Investing 101: Basics for Beginners

You may have heard that investing is important, but the basics are seldom taught in schools. What's the purpose of investing? How can you identify your financial objectives? What types of investment vehicles may help pursue them? Is stock market investing necessary for your goals?

This investing 101 guide provides some basics of what you need to know to get started.

How Investing Works

Learning how investing works begins with understanding the reason to invest in the first place. The primary purpose of investing is to seek to build wealth over time to effectively pursue your financial goals. The most effective way to do so is by earning interest, or annualized rates of return, that can outpace inflation. If you can't beat inflation, your money is worth less tomorrow than it is today.

A key component in the way investing works is compounding growth, which is simply explained as adding growth on top of growth. Compounded growth may help your investment grow faster over time and can be a powerful tool.

The average rate of inflation over time historically has been about 3%. To outpace that rate, you'll likely need to invest. Certain types of financial assets, such as stocks and bonds, historically have returned more in the long run compared to a simple savings account. Bear in mind, past performance is no guarantee of future results.

Creating a financial portfolio with assets like stocks, bonds, and mutual funds manages risk and aligns with goals. Diversification balances risk and return. but does not ensure a profit or protect against a loss in declining markets. Stocks offer growth, while bonds provide stability; thus, adjusting your portfolio over time is important to match market conditions and personal needs.

What to Consider Before You Start Investing

Setting Financial Goals

Different goals may require different investment types. For this reason, setting your financial goals is the beginning of investing 101 and requires no knowledge of investing. You simply envision what you want money to do for you.

You can begin by answering a few basic questions: What do you want to achieve by investing? Are you looking to accumulate for retirement, save for a child's education, generate passive income or build long-term wealth? How many years do you have to pursue your goals? How can you start investing in your 20s? Or, how about start investing in your 30s?

Determining Time Horizon & Risk Tolerance

Different investments carry different levels of risk. The risk levels will be determined by your time horizon, which is how much time you have to reach your goals, and your risk tolerance, which is how much risk you are willing to accept.

• Time horizon: Determine how many years you have between today and the day you need to begin withdrawals from your investment. In general, the longer you have to reach your goals, likely the more risk you can afford to take with your investments. This is because riskier investments, such as stocks, tend to fluctuate up and down in the short term but generally outperform other assets, such as bonds, especially over longer periods of time than three years. (Again, understand that past performance is no guarantee of future results.)
• Risk tolerance: How comfortable are you with short-term market fluctuations? With investing, there is a risk-return tradeoff. That means that the higher the risk taken, generally the higher the potential return the investor may receive over time.

Types of Investment Vehicles

There are various types of investments that may help individuals pursue their goals. In many cases, it makes sense to combine multiple asset classes and types of investments to build a diversified portfolio customized to fit an investor's situation and goals.

The main types of investments are:

• Stocks: Stocks represent ownership in a company. Investors can purchase them in the hopes that their value will increase over time. Stocks can be suitable for investors who seek long-term growth but are also willing to accept fluctuations in the value of their investments.
• Bonds: Bonds are a type of loan. Investors lend money to a corporation or government in exchange for interest payments and repayment of the principal at a later date. Certain bonds may be a better fit for more conservative investors or those who are seeking fixed income in retirement.
• Mutual funds: A mutual fund pools money from multiple investors to purchase a diverse range of investments, such as stocks, bonds or other securities. Mutual funds can be appropriate for investors who prefer participating in a professionally managed portfolio rather than building one themselves with individual securities.
• Exchange-traded funds (ETFs): ETFs trade like individual stocks on an exchange. Most ETFs are passively managed, which means they track the performance of a benchmark index, such as the S&P 500^®.
• Real estate: Real estate investments can include owning physical properties, investing in real estate investment trusts (REITs) or participating in crowdfunding platforms. Real estate can be appropriate for long-term growth but can also be used for generating passive income.
• Alternative investments: Alternative investments can include commodities such as gold or oil, artwork or collectibles. These investments tend to be more complex in nature due to factors such as valuation and liquidity. But they can be used as diversification tools in a broadly diversified portfolio.

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Investment Strategies to Consider

The foundation of any investment strategy is asset allocation. That's the mix of assets (such as stocks, bonds and cash) making up an investment portfolio. For example, a medium-risk portfolio for a long-term investor might consist of an asset allocation of 60% stocks and 40% bonds. From there, specific strategies, such as growth investing or value investing, may be implemented.

The basic types of investment strategies are:

• Growth investing: Identifying companies with strong earnings growth potential, often in emerging industries or sectors.
• Value investing: Identifying stocks that are undervalued by the market and have a strong potential for long-term growth.
• Income investing: Seeking out investments that provide a steady stream of income, such as dividend-paying stocks, bonds or REITs.
• Index investing: Also called passive investing, this involves investing in a diversified portfolio of stocks or bonds that tracks a market index, such as the S&P 500, through lower-cost index funds or ETFs.
• Momentum investing: Buying stocks that have shown strong price trends in the recent past and selling those that have shown weak trends.
• Contrarian investing: Taking positions opposite to the market consensus. Investors in this strategy seek to buy undervalued assets that are out of favor with the market.
• Tactical investing: Actively adjusting the asset allocation of a portfolio based on market conditions or other factors, with the goal of maximizing returns while minimizing risks.

Common Types of Investment Accounts

Implementing your investment strategies means putting them into action by establishing investment accounts and owning your chosen investment types. There are various types of investment accounts, such as brokerage accounts and retirement accounts, that investors can use for holding and managing their investments.

Here are some of the most common:

• Individual brokerage accounts: An individual brokerage account is a taxable account that allows an individual to buy and sell investments, such as stocks, bonds and mutual funds.
• Retirement accounts: Retirement accounts, such as Individual Retirement Accounts (IRAs) and 401(k)s, offer tax benefits and are designed to help individuals save for retirement.
• Education accounts: Education accounts, such as 529 plans and Coverdell Education Savings Accounts (ESAs), are designed to help individuals save for education expenses, such as tuition, books and supplies.
• Trust accounts: Trust accounts are set up to hold and manage assets for the benefit of another person, such as a child or spouse.
• Robo-advisory accounts: Robo-advisory accounts are managed by automated investment platforms using algorithms to create and manage investment portfolios.
• Compound interest accounts: Compound interest is the calculation of interest on principal and previously accumulated interest, resulting in faster growth over time compared to simple interest which is calculated only on the principal amount.
• Money market accounts: Low-risk deposit accounts that offer higher interest rates, liquidity, and limited transactions, making them ideal for conservative investors.

Each type of investment account has its own set of benefits, limitations and rules. The most suitable account type will depend on an individual's investment objectives, financial situation and tax considerations. It's important to consult with a financial professional to consider which options seem most appropriate.

Managing & Reviewing Your Portfolio

Monitoring and reviewing investment portfolios is an ongoing process. It's one that requires regular attention. Investors can monitor and review their investment portfolios in several ways to ensure their investments remain aligned with their goals and to make adjustments as necessary.

Here are some common methods:

• Regularly review performance and investment statements: Investors should review their investment account statements, which typically provide information on investment performance, fees and holdings, on a regular basis. This can help investors identify any changes in their investments and ensure they are aligned with their goals.
• Periodically review investment goals: Investors should establish clear investment goals, such as saving for retirement or a child's education, and periodically review progress toward these goals. This can help investors determine whether their investment strategy is appropriate and make adjustments as necessary.
• Assess risk tolerance: Investors should periodically reassess their risk tolerance, which can change over time due to changes in financial situations or life circumstances. This can help investors consider whether their investments are appropriately balanced between risk and return.
• Rebalancing and asset allocation: This involves revisiting how investments are divided between different asset classes, such as stocks, bonds and cash, to achieve an intended composition. Investors may need to rebalance their portfolio on a periodic basis, such as once per year. Because the various asset classes perform differently over time, the allocation can change. This shifting can, in turn, create imbalances in the intended allocations.

Selling Investments

You've reached your goal. What now? For the larger investment goals, such as retirement or education, you likely won't sell all of your investments at once. Doing otherwise could risk some unwanted tax consequences, and you don't usually need all of your money in one year. Therefore, consciously selling assets or shifting to income-generating investments may be necessary.

Investors should carefully consider their investment goals, investment performance, tax implications, diversification and transaction costs when deciding whether to sell an investment. Here's what to keep in mind:

• Investment goals: Investors should consider whether selling an investment aligns with their overall investment goals. If the investment is no longer aligned with their goals, it may be appropriate to sell it or change strategies. For example, an investor nearing retirement may consider shifting from a growth strategy to an income strategy or a combination of growth and income.
• Investment performance: Investors should consider the investment's historical performance and current market conditions. If an investment has performed poorly or is likely to underperform in the future, it may be appropriate to sell it. In some cases, it may be disadvantageous to sell an investment when it is down, so selling other investments may make more sense.
• Tax implications: Investors should consider the tax implications of selling an investment, including the capital gains tax and any potential tax benefits from holding the investment. It may be appropriate to consult with a tax professional to determine the most tax-efficient way to sell an investment.
• Diversification: Investors should consider the diversification of their investment portfolio and whether selling an investment will leave the portfolio overly concentrated in one area. If so, it may be appropriate to sell the investment to rebalance the portfolio. Diversification does not ensure a profit and does not protect against a loss in a declining market.
• Transaction costs: Investors should consider the transaction costs associated with selling an investment, including brokerage fees, taxes and other expenses. If the costs outweigh the potential benefits of selling the investment, it may not be appropriate to sell.

Considering Help With Your Investments

Each type of investment has its own benefits and risks, and the appropriate mix of investments depends on an individual's investment goals, risk tolerance and time horizon. It's important to consult with a financial professional to determine the most suitable investment strategy for you.

Investors can work with a financial professional to develop and monitor investment portfolios, particularly if they have complex financial needs or investment goals. A financial professional can provide guidance on investment strategy, asset allocation, stock market investing and risk management.

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