Everybody likes making money. If you are in high school or college, maybe you already have an after-school or summer job. If you’re beyond high school or college, maybe you are working full-time and collecting a salary. That’s great…but working for a paycheck may only get you so far. Once you spend what you make, that money is gone.
Investing lets you put some of what you earn to work. Think of it as working smarter, not harder.
It’s safe to assume you have at least one goal that will cost money to achieve, right? Maybe you want a new car, a house, or to pay for your college education. Or maybe you’re really thinking of the long game, and you want to start saving now for retirement.
Depending on how you invest, it’s possible to attain all of the above goals. But first you’ll need to understand the basics of investing.
What types of investments are there?
For now, we’re going to keep it simple and talk about the three basic types of investments: cash, bonds and stocks.
A few words about risk
Everyone thinks about investing as a way to make money. And it can be. But there is no such thing as a 100% risk-free investment.
But, risk does exist on a spectrum. Some investments represent a small risk; others, much more. Generally speaking, the bigger the risk, the bigger the potential gain — and loss.
Cash and cash investments
The least risky type of investment is short-term reserves (also sometimes called “cash” investments).
Savings and checking accounts are considered cash, while certificates of deposits (CDs) (which can be short- or long-term) are considered cash investments.
What makes cash investments so safe? Most bank products, such as those listed above, are insured by the Federal Deposit Insurance Company (FDIC) up to $250,000 per account, which means you’ll never lose your original investment (as long as it was $250,000 or less1).
Bonds are another way to loan out your money in exchange for interest income. It’s a little bit like a cash investment, but without the protection of insurance and more risk.
Companies and government entities (like your school district or your state government) issue debt (another commonly used name for bonds) for a set period of time in exchange for set interest rate.
Then, when the loan is repaid, your original investment is returned to you. Of course, without any insurance, there’s always a chance that you won’t get paid back, which is called default risk. There’s also a chance that the value of a bond will go down as interest rates rise.
When you buy a company’s stock, you buy a share of ownership in the company.
If the price of your stock goes up, you can sell it and keep the profit. Some companies also pay out a portion of their profits through payments known as dividends. If the price of your stock goes down, you may lose money, up to the value of your investment.
Investors who want to grow wealth often choose stocks that do not pay dividends, as these companies tend to reinvest their profits back into the company instead of paying it out to shareholders.
On the other hand, some investors (like retirees) buy dividend-paying stocks because they rely on regular income from dividends to pay their bills.
Either way, a stockholder can express their views on how they want the company to be run by voting on such issues as mergers and appointments to the company’s board of directors.
If you invest in just one company’s stock or bond, you may lose most (or even all) of your money if the company tanks.
Individual stocks and bonds can also be expensive to buy. Often, you must buy a minimum of $500 to $1,000 to get started…and sometimes even more. And, for some of the most well-known stocks, that amount of money won’t buy you much.
Let’s say you want to invest in Apple. As of December 31, 2019, one share of Apple stock cost about $294. If your broker requires a minimum initial investment of $500, that won’t even get you two whole shares!
Instead of buying individual stocks or bonds, mutual funds are a very popular way to invest. A mutual fund is a pooled investment consisting of money from many investors.
There are three big benefits to investing in mutual funds.
- Professional money managers oversee them. These are professionals who do all the research before making investment decisions. That means less work for you.
- You can buy smaller portions of many stocks or bonds instead of just a single stock or bond. So your $500 will buy you fractional shares in hundreds of stocks or bonds, instead of one share of Apple.
- Your money is diversified. Diversification is one of the core concepts of investing. It equates to not putting all of your eggs in one basket. Still, it’s important to remember that diversification doesn’t guarantee against a loss — and not all mutual funds may be diversified.
So what should I invest in?
There are two things to consider when choosing an appropriate investment for you.
First, think about what you would like to achieve with your money. Anything that’s important to you can be a goal.
We already mentioned common investing goals, such as college, a new car, and retirement. Other goals may include saving for a vacation, a house or another big purchase. You can also make investments that support charitable causes.
After identifying your goals, you’ll need to think about when you want to achieve them. How you invest for a goal that you want to achieve in the next 12 months will be much different than how you invest to pay for a goal next week…or 40 years from now.
How can I learn more?
Learning about investing can be a time-consuming process. There is a lot of good information available online from reputable financial institutions and finance education websites.
Or, you may want to speak to an investment professional to learn more. Ask for referrals from trusted family members, friends or people you know who understand finance and investing.
1 Per co-owner per account
Information provided by SEI Investments Management Corporation. This information is for educational purposes only and should not be relied upon by the reader as research or investment advice. Investing involves risk, including possible loss of principal.