Investing doesn’t have to be complicated. Here are the common sense ideas that investing is built around.
Why not keep my money in the bank?
The main reason is that banks might not provide enough of a return to help you meet your financial goals. A bank is a good place to park money that you know you will need in the short term. But bank savings rates can’t compare with what you can potentially earn by investing, and the difference can be significant over time.
A bank account’s value won’t go down like investments can. But low-returning assets like CDs may not keep up with inflation, and that’s the same as losing money every year. Sound, risk-aware investing is the only way to stay ahead of inflation in the long run.
Why should I invest in mutual funds?
In general, investing in mutual funds is less risky than investing in a single stock or bond because mutual funds offer diversification. Diversification means spreading your money and your risk across different investments instead of putting all of your eggs in one basket.
Mutual funds pay professionals to combine investments according to a specific strategy. Typically, those strategies prevent a price decline for any single stock or bond from having a big impact on your savings. Diversification does not guarantee a profit or prevent a loss when markets fall, but it is one of the most important methods funds use to manage investment risk.
Does it matter what type of mutual fund I invest in?
Investing in mutual funds is not “one size fits all.” Different types of funds use different strategies and include different combinations of investments. That means they have different risk levels and are best used for different types of goals.
Most investments belong to one of three general “asset classes”: stocks, bonds and money market securities. Each asset class has its own characteristics and serves a different purpose in helping investors:
- Stocks offer strong return potential involving significant risk.
- Bonds deliver the potential to earn a steady stream of income with moderate risk.
- Money market securities provide small returns but almost no risk.
Most investors hold a combination of mutual funds to achieve a balance that suits their personal financial goals.
Want to learn more? Read Handling Investment Risk.
How do I make money?
The returns you earn from investing can take several forms. They include:
- Interest from the bonds in your fund.
- Dividends, which are annual payouts made by some companies to their stockholders. Your fund will pass your share of these payouts directly to you.
- Capital gains, which occur when the price of a stock or bond rises above the price you paid for it. Those gains are typically reflected in a rising price per share of your mutual fund. If you decide to sell at that higher price, you “realize” that gain (you lockit in).
No matter what form your investment returns take, you probably care most about your “total return.” That’s the change in the value of your investment account, including interest, dividends and capital gains, over time.
What advice do you have for a first-time investor?
The best advice is to make a sound investment plan and stick with it. Make changes to your investments only when your goals have shifted or there has been a significant change in your life. It’s always tempting to try to make predictions about what’s going to happen or to react to the latest market news. But historically, investors who stay focused on the long term tend to have better outcomes.
Here’s an example: An investor who held the overall stock market over any 15-year period during the past 65 years would have earned a positive return. Stocks go up and down every day, but history shows the chance of incurring a loss in your stock investment declines the longer you remain invested.
Why bother saving for the future now?
When you invest for a long time, the interest earned on your money earns its own interest, and that interest earns its own interest, and so on. Over time, this compounding really adds up.
Invest today for retirement or any other long-term goal, and you could earn compound interest for maybe 25 or 30 years. That’s interest on top of interest on top of interest — every month. That can turn into a pile of savings two to three times as large as the exact same amount put aside for only 10 years. Compound interest is sometimes called the most powerful force in the investing universe, and the longer you save, the more it works for you.
Neither asset allocation nor diversification guarantees a profit or protects against a loss in a declining market. They are methods used to help manage investment risk.
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