traditional IRAs
If you are looking to begin investing toward your retirement (and it’s never too early to start), signing up for a 401(k) or an IRA is a great place to start. These accounts are created specifically with long term goals in mind (such as retiring) and so the sooner you start putting money into these accounts, the greater growth potential they have.
If you work, your employer may have a 401(k) program already set up and may offer to match whatever you put in up to a set percent. Matching means that whatever amount of money you put in, your company will also put in a portion of money to your account. Essentially, this is free money from your employer and guarantees at least some return on your investment.
High-Yield Savings Accounts
A high-yield savings account typically offers higher interest rates than regular savings accounts and is especially useful in helping you save money for an emergency fund. Traditional savings accounts may pay you an interest rate as low as 0.01%, but high-yield savings accounts can allow you to access interest rates that range from 1-2.2%.
Different high-yield accounts may have different requirements, such as maintaining a required amount of money in the account at all times (a minimum balance) or paying a monthly or yearly service fee. Not all accounts come with these stipulations and there may be ways to waive these requirements. You may also be able to link a debit card to your account. This will allow you access to your money at an ATM (which may also have a fee associated with it). You may want to research a few different banks to see what terms and conditions are available to you when it comes to a high-yield savings account.
Certificates of Deposit (CDs)
CD accounts are a bit like a savings account, but the money you put into the account is usually a set amount, also known as the principal or a lump sum and this money is meant to remain in the CD for set time period. The money deposited into a CD typically has an interest rate that is locked for the same set period of time (also known as the term). Many CD accounts will charge you a penalty if you need to take out (withdraw) your money early. Once the account reaches the end of the time period, (or it reaches maturity), you can withdraw your money without paying the penalty, or you may have the option to renew your CD with the current balance (including earned interest) with the same terms, thus allowing you to tap into compound interest.
Because you agree to “loan” your money to the lender for a specific amount of time, CD accounts usually will have higher interest rates than typical savings accounts. This also allows for you to earn more savings while avoiding the risk associated with other types of investments. Some accounts may have a minimum amount required to open the account, and typically the longer you allow your money to be in a CD, the higher the annual percentage yield (AYP).
Stocks
When you invest your money in stocks, you are buying shares (or parts) of ownership of a company. By purchasing shares, you are hoping the company will do well and grow over time. If the company does well, the shares you own may become worth more than you paid for them and other investors may be willing to buy your stocks for the new higher price, resulting in a profit for you.
The stock market has had some historic highs and lows. However, in general stocks perform well over time for those who are patient. The stock market has an average annual return of 10%, but that also means when you invest, you should be ready to leave your money in the market for several years to realize meaningful gains.
When investing in stocks, you will need a brokerage account to start buying and trading. A professional financial advisor can help you navigate the stock market with your financial goals in mind, but keep in mind they may charge you a fee or a percentage of what you gain. If you are just beginning your stock investing journey, the majority of your needs can be met with the help of online brokers and robo-advisors.
Online brokers allow you to purchase and manage your own individual stocks through the broker company’s website. A robo-advisor takes the place of a human investment advisor and is replaced by computer algorithms intended to choose, manage, and track your investments for you depending on your declared goals and timeline.
Bonds
Bonds are a different financial product as they are created in a similar structure as a loan. You buy a bond from a company, municipality or government, and the bond issuer agrees to pay a declared interest rate over a certain amount of time. When companies or governments need to raise money, they often turn to bonds.
Each bond comes with a face value, or the value you will receive when the bond reaches maturity (the agreed upon time period the bond is issued for). The coupon rate of a bond is the annual rate of interest that you will receive for your bond. Higher coupon rates mean that you will collect higher interest payments on the bond. You may receive semi-annual, quarterly, or monthly payments depending on the terms of the bond. Lastly, each bond will have a maturity date in years that tells when the money you loaned will be repaid back to you in full.
Target-Date Mutual Funds
If you hold a retirement plan you may have a target-date mutual fund. These are investments that are automatically invested in with an estimated retirement year as a goal. These mutual funds often hold a variety of stocks and bonds, depending on the planned target-date fund. How aggressive or conservative your fund is will depend on how close you are to your target-date.
If you are planning to retire in 35 years, or around 2057, your fund will mostly hold stocks since your retirement date is far away and stock returns tend to be better for long term investing. (Tip: if you are looking at target-date mutual funds, look for the date you plan to retire in the name.) As you near retirement, your mutual fund will move more of your money toward bonds as they are less risky investments as you near retirement and will be counting on your money.
Index Funds
Index funds are a collection of investments that are representing a particular portion of the market. A popular market index is the S&P 500 which holds stocks of about the 500 of largest U.S. companies. If you were to buy an S&P 500 index fund, the intent of the fund would be to copy the performance of the S&P 500.
Index funds do not have the human element of active traders, but rather are an investment tool for investors who are looking for lower risk and prefer to be more passive in their investing.
Exchange-Traded Funds (ETFs)
Like index funds, ETFs give you access to a particular group of investments. This could be a particular industry (such as technology), commodity (such as crude oil), or currency (such as for bitcoin and speculating on the prices of other countries’ currency.) EFTs are traded daily, and EFT share prices fluctuate in a similar manner to that of a stock. Investment apps such as Robinhood allow investors to purchase EFTs, or you can use brokerages with dedicated investors to buy and trade EFTs.