You don’t have to be a finance major or millionaire to become an investor. In fact, if you participate in your employer’s 401(k) plan, then you’re already an investor; maybe you just haven’t thought about it that way. Understanding the basics of investing can help you see how it may fit in with your long-term financial plans.
Let’s start with a simple definition: Investing is putting your money into one or more investment vehicles (stocks, bonds or mutual funds, for example) with the hope that it will grow over time. This is why financial experts often say that people should start investing early in life, when their money has decades ahead to grow.
Investing differs from saving in a traditional savings account in that it offers the potential of earning a higher rate of return over time. NerdWallet offers an example of how an investment might grow over 10 years:
If you invest $200 a month for 10 years and earn an average 6% annual return, you will have $33,300 at the end of that 10-year period — $24,200 that you invested and $9,100 in earned interest.
This isn’t a guaranteed rate of return, however; it may be higher or lower, depending how the investment performs. That’s where a discussion of risk comes in. Investments also differ from traditional savings in that they carry a certain level of risk, meaning you can lose the money you invest due to market volatility — perhaps you’ve invested heavily in a company that goes out of business or in a new technology that doesn’t make it to market, for example. So while you may have the potential to earn more on your money when you invest, you also have the potential to lose some or all of it.
The level of risk varies, depending on the vehicles you invest in. Generally, financial advisors recommend diversifying your investment portfolio — meaning you invest in a variety of types of investments — to help reduce your level of risk overall. Still, a common rule of thumb among investors is to never invest more than you can afford to lose. For beginning investors, this means making sure you have emergency savings tucked away and are meeting all of your financial obligations comfortably before you start investing.
Types of Investments
Among the various types of investment vehicles, stocks, mutual funds, exchange-traded funds and bonds are the most common. Here’s a very brief introduction to each.
Stocks - A stock, sometimes referred to as an equity, is a share of ownership in a company. These shares can vary in price from company to company, and from day to day. Buying a stock in a small startup company could potentially cost as little as $10 or less, while the share price of a large, well-known, thriving company could be in the thousands.
Mutual Funds - Generally considered less risky than individual stocks are mutual funds, groups of various investments brought together into a single fund. Mutual funds are usually an option available to 401(k) plan participants. For individual investors, they offer the advantage of being professionally managed, which means you don’t have to handpick individual stocks and bonds, and you can achieve diversification through a single purchase.
Exchange-traded Funds - EFTs also bundle individual investments, at a share price that may be lower than that of mutual funds due to the way they are managed and traded. While mutual funds are actively managed by professionals, EFTs are generally passively managed, following a particular market index, such as the S&P 500 Index.
Bonds - Bonds, also known as fixed income securities, are generally a conservative investment option, meaning they offer lower risk than stocks but also lower return potential. In general, bonds pay a fixed rate of interest over a specified period of time.
How to Get Started
As mentioned above, signing up for your employer’s 401(k) plan may be a good place to start investing. You also have the option of opening an individual retirement account — a traditional or Roth IRA — to save for retirement.
If you also have investment goals unrelated to retirement, then you can open an investment account with a brokerage firm. Some have no specified minimum investment, so you can start small if you’d like and build from there. Talk with an investment representative to make sure you understand what types of accounts and brokerage services are available to you, and which may be the right fit. You can choose to have an investment professional manage your account or to make online trades yourself.
Once you’ve got the hang of it, you can commit to making regular deposits to your investment account. Consistency is key to making your investments work for you and moving toward your financial goals.