Whether you want to save for your dream home, a child’s education, or your own retirement, investments could help you reach your financial goals. But exactly what is an investment and how might it benefit you more than simply stashing cash at a bank? Here’s a breakdown of investments, including some advantages and disadvantages, and how you can buy them.
What is an investment?
An investment is something you spend money, time, or effort on in hopes it creates more value than its original cost. You may hear people talk about “investing time” or “investing in education.” Both sentiments reflect the idea that spending or allocating a resource in a certain way creates a greater benefit in the future. In financial investing, an investor takes their money (also called “capital”) and spends it by buying investments (often called “assets”) with the goal to generate a profit over time.
How do investments work?
Investments work by potentially creating a profit for investors in 2 different ways: income and appreciation.
Income is when an investment generates money without having to sell the asset. That could be through a dividend (a payout from a company to stockholders), a coupon payment from a bond (the periodic interest payout), or even a rent payment from a real estate property.
Appreciation is when the price of an investment grows in value. Generally, the only way to turn appreciation into profits is to sell at least a portion of your investment.
The flipside to potential profit is risk of loss. With any financial investment, there’s a chance you’ll lose some or all the money you spent on buying that investment. Different investments carry different amounts of risk, and usually, an investment’s risk level correlates with that investment’s profit potential. The key is finding your risk tolerance—or your ability and willingness to handle potential losses—for a given financial goal.
Related: Investing for beginners
Types of investments
There are many types of investments financial investors could use to try to generate a return, including:
Stocks
Stocks represent a slice of ownership of a company. Not all stocks are publicly traded, but for those that are, you can buy them through a brokerage firm such as Fidelity. Stocks are bought and sold using their ticker symbol, a unique 1- to 5-letter abbreviation. Investors trade stocks when the markets are open (usually Monday through Friday) during stock market hours (usually 9:30 a.m. to 4:00 p.m.), and stock prices fluctuate throughout the trading day. Stocks could return potential profits to investors through either share price appreciation or through dividends, typically issued quarterly to shareholders.
Bonds
Bonds are a way for companies and governments to borrow money from investors. In exchange for lending them money for a fixed period of time, you’re paid interest from the company or government that issues the bond. Typically for shorter-term bonds (1 year or less), that interest is paid, along with the money you lent upfront, when the bond matures at the end of the fixed period. For longer-term bonds (up to 30 years), income can be paid over regular periods, like twice annually, throughout the bond’s duration.
ETFs
Exchange-traded funds (ETFs) are baskets of securities, such as stocks or bonds, bundled into a single investment. These funds typically follow a theme or category, like a stock market index, the price of gold, or the yield of government bonds. These funds are called exchange-traded because they trade just like stocks, with each fund having its own unique ticker and able to be bought and sold throughout the weekday. Generally, ETFs that contain many different stocks or bonds may be considered less risky than individual stocks or bonds, as diversifying your dollars across many different investments can help protect against a single poor performer. However, diversification does not ensure a profit or guarantee a loss.
Mutual funds
Mutual funds collect money from many different investors to buy investments around a different objective or theme. That could be following a stock market index, investing in a single sector of the stock market, or buying corporate bonds of a certain credit rating, not unlike ETFs. Frequently, a team of financial professionals actively manage mutual funds. Unlike ETFs, they trade only at the end of the day when the market closes.
Advantages of investments
Investments could have many benefits, including:
Potential for compound returns
If you’re investing over a long period of time, you could benefit from compounding. Compounding lets your interest and returns earn interest and returns on their own.
Potential for passive income
Investments that generate passive income, through dividends or interest, could potentially help supplement your work wages, grow your wealth, or even help you retire early.
Tax benefits
Certain investment accounts, like 401(k)s, 403(b)s, health savings accounts (HSAs), and individual retirement accounts (IRAs), have tax advantages. Some of these, such as traditional IRAs, allow contributions that could reduce your taxable income, if you’re eligible. Others, such as HSAs, allow your investment dollars to potentially grow tax-free.1
Disadvantages of investments
Although these don’t necessarily apply to all investments, many investments have the following drawbacks to understand and consider:
Risk of loss
With investing, there’s always the risk you’ll lose the money you put in upfront, even though there’s also the chance you’ll make a potential profit.
Market volatility
Stock values can swing sharply in the short term for many reasons outside of investors’ control, like companies releasing unexpected earnings reports, government policy changes, and world events. Market volatility can be not only stressful, but also potentially costly, especially if you’re planning on using that money soon.
Lack of liquidity
Investing in tax-advantaged accounts could make it harder to access your money before certain conditions, like reaching a certain age, are met since you may be subject to taxes and penalties.
How to buy investments
Now that you have a better understanding of what an investment is, you might decide you’re interested in buying some. Here are the steps to take:
1. Determine what you’re investing for
Before deciding what to invest in, set a financial goal. This will be your north star when choosing when, where, and how to invest.
2. Choose an investment account
Next, decide what type of investment account best fits your financial goal. Some accounts have tax advantages for certain savings goals, like 529 plans for education savings and HSAs for health savings. Check this list of investment account types to get ideas on which account might best fit your needs.
3. Pick a brokerage firm
Then comes choosing a financial institution to host your account. Where to open an investing account is a decision to take seriously. Consider any fees or commissions, tools and resources, and user-friendliness.
4. Choose an investing strategy
Once you’ve figured out where to invest, determine how you’ll invest. Creating an entire investing plan on your own isn’t for everybody. Here are 2 different paths to investing that you could take:
- Hands-off: If you’d rather leave decision-making to the financial professionals, you could consider professionally managed investments or accounts. Some types of mutual funds, like target date funds, are ready-made retirement portfolios that automatically rebalance their investments based on an investor’s target retirement date. Robo advisors use technology to manage investments on your behalf using a strategy built around your goals and preferences. Or you could hire a financial advisor,2 who may offer more personalized advice for your specific circumstances.
- DIY: Want to be in the driver’s seat? Deciding how to invest starts with determining your time horizon and risk tolerance. Here’s how to create your own investing plan in 3 steps.
5. Open and fund your investment account
Time to take action. Open the account that makes the most sense for your financial goal and transfer money into that account. (Psst … here’s how to open an account with Fidelity.)
6. Research investments
Examine the different investment types. Explore your financial institution’s investment research tools to learn more about assets you might want to invest in.
7. Buy investments
You could place a one-time trade or consider a strategy like dollar cost averaging, when you invest a set amount at regular intervals. Here’s how to set up recurring investments, when you choose how much and how often to invest, plus what to buy.
8. Check on your investments regularly
It’s important to peek at your investments at least once a year to make sure they stay in line with your financial plan. It’s also smart to calculate your return on investment (ROI) occasionally to see whether your investments are working as hard for you as you expect them to. Checking on your investments is a good way to stay informed, make adjustments when necessary, and ensure your portfolio stays aligned with your financial goals.