Feel like you should know more about investing than you do? Or, like so many of us, do you just want to get a few more investing basics under your belt? Either way, here are some core concepts to help you get started.
Remind me: Why should I consider investing my money (instead of just putting it in a savings account)?
The money you invest in the stock market may earn a return (meaning, you may get back more than you put in—and typically more than you would by putting your money in a regular savings account). Over time, if you continue to reinvest the returns you've earned on your investment, they can become part of your investment foundation. And because interest is calculated on the total amount of the investment, the money you've invested can grow exponentially.
Keep in mind: it's unlikely that you'll receive a positive return on your investments every year. The stock market will have upturns and downturns—and you should be prepared to experience that. But think of it this way: over the short term, the stock market is unpredictable, but over the long term, it has historically trended up.
The security of a regular savings account can also be misleading. If you only save your money, you'll likely earn less than a 1% interest rate on those funds per year. Inflation averages about 3% a year, meaning that if you leave your cash sitting in the bank for 30 years, your money could very well be worth less than it is today.
Learn the lingo
To better understand how the stock market and investments work, it helps to have some basic knowledge of the investment language used. Here are some of the basic terms to get used to:
- The stock market is a collection of marketplaces and exchanges on which you can buy, sell, or trade securities.
- Securities is a general term used to define different types of investments (stock, bonds, etc.).
- Asset classes are collections of securities that operate similarly within a marketplace. The main securities that you can buy, sell, or trade on the market are:
Stocks: Stocks (also called equities) are shares issued by publicly-owned corporations. When you hold a stock, you hold a share in the company and are known as a shareholder. Stocks give you a greater potential for growth. But they also come with a higher investment risk. Generally, the more time you have to invest—and the longer you have to ride out short-term changes in the market—the bigger the role stocks could play in your investment strategy.
Bonds: Bonds (also known as fixed-income investments) represent a debt. Think of them as "IOUs." When you put money into a bond, another entity receives your money. They owe the amount of your investment back to you over time with interest. (There are also "zero coupon bonds" that don't pay interest during the time the bond is held—but when they mature, the bond holder gets both the original amount paid and the interest.)
Bonds are generally less risky than stocks, so they can help offset some of the investment risk stocks can create. The potential risk and return on bonds is moderate: generally lower than stocks, but higher than short-term investments. In general, bond prices rise when interest rates fall, and vice versa.
Short-term investments: Also referred to as money market or cash investments/cash equivalents, short-term investments are highly liquid, relatively stable investments and can include Treasury bills, money market funds, and short-term government bonds. While they are considered the least risky of the 3 basic investment types, they also tend to produce the lowest returns over the long run.
So how does this all fit together?
The percentage of stocks you hold in your investment portfolio versus the percentage of other securities like bonds or short-term investments is what makes up your asset allocation.
The right allocation for you depends on your own personal investing time horizon (i.e., how long you plan to leave the in the money in the market), your tolerance for risk, and your investment goals.
Diversification is a critical risk management strategy. It's what helps decrease risk within your portfolio when one segment of the market performs poorly. If you're diversified, your investments are more balanced among stocks, bonds, and short-term investments.
While you can buy, sell, or trade individual stocks and bonds, as an average investor it can be tough to do so in a way that ensures your portfolio is well-diversified. One popular strategy to this common issue is to invest in mutual funds.
Mutual funds are "baskets" of assets usually managed by a portfolio or fund manager, composed of a pre-selected mix of individual securities. This collection of securities might be difficult to recreate on your own, but the fund allows you to pool your money with other individual investors and gain access to investments that you might not otherwise be able to use.
Putting your investment know-how to work
There are countless investment strategies and philosophies out there, but for new investors, a good rule of thumb at the outset is to keep it simple: Start today. Get in the game and discover what approach works best for you. Educate yourself on the various investment vehicles available to you. Consider opening a brokerage account and investing a set amount of money each month. Maybe look into an all-in-one index fund that tracks the broad stock market and makes it easier to keep your portfolio diversified, and invested with low fees. For a newcomer, it's also probably best to avoid the temptation to pick the next hot stock or jump around from fund to fund.
The sooner you start investing, the longer your time horizon. And the longer your time horizon, the better positioned you will be to benefit from potential compound interest and grow your nest egg.
Fidelity Brokerage Services LLC, Member NYSE, SIPC, 900 Salem Street, Smithfield, RI 02917