Introduction to Investing
A lot of people just like you turn to the markets to help buy a home, send children to college, or build a retirement nest egg. But unlike the banking world, where deposits are guaranteed by federal deposit insurance, the value of stocks, bonds, and other securities fluctuates with market conditions. No one can guarantee that you’ll make money from your investments, and they may lose value.
The Securities and Exchange Commission enforces the laws on how investments are offered and sold to you. Protecting investors is an important part of our mission. We cannot tell you what investments to make, but this website provides unbiased information to help you evaluate your choices and protect yourself against fraud.
Definition of Investment
It is the act of allocating resources, usually capital (i.e., money), with the expectation of generating an income, profit, or gains. Investing, broadly, is putting money to work for a period of time in some sort of project or undertaking to generate positive returns (i.e., profits that exceed the amount of the initial investment). Investment refers to putting your money in an asset with the aim of generating income. Financial investments come in different forms, such as mutual funds, unit linked investment plans, endowment plans, stocks, bonds and more. However, the primary goal behind all investments remains the same, i.e., to increase the value of your invested money.
Investing
Investing is to grow one's money over time. Core premise of investing is the expectation of a positive return in the form of income or price appreciation with statistical significance. The spectrum of assets in which one can invest and earn a return is vast.
Risk and return go hand-in-hand in investing; low risk generally means low expected returns, while higher returns are usually accompanied by higher risk. At the low-risk end of the spectrum are basic investments like; Certificates of Deposit bonds or fixed income instruments are higher up on the risk scale, while stocks or equities are regarded as riskier.
Why is investing important?
Investing is can be seen as an effective way to put your money to work and potentially build wealth. Smart investing may allow your money to outpace inflation and increase in value.
The greater growth potential of investing is primarily due to the power of compounding and the risk-return tradeoff.
How to start investing
Investing is the process of determining where you want to go on your financial journey and matching those goals to the right investments to help you get there. This includes understanding your relationship with risk and managing it over time.
When you understand what you want, you just have to jump in. You can decide to invest on your own or with the professional guidance of a financial planner. Below we discuss in detail each of the key steps to help you get started with investing.
1. Decide your investment goals
Right before you decide to open an account and begin comparing your investment options, you should first consider your overarching goals. Are you looking to invest for the long term, or do you want your portfolio to generate income? Knowing this will narrow down the number of investment options available and simplify the investing process.
“Consider what your ultimate goal is for this money—is it for retirement, a down payment on a house in the next five years, or something else?” says Lauren Niestradt, CFP, CFA, and portfolio manager at true point wealth counsel.
Understanding your goals and their timelines will help determine the amount of risk you can afford to take and which investing accounts should be prioritized.
E.g, if your goal is to invest your money for retirement, you’ll want to choose a tax-advantaged vehicle like an individual retirement account (IRA) or a 401(k), if your employer offers one. But you may not want to put all your money earmarked for investing into a 401(k), because you can’t access that money until you turn 59 ½, or you will get hit with penalty fees (with a few exceptions).
You also don’t want to invest your emergency fund in a brokerage account because it’s not easy to access money if you need it quickly. Plus, if you need that cash when the market is facing a downturn, you might end up losing money when you’re forced to sell low.
2. Select investment vehicle(s)
After determining your goal(s), you need to decide which investment vehicles sometimes referred to as investing accounts to use. Keep in mind that multiple accounts can work together to accomplish a single objective.
If you’re looking to take a more hands-on approach in building your portfolio, a brokerage account is the place to start. Brokerage accounts give you the ability to buy and sell stocks, mutual funds, and ETFs. They offer a lot of flexibility, as there’s no income limit or cap on how much you can invest and no rules about when you can withdraw the funds. The drawback is that you do not have the same tax advantages as retirement accounts.
There are several financial firms that offer brokerage accounts like Charles Schwab, Fidelity, Vanguard, and TD Ameritrade. Working with a traditional brokerage usually comes with the benefits of having more account types to choose from, such as IRAs or custodial accounts for minors, and the option to speak with someone on the phone and, in some cases, in person if you have questions.
But there are disadvantages: Some traditional brokerages may be a bit slower to incorporate new features or niche investment options like cryptocurrencies. For example, fintech companies like robinhood and M1 Finance offered fractional shares to investors years before traditional brokerage did.
Another brokerage account option is a robo adivsor, which is best for those who have clear, straightforward investing goals. The advantages of using robo advisors include lower fees compared to a human financial advisor and automatic rebalancing to name a few.
If you have more complex financial goals and prefer more customized investing options, a robo-advisor may not be the best fit.
One important thing to note: Opening a brokerage account and depositing money is not investing. It is a common mistake for new investors to assume that opening the account and adding money is enough, however the final step is to make a purchase.
3. Calculate how much money you want to invest
As you decide which investment accounts you want to open, you should also consider the amount of money you’ll be investing in each account type.
How much you put into each account will be determined by your investment goal outlined in the first step—as well as the amount of time you have until you plan to reach that goal. This is known as the time horizon. There may also be limits on how much you can invest in certain accounts.
Decide on a percentage of your income that you can dedicate to building your portfolio. The general rule of thumb for retirement goals is to invest 15% of your income each year, but if you started investing later in your career or want to retire early you may want to consider investing a higher percentage. Keep in mind that 15% also accounts for any matches you receive from your employer. This means that you could contribute 10% of your W2 income with a 5% match from your employer to reach a total of 15% to hit this benchmark.
If you live paycheck to paycheck, 15% might seem like a crazy amount to invest. Don’t panic: It’s OK to start small, even just 1%. The important thing is to get started so your money will grow over time.
Plan how you’d like to invest your money. A common question that arises is whether you should invest your money all at once—or in equal amounts over time, more commonly known as dollar cost averaging (DCA). Both options have their advantages and disadvantages.
4. Measure your risk tolerance
Risk tolerance describes the level of risk an investor is willing to take for the potential of a higher return. Your risk tolerance is one of the most important factors that will affect which assets you add to your portfolio.
“Before deciding on what level of portfolio risk an investor wants to target, they first need to assess the comfort level with risk, or volatility. Does it make them nervous to invest when they see the S&P 500 drop over 24% as it has this year? . These questions are important because certain assets tend to be more volatile than others.
Risk capacity considers the factors that impact your financial ability to take risks and would include things like job status, caretaking duties, and how much time you have to reach that goal. Because these other priorities can be capital intensive, your ability to take on risk must fit within those parameters.
5. Consider what kind of investor you want to be
There is no one-size fits-all approach to investing. The type of investor you want to be is directly tied to your risk tolerance and capacity as some strategies may require a more aggressive approach. It is also tied to your investing goals and time horizon. There are two major categories that investors fall into: short-term investing and long-term investing.
Short-term investing strategies
There are two types of short-term investing strategies:
Day trading: An investment style that enters and exits an investment between market hours. Day trading is notoriously difficult, especially for new investors and over time has not yielded positive results for the majority of those who have tried.
Swing trading: Investors who take this approach are looking to buy and sell an investment after a few days or months to achieve a profit. The goal is to take advantage of significant swings around seasonal events or trading patterns.
Long-term investing strategies
Long-term investing, on the other end of the spectrum, comes with the upside of allowing more time for compounding interest and more margin for error when the market experiences volatility. One of the drawbacks of long-term investing is that it can become more difficult to catch up with your goals if you’ve delayed your investing efforts.
There are a few different long-term investment strategies to consider. You don’t have to follow just one; it’s OK to try a few different strategies.
6. Build your portfolio
Once you’ve determined your goals, assessed your willingness to take risks, decided how much money you have to invest, and what type of investor you want to be, it is finally time to build out your portfolio. Building a portfolio is the process of selecting a combination of assets that are best suited to help you reach your goals.
7. Monitor and rebalance your portfolio over time
Once you’ve selected your investments, you’ll want to monitor and rebalance your portfolio a few times per year because the original investments that you selected will shift because of market fluctuations.
The difference between savings and investment
a) Savings
This is the money you set aside from your income for a particular goal, such as buying a car, travelling, staying financially prepared for an emergency, and more. The risk associated with savings is minimal. However, savings do not offer any considerable growth of money.
b) Investment
When you invest your money in the right way, it grows in value and provides you returns. Your investments can be used to fulfil your financial goals such as buying a house, your child’s higher education, and more. Investments also carry a risk that may vary for different investment products.