Many of us have heard the term “investments” used in many ways - and it’s a concept most of us are familiar with to some degree. But unless you’ve really taken an interest in the markets or set aside time to study them, you may not have a total understanding of what investing is, everything involved with investing or what different types of investments are out there. But before you do a deep dive into theories, past performances or principles, we’ll get you up to speed with the basics of investing and what you should know as you look to grow your financial knowledge.
What Is Investing?
This is Investing 101, meaning we’re going to start by defining what exactly investing is. In its simplest form, investing is the process of giving money to another entity (such as the government or a company) with the hope that they will return more money to you (a profit) at a later time. While it sounds simple enough, giving money to another with the expectation of gaining more in return introduces the idea of weighing risk versus reward.
Why Do People Choose to Invest?
Due to inflation, the value of a dollar in your hand (or under the mattress) is continuously deteriorating - which is what makes investing an appealing choice for many. The idea is to put a certain amount of your dollars in a place where they’re expected to earn more in the future (assuming a positive return is earned) than a dollar left sitting in savings.
Common Types of Investments
While there are more out there, below are a few of the most common types of investments along with a brief description of each.
- Stocks: Giving your money to a specific company, earning you a share or piece of the company in return.
- Bonds: Loaning your money to a government or other issuer, with the agreement that you will receive that amount back with interest at a later date.
- Mutual Funds: Using a professional money manager, pooling your money together with other investors and purchasing a group of stocks, bonds or a mix of both in a single transaction.
- Index Funds: A type of mutual fund that doesn’t use the services of a professional manager, index funds aim to mirror the performance of the index they’re tracking (such as the S&P 500).
- Exchange-traded Funds: Index funds that can be traded on an exchange throughout the day, as the prices of stocks fluctuate.
- Real Estate: Typically broken down into four categories: residential, commercial, industrial and land, real estate investment is purchasing, owning, leasing and/or selling land with the intention of gaining a profit.
What Is Risk?
According to the Securities and Exchange Commission, risk refers to “the degree of uncertainty and/or potential financial loss inherent in an investment decision.”1 How does this relate to investments? In general, the higher the risk of an investment, the greater the potential reward. Every investment vehicle and product comes with its own set of risks, from determining how quickly an investor will be able to access their money when they need it, to figuring out how fast their money will grow where it is.
Everyone’s tolerance for risk is unique to them. A common determining factor may be a person’s time horizon, such as how far away they are from retirement, or how close they are to needing access to the money invested. Another factor could be considering how much money you’re willing to risk losing without affecting your lifestyle or jeopardizing your needs.
Whether you’re new to the world of investing and interested in taking a do-it-yourself approach or you’re looking to work with an advisor to develop a tailored portfolio, it’s important to understand the basics of what investing is, how diverse your options are and the risks involved with seeking returns.