Although “investor” may sound like a title reserved for real estate barons and Rich Uncle Pennybags, anyone can claim it—and if you’re hoping to build significant wealth over time, investing is one way to make that happen.
But if you’re a total newbie, the stock market can be intimidating. There’s lingo to learn and a steep learning curve: What exactly does it mean to “buy shares,” and how do you do it?
Fortunately, modern technology makes it easier to get started with a basic investment portfolio. So long as you have an internet connection and a bank account, you could get started today. But it’s worth understanding what you’re doing before you put your money into the nebulous “market.”
Investing vs. Saving—and Why Investing May Be Worth the Risk
When you’re making the effort to set aside a significant chunk of your income, you may wonder why you’d want to risk it on the market rather than simply stashing it in a savings account—or even under your mattress. But although investing does involve risk, there’s a pretty solid argument to be made that not investing could be even riskier.
Why, you ask? It comes down to one word: inflation.
Let’s say that back in 2010, you took a one-dollar bill and stuck it under your mattress. Today, that same dollar wouldn’t buy you as much as it would back when Bruno Mars was just exploding onto the scene—in fact, it would be worth 17% less, thanks to inflation.
Now let’s say you took that same dollar and put it into an interest-earning savings account instead. Although most savings accounts earn interest, it’s typically modest; the average savings account earns about 0.1% annual percentage yield (APY) today .
Let’s be really generous and say you found a great savings account, where your cash earned more than double today’s average: 0.2%. Today, that dollar would be worth $1.02, which still wouldn’t keep up with the 17% inflation rate, but would be slightly better than the mattress situation.
Now, let’s say you invested that dollar in the stock market. Although your exact results would vary depending on what, exactly, you invested in (more on that in a second), the annual return on stock market investments has averaged about 10% over the last decade per the S&P 500 index, which tracks 500 of the country’s largest publicly traded companies.
At that rate, that single 2010 dollar would now be worth $2.46—which, if you’re keeping track, would easily eclipse the rate of inflation and earn you a tidy little profit.
And that’s why investing is such commonplace financial advice: The money you put into the market may be at risk, but it’s also subject to fairly solid growth potential. And historically, the market’s trend line has continued to climb on the whole, even accounting for major crashes like the Great Depression and the 2008 crisis.
Of course, that doesn’t mean there’s no place for a healthy savings account. While investments may have greater potential for long-term gains, compound interest (which is the interest calculated not only on the starting principal, but also on the interest that accumulated over the previous period or periods) often does need time to work its magic—which means your investments are best left untouched for years at a time.
When it comes to a cash cushion you need quick access to, like an emergency fund, a savings account could be a better option. It’s all about striking a balance and assessing your personal financial goals.
Speaking of which…
Since investments have such strong growth potential over time, many people use their investment accounts as savings vehicles for major, future financial goals, like purchasing a home or retirement. Figuring out which investment strategy is right for you starts by assessing and understanding what your goals are. They’re not the same for everyone!
Although homeownership has long been considered a sign of success and maturity, you may decide that renting is right for you for the foreseeable future—or choose a less-expensive alternative housing option, like an RV or tiny home.
That said, many people look forward to retiring after a long life of hard work, and getting started early is often the key to building up a sustainable nest egg. Although exact retirement needs will depend on your lifestyle and fixed expenses, most rough financial guidelines suggest you plan to have 70% to 80 % of your pre-retirement income available for each year of your retirement. You can also try out our retirement calculator to see if your savings plans are on point.
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Types of Investments
Once you have a better understanding of what you’re investing for, you can start to make more informed decisions about your investment strategy. Although the stock market might be the first thing you think of when you hear the word “investment,” there are plenty of other types of investments out there, though they may require more effort and education than stock market investing
Real estate investments can be used to earn money—for instance, by starting a rental property business or investing in up-and-coming commercial properties that stand to increase in value.
Fine art is a fairly common physical investment, and the value of art tends to be less vulnerable than other types of assets to market fluctuations. On the other hand, you really have to know what you’re doing to identify a high-value piece.
Gold and other precious metals have been stockpiled for their perceived value for literally centuries.
Stock market investing is perhaps the most accessible type of investing to get started with—in fact, you can get going today with just your computer and bank account.
How Does the Stock Market Work?
Although many of us learn stock market basics in grade school, it’s pretty easy to lose track of that knowledge after you pass your social studies test—especially if you’re not actively investing. (Which you’re probably not, in eighth grade.)
When you invest in stock, you’re purchasing a small piece of ownership in a company. These portions of the company are known as “shares.” As a part owner, you’ll get a cut of the profits if the company grows and earns money—though your investment is also vulnerable to recessions, company losses, and complete failure.
The value of individual stocks rises and falls based on perceived market value, which is affected by things as diverse as world events, company decisions, and plain old supply and demand.
Along with earning company profits in the form of potential dividends, you can also earn money through simple appreciation: the value of the stock you own increasing over time due to demand, company growth, or other factors. But, again, the value of a stock can drop for the exact same matrix of reasons.
Although stocks may be the most common asset (it is known as the “stock market,” after all), they’re not the only type of security (exchangeable, tradable financial asset such as a stock, bond, or option) you can purchase.
Types of Stock Market Assets
Here are some of the other types of assets you may encounter.
As defined above, stocks are portional pieces of ownership of a company, also known as “shares.” Along with earning you a piece of company profits, most also come with voting rights, allowing you to have a say in some company decisions, such as electing the board of directors.
While stocks are generally considered a relatively risky asset, they also offer some of the best potential ROI (return-on-investment). When a company does really well, its stocks can rise in value exponentially—think about the lucky folks who invested in Amazon stock back in 1997!
But as tempting as it is to try to pick the right startup and ride its rocket to the top, the fact is that most companies aren’t Amazon, and putting all your eggs in one basket may be a recipe for disaster if you aren’t exceptionally lucky.
That’s why it’s generally recommended to build a “diversified” portfolio made up of various stocks from a wide range of companies and industries, as well as other asset classes.
Bonds are also available on many market exchanges, but work differently from stocks. Instead of purchasing a portion of a company, you’re essentially loaning the bond issuer—usually a government or business—a sum of money, in exchange for the written promise that it will be paid back, with interest, after a set amount of time.
Because bond repayment terms are agreed upon ahead of time and the issuer is obligated to pay the face value, bonds are generally considered a safer investment than stocks, though they do still carry risk.
Furthermore, bonds don’t carry the same kind of exponential growth potential that stocks do, and, in fact, have an inverse relationship with overall stock interest rates. They can be a great way to add some predictable growth to your portfolio, but may not be able, on their own, to help you amass the wealth you need to fully fund, for example, a comfortable retirement.
You know how everyone talks about the importance of diversification? A mutual fund is a type of investment vehicle that can help you get a well-rounded portfolio without the research and footwork you’d need to DIY it.
It’s basically a pre-arranged basket of stocks, bonds, and other types of assets, created and managed by professional money managers who collect a fee for the service.
These fees are assessed annually and are generally calculated as a percentage of your managed assets (i.e., the total value of your mutual fund investment). Average annual mutual fund fees tend to range between 1 to 3%. You may also still be responsible for costs associated with trades and commissions on top of this management fee.
ETFs, or exchange-traded funds, are a subclass of mutual funds. However, rather than being professionally managed by human beings, most are built to track pre-existing collections of assets, like stocks from a particular industry or companies listed in a specific index like the S&P 500.
Also, since ETFs trade on the open market, it’s possible to make trades multiple times a day, unlike mutual funds.
Although some indexes are actively managed, the majority are not, meaning they generally carry lower expense ratios (ERs) than other types of mutual funds.
(An expense ratio, FYI, is the amount of a fund that gets put toward overhead expenses like management and operations. It’s calculated by dividing the total of the fund’s costs (expenses) from the total of the fund’s assets (sum).
Some brokerages also offer a suite of commissions-free ETFs, making for a relatively low-cost way to get started on building a diversified portfolio.
How to Get Started—Quickly and Easily
Ready to put your own money to work on the stock market?
Whether you’re eager to become an expert or want to be as hands-off as possible, there are plenty of ways to get started on your own investment portfolio.
And since compound interest works best with a healthy helping of time, it’s a good idea to get started as soon as possible.
If you want to learn everything you can about the market and have the greatest amount of control over your asset allocation, active investing might be the choice for you. You can open a brokerage account which will allow you to handpick the stocks, bonds, and ETFs you’ve got your eye on, and you’ll also be able to sell them off whenever you’re ready.
If you’re looking for a super-basic stock market investing option for total beginners, however, automated investing can help you get started fast—and still give you the option to learn the ropes along the way.
A hands-off option that builds a diversified portfolio based on your personal goals, automated investing takes the stress out of stocks while still helping you get set up for the future.
No matter which type of investment approach you choose, just remember: There’s no such thing as a sure thing, and investing always carries a risk factor. That said, making careful, informed choices and making it a point to diversify your portfolio can help hedge the odds in your favor!
Ready to Put Your Money to Work?
Phew! As much information as we’ve covered in this guide, when it comes to investing, all of this is just the tip of the iceberg. As you move through your own investing journey, you’ll doubtless encounter more investment questions and challenges.
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Investment Risk: Diversification can help reduce some investment risk. It cannot guarantee profit, or fully protect in a down market.
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