Investing is one of the best ways to put your hard-earned money to work for you. By investing in assets like stocks and bonds, you can use your money to make more money. That’s a big difference from simply saving your money, in which case your wealth isn’t growing and could even diminish as a result of inflation. Investing generates passive income that you can later rely on for a rainy day fund, for buying a home, or for enjoying your retirement.
At the end of the day, investing your money is about establishing financial security. It not only promotes good financial discipline now, but also ensures that you’ll have enough money saved up later for whatever life has in store.
If you’re ready to get started investing your money and growing your wealth over time, this guide is for you. We’ll cover all the basics of investing, from the different types of investments to how to pick where to put your money.
The Purpose of Investing
The purpose of investing is to increase your wealth over time. Essentially, that means making money using the money you already have or get as income from a job.
So, why would you want to see a return on your money? The reasons differ from person to person.
For a lot of people, the main reason to invest is to gain financial security. By growing your wealth over time, you can reduce the amount you have to think about money when considering retirement or gain the ability to retire early if you want to. Having more wealth also gives you a cushion in case you ever lose your job or there’s a medical emergency or death in the family. Gaining financial independence through investments can also allow you to buy a home, send your kids to college, or even leave your job and pursue a life-long goal.
Alternatively, investment can be a way not to guarantee your own financial independence, but that of the next generation. By growing your wealth over your lifetime, you can leave behind an inheritance for your kids or grandkids. Investments can even be a way to build wealth that you ultimately donate to charity to make a significant difference in the world.
Ultimately, there’s no one reason to invest or a single reason that’s better than all others. But, for the vast majority of people, investing is a sound financial decision that can open up a world of options down the road.
Learn the Investing Lingo
The best place to start investing is to understand the basic terms of the trade. Really, that starts with understanding what we mean by the word “investing” itself.
Technically speaking, anything that increases your money over time is an investment. In that sense, putting your money in a savings account could be considered investing it. But, when people talk about investing, they’re usually talking about holding specific assets like stocks, bonds, or real estate.
Here are some other terms that you need to know:
- Principle – Your principle is the money that you initially invest. If you buy $2,000 worth of stocks, your principle is $2,000. Even if that stock eventually is worth $5,000, the principle – the amount of money you originally put in – is still $2,000.
- Interest – Interest is the price paid to borrow money or the additional money you get when lending money out. If you keep your money in a savings account, you receive interest because the bank lends your money out to others.
- Return – Your return is the amount of money you make from an investment. You can calculate return as the total value of your assets minus your principle.
- Return on Investment (ROI) – ROI is a metric used to evaluate the performance of an investment. It’s equal to the return divided by the principle. If you double your principle with an investment, your ROI would be 100%.
- Brokerage – A brokerage is a middleman that allows you to buy and sell assets like stocks and bonds. When you want to buy a stock, for example, a brokerage will find someone who is selling that stock and purchase it on your behalf.
- Individual Retirement Account (IRA) – An IRA is a special type of investment account that comes with some tax advantages. Investments that you hold in an IRA aren’t taxed at the normal rate for investments. But, you can’t remove the money before you turn 59½ without tax penalties.
- Portfolio – Your portfolio is your entire collection of investment assets and cash. Your portfolio may consist entirely of stocks, it may be 25% real estate, 50% stocks, and 25% cash, or any other composition that you choose.
Types of Investments
There is a huge number of different types of investments, some of which are very creative. But, the vast majority of invested money is distributed in five common types of assets: stocks, bonds, funds, savings accounts, and real estate.
Stocks are shares of ownership in a specific company. When you own one share of Apple, for example, you own a tiny percentage of the company.
There are two main ways in which stocks can help you grow your wealth. The first is price appreciation over time. When a company does well – that is, its revenue or profits increase – the price of the stock you own goes up. If you wanted to sell your stock, you’d get more money back than what you paid for it (a return).
The second way stocks help build your money is by paying dividends. Not all stocks offer dividends, but many stocks of large, well-established companies do. A dividend is essentially a payout that’s made monthly, quarterly, or annually. You can use dividend money as passive income or reinvest it in more stocks.
A bond is like an I.O.U. note. When you buy a bond, you’re essentially giving a loan to a company or government. Typically, an individual bond is just one share of a much larger loan.
The advantage of buying a bond is that you get fixed, passive income. The company or government that issued the bond pays out interest on the bond at regular intervals. At the end of the bond term (which may be months or years), they also pay back your principle – allowing you to reinvest in another bond.
The important thing to keep in mind about bonds is that some are riskier than others. There’s always a chance that the bond issuer will default on their debt, meaning that you won’t be paid back. The more risky the bond, the greater your interest payments will be.
Funds are baskets of assets. The advantage of a fund is that you can buy an entire portfolio at once, rather than assemble it piecemeal on your own. The price of the fund will go up or down depending on the performance of the stocks, bonds, or other assets that are inside of it.
The disadvantage is that funds require someone to manage them, so they aren’t free. You can expect to pay anywhere from 0.1% to 3% of your total fund investment each year in fees.
There are two main types of funds: mutual funds and exchange-traded funds. Mutual funds are typically managed by a brokerage or money manager, and many need to be purchased through the brokerage that owns them. Fees on mutual funds also tend to be on the high end of the range for funds.
Exchange-traded funds (ETFs) are bought and sold on the stock market, just like stocks. The structure is the same as for mutual funds, but ETFs often have less active management and they are available to the public.
Savings accounts are extremely low-risk options for investing your money. With a savings account, you give your money to a bank and allow it to lend your money out to other customers. In return, the bank pays you a small amount of interest (between 0.1% to 2.5%). Savings accounts offer such low risk because your money is insured by the federal government up to $250,000 in the event that the bank fails and doesn’t pay you back.
Real estate is land, a building, or part of a building, like an apartment or office space. When you invest in real estate, you own all or part of one of these physical assets. The idea behind real estate investing is that the price of your land or building goes up over time, either because you make improvements to it or demand in the area increases.
Real estate investing isn’t for the passive investor. Maintaining land and buildings requires a lot of work and can be expensive in its own right. While you can generate “passive” income by renting out a second home or apartment, you’ll still have to deal with finding renters and fixing anything your tenants break.
Choosing Your Investments
With those basic investment options in mind, how do you decide which assets are right for you? Choosing your investments comes down to thinking about four important factors.
The first thing you need to consider is how long you plan to invest your money for and when you might need it back. If you could need your money at any time to meet expenses, a savings account is a better option than real estate – you can withdraw your money from the bank at any time, but it takes months to years to sell a home. On the other hand, if you’re interested and buying and holding all the way until retirement, stocks and real estate could offer higher returns in exchange for not being able to access your money quickly.
How much money do you have to invest? At the end of the day, different types of investments require different amounts of money. You might be able to buy stocks or bonds with a few hundred dollars, but buying real estate take tens of thousands of dollars. The amount of capital you have may also limit how much you’re able to diversify your portfolio by holding different types of assets.
Risk tolerance is one of the most important factors that differentiates investors. In the investing world, the more risk you take on, the greater your potential return will be – but correspondingly, there’s a greater chance that you’ll lose money rather than grow your wealth.
When thinking about risk tolerance, it’s important to consider how much money you’re willing to lose. If thinking about losing 10% of your investment during a stock market downturn makes you queasy, safer investments like savings accounts and bonds may be a better bet.
On the other hand, if you’re willing to take on a little bit more risk, there is a whole spectrum of risk available in the stock market. Some companies are very steady over the long term and are likely to yield modest returns, while others see wild price fluctuations and could yield high returns for risk-tolerant investors.
Deciding on what your investing goals are – what your purpose in investing is – is critical to figuring out your risk tolerance, how much capital you’re willing to invest, and your investing timeframe. Saving for retirement will have very different requirements compared to using investment as a way to generate income.
A good way to approach goal setting is to think about what kinds of return you want to see, and what kind of return you’d be okay with. Keep in mind that you’re not limited to a single investing goal, and you can have different portfolios that are managed for different goals.
Best Investment Options for Beginners
Now that you know the basics of investing, let’s take a look at some beginner-friendly options.
Premium Savings Accounts
Premium savings accounts are very low risk, although your return is also low. With a high-yield savings account, you can expect to see annual returns of around 1.0% to 2%. In most cases, your money is guaranteed by the federal government up to $250,000.
If you’re interested in a premium savings account, check out Wealthfront’s Cash Account. It currently offers a 1.27% annual return, which is far better than what you’ll get from a savings account at any major bank. This rate was as high as 2.57% in the past year, so make sure to pay attention to rate changes.
Robo advisors use an algorithm to help you invest your money. Most robo advisors allocate your money into ETFs, although some invest directly in stocks. The advantage of a robo advisor is that the algorithm typically takes into account your risk tolerance and goals when deciding how to invest your money.
Since every robo advisor uses a different algorithm, the risk-reward balance can vary a lot. Some options that offer a nice balance are Wealthfront, Betterment, and Acorns. All three of these platforms invest your money in low-fee ETFs and will automatically keep your portfolio on course over time.
More risk-tolerant investors can also dive directly into buying individual stocks. This takes some work since you’ll need to create and manage your own portfolio, as well as conduct research into what stocks to buy. However, your potential returns are much higher and you have the flexibility to invest in companies that you think are attractive.
To invest in stocks, you’ll need a brokerage account. Webull and ETrade both offer commission-free trading (meaning they won’t charge you to buy and sell stocks) and some basic tools you can use for research. For figuring out what stocks to invest in, check out The Motley Fool. This newsletter and research service has an extremely impressive track record of picking winning stocks.
Investing your money is one of the best ways to build wealth over time and to gain financial independence. Although investing can seem complicated, it doesn’t need to be difficult to start out. Once you understand the basic types of investments and think carefully about factors like your timeframe, risk tolerance, and goals, you can choose the investments that are right for you.