You may have heard that investing is important, but the basics are seldom taught in schools. What is the purpose of investing? How can you identify your goals? What types of investment options may help you work toward them? Is investing in the stock market necessary for your goals?
This investing 101 guide covers the basics to help you get started.
How Investing Works
Learning how investing works begins with understanding why people invest. The main purpose of investing is to build wealth over time to help reach your goals. One way to do this is by earning interest or returns that may outpace inflation. If your returns do not keep up with inflation, your money can lose value over time.
A key part of investing is compounding. This means earning returns on both your original investment and the returns it has already earned. Over time, this may help your investment grow faster.
Historically, inflation has averaged about 3% per year. To keep up with or exceed that rate, many people turn to investing. Some financial assets, such as stocks and bonds, have shown higher long-term returns compared to a basic savings account. Keep in mind that past performance does not guarantee future results.
Building a portfolio with a mix of stocks, bonds, and mutual funds can help manage risk and align with your goals. Diversification helps balance risk and return, but it does not guarantee a profit or prevent losses in a declining market. Stocks are often used for growth, while bonds can provide more stability. Over time, adjusting your portfolio can help reflect changes in the market and your personal situation.
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. You do not need prior investing knowledge to get started. Focus on what you want your money to do.
Start 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?
- How about start investing in your 30s?
Determining Time Horizon & Risk Tolerance
Every investment carries some level of risk. Two key factors help guide your decisions: time horizon and risk tolerance.
| Factor | What It Means | What to Consider |
|---|---|---|
| Time Horizon | The number of years until you need to use your money | A longer time horizon may allow for more risk. Short-term investments often need a more conservative approach. |
| Risk Tolerance | Your comfort level with market ups and downs | Higher risk can lead to higher potential returns over time, but values may fluctuate in the short-term. |
Stocks may rise and fall in the short term but have historically outperformed more stable assets like bonds over longer periods. Past performance does not guarantee future results.
Types of Investment Vehicles
There are many types of investments that may help people work toward their goals. In many cases, combining different types of assets can help create a diversified portfolio that fits your situation.
Stocks
Stocks represent ownership in a company. Investors buy them with the expectation that their value may grow over time. Stocks can suit those who want long-term growth and can handle changes in value.
Bonds
Bonds are a type of loan. Investors lend money to a company or government and receive interest payments, along with the return of the original amount later. Bonds may appeal to those who prefer more stable income.
Mutual Funds
A mutual fund combines money from many investors to buy a mix of investments, such as stocks and bonds. These funds are managed by professionals and can be useful for those who prefer not to select individual investments.
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.
Real Estate
Real estate investing can involve owning property, investing in real estate investment trusts, or using crowdfunding platforms. It may support long-term growth and can also generate income.
Alternative Investments
These can include commodities like gold or oil, as well as collectibles or artwork. They are often more complex in nature and may involve different risks, but they can add variety to a portfolio.
Investment Strategies to Consider
The foundation of any investment strategy is asset allocation. This is the mix of assets, such as stocks, bonds, and cash, that make up an investment portfolio. For example, a medium-risk portfolio for a long-term investor might include 60% stocks and 40% bonds. From there, investors may use specific approaches like growth or value investing.
Types of Investment Strategies
- Growth Investing: Focuses on companies with strong earnings growth potential, often in newer industries or sectors.
- Value Investing: Looks for stocks that may be priced lower than their actual worth and have the potential to grow over time.
- Income Investing: Focuses on investments that generate regular income, such as dividend-paying stocks, bonds or real estate investment trusts (REITs).
- Index Investing: Also known as passive investing. This approach involves investing in a broad mix of stocks or bonds that follow a market index, often through index funds or ETFs.
- Momentum Investing: Involves buying stocks that have shown strong recent price performance and selling those with weaker trends.
- Contrarian Investing: Takes the opposite view of the overall market. Investors look for assets that are out of favor and may be undervalued.
- Tactical Investing: Involves adjusting a portfolio’s asset mix based on market conditions or other factors, with the goal of improving returns while managing risk.
Common Types of Investment Accounts
Putting your investment strategy into action starts with choosing the right investment accounts. Investment accounts help you buy, hold, and manage assets like stocks, bonds, and funds.
Account Types at a Glance
| Account Type | What It Is | Key Features |
|---|---|---|
| Individual Brokerage Accounts | Taxable accounts used to buy and sell investments | Flexible access, no contribution limits |
| Retirement Accounts | Includes IRAs and 401(k)s | Tax advantages, designed for long-term retirement savings |
| Education Accounts | Includes 529 plans and Coverdell Education Savings Accounts (ESAs) | Used for qualified education expenses like tuition and books |
| Trust Accounts | Managed for the benefit of another person | Often used in estate planning or for dependents |
| Robo-Advisory Accounts | Automated investment platforms | Portfolios managed using algorithms |
| Money Market Accounts | Deposit accounts with interest earnings | Liquidity, stable returns, limited transactions |
Additional Concept to Know: Compounding
Compounding is interest earned on both your initial investment and accumulated interest. This can help grow your balance over time compared to simple interest, which applies only to the original amount.
Each account type comes with its own benefits, limitations and rules. The right choice depends on your goals, tax situation, and timeline. A registered representative can help you evaluate which options fit your needs.
Managing & Reviewing Your Portfolio
Monitoring and reviewing an investment portfolio is an ongoing process. It requires regular attention. Investors can track and review their portfolios in several ways to help keep their investments aligned with their goals and make changes when needed.
Here are some common methods:
- Regularly Review Performance and Investment Statements: Investors should review their account statements on a regular basis. These statements usually include details about performance, fees, and holdings. This can help investors spot changes and check that their investments still match their goals.
- Periodically Review Investment Goals: Investors should set clear goals, such as saving for retirement or a child’s education, and review their progress over time. This can help them decide if their strategy is still on track or needs updates.
- Assess Risk Tolerance: Risk tolerance can change over time due to shifts in income, expenses, or life events. Reviewing risk tolerance from time to time can help investors decide if their portfolio still reflects how much risk they are comfortable taking.
- Rebalancing and Asset Allocation: This step involves reviewing how investments are divided among asset classes, such as stocks, bonds, and cash. Over time, some investments may grow faster than others, which can change the original mix. Rebalancing helps bring the portfolio back to its intended allocation.
Selling Investments
You've reached your goal. What now?
For larger goals like retirement or education, you may not sell all investments at once. Doing so could lead to unwanted tax consequences, and you may not need all the funds in a single year. Instead, you might gradually sell assets or shift toward income-generating investments.
What to Consider Before Selling
| Factor | What to Think About |
|---|---|
| Investment Goals | Does selling align with your current goals? For example, as retirement approaches, you may shift from growth to income or a mix of both. |
| Investment Performance | Review past performance and current market conditions. If an investment is underperforming or expected to decline, selling may make sense. In some cases, it may be better to hold and sell other assets instead. |
| Tax Implications | Selling may trigger capital gains taxes. There may also be tax benefits to holding. A tax professional can help you evaluate your options. |
| Diversification | Selling may affect your portfolio balance. Avoid becoming too concentrated in one area. Diversification does not guarantee a profit or protect against loss. |
| Transaction Costs | Consider fees, taxes, and other expenses. If costs outweigh the benefits, it may not make sense to sell. |
Taking a thoughtful approach can help you manage withdrawals and stay aligned with your overall strategy.
Considering Help With Your Investments
Each type of investment has its own benefits and risks. The right mix of investments depends on your goals, risk tolerance, and time horizon. It helps to work with a registered representative to find an investment strategy that fits your needs.
Investors can work with a registered representative to build and monitor their portfolios, especially if they have more complex goals. A registered representative can offer guidance on investment strategy, asset allocation, stock market investing, and risk management.
Final Thoughts
Investing starts with clear goals, a realistic timeline, and an understanding of your risk tolerance. By choosing a mix of investments and reviewing your portfolio over time, you can stay aligned with your goals. With a thoughtful approach and, when needed, guidance from a registered representative, you can build a strategy to help grow your money over time.
Footnotes
- Provided for informational purposes only. Not all products and services discussed are available through member of Western & Southern Financial Group.
- Neither asset allocation or diversification ensures a profit or protects against a loss in declining markets.
