Investing doesn’t have to be intimidating or full of technical jargon. If you’re starting your career, and need to decide how to invest in your 401(k), or have been working for a while and never felt comfortable asking how investing works, this article aims to help.
Definition: Using money to purchase assets with the expectation of generating income or profit. What’s an asset? Well, it could be a stock, or a bond, or a mutual fund…or a piece of real estate, or many other things. But we’ll stick with stocks, bonds, and mutual funds, which we’ll explain below.
Why Invest?
- People invest for the long-term with the expectation that their money will grow faster than inflation, so they’ll have the funds to provide for their needs in the future.
- Beat Inflation: Preserve purchasing power of money over time
- Build Wealth: Grow money beyond what’s possible with savings accounts
- Achieve Financial Goals: Fund major life events (retirement, education, etc.)
Basic Types of Investments
- Stocks: Ownership shares in companies
- Provide capital appreciation and some dividends.
- Bonds: Loans to governments or corporations
- Primarily provides income payments rather than capital appreciation.
- Mutual Funds: Professionally managed collections of stocks and/or bonds
- Exchange-Traded Funds (ETFs): Like a mutual fund, but traded like stocks
- Real Estate: Property, like a rental house or building
Key Investing Concepts
- Risk vs. Return: Higher potential returns often come with higher risk
- Stocks have had higher returns than bonds, historically, but carry higher risk.
- Risk can include loss of money.
- Diversification: Spreading money across more than one investment to manage risk
- Holding stocks and bonds.
- Ensuring the stocks held are diversified across different asset classes and countries (such as not only owning large US companies such as those in the S&P500)
- Compound Interest: Earning returns on your returns
- Time Horizon: Length of time you plan to hold investments
- Your time horizon can help inform the level of risk that should be taken.
Getting Started with Investing
- Set Financial Goals: Determine why you’re investing.
- Assess Risk Tolerance: Understand your comfort level with potential losses.
- A lower risk tolerance (risk averse) generally indicated that a more conservative portfolio with more bonds may be appropriate.
- Start Small: Begin with what you can afford, even if it’s a small amount.
- Saving into your 401(k) is a good way to start investing.
- Target date funds are managed for you and become less risky as you approach retirement age.
- Educate Yourself: Learn about different investment options and strategies as well as the risks associated with them.
Common Investing Mistakes to Avoid
- Trying to time the market – people are bad at predicting the future.
- Not diversifying enough – “putting all of your eggs in one basket”.
- Letting emotions drive decisions.
- Neglecting to rebalance a portfolio.
Conclusion
- Investing is important to ensure you have money for retirement and build wealth over time. While investing does have risks, these can be mitigated through a well-diversified portfolio that matches your risk tolerance and time horizon.
- The earlier in life one begins investing, the more time that money has to grow and weather volatility.
Remember, this outline provides a basic overview. We recommend consulting with a Certified Financial Planner® professional for personalized investment advice.
