Unless you majored in economics or finance in college, you probably didn’t learn much about the stock market growing up. And, if you’re like many people, your eyes glaze over when you hear stock market news. Nonetheless, despite the economic turmoil of recent years, the stock market remains among the most important option for Americans to build their wealth and secure a comfortable retirement. So, while you may still choose to work with a financial advisor to guide your investment strategy, here are some investment basics you should know.
When is the right time to invest?
Right now! Depending upon your age, how and what you should be investing will be different.
Who can invest?
Anyone, regardless of age, gender, income, etc.
Why should you invest?
Thanks to the power of compound interest, you’d be surprised how a little money will go a long way, especially if you have time on your side. Compound interest can cause your wealth to snowball by growing your money at a faster rate than simple interest. In addition to earning returns on the money you invest, you also earn returns on those returns at the end of every compounding period, which could be daily, monthly, quarterly, or annually.
Where should you invest?
The simplest starting point is to contribute to your employer’s 401(k) plan, a tax-advantaged retirement savings account that many companies offer, or other retirement savings accounts, such as a Roth IRA or traditional IRA.
Before you begin investing additional money, you should understand the different types of asset classes (a group of similar types of investments) available to you. You can invest in one asset class or a mix of them. The mix of asset classes is referred to as your “asset allocation.” Historically, the four main asset classes have been:
- Stocks or Equities. Stocks are bought and sold as shares in companies that list their stock on one of the stock exchanges such as the New York Stock Exchange (NYSE), the American Stock Exchange (AMEX), and the National Association of Securities Dealers Quotation System (NASDAQ), which makes you a shareholder. When you hear the term “equities,” remember it’s just another word for stocks.
- Bonds or fixed income. Your money is used to lend to an institution or government in return for interest (government bonds, other types of bonds, and certificates of deposit).
- Money market funds, cash, or cash equivalent. Money held in the form of cash or cash
equivalents that can be accessed at any time. - Real estate or other tangible assets. Real estate and other physical assets such as natural
resource commodities like oil, precious metals like gold, art, etc. are considered an asset class
that offer protection against inflation.
How do you make money in the stock market?
There are two basic ways to make money in the stock market.
1. Buy a stock, and then sell it after it increases in value. The profit you make is referred to as a capital gain.
2. Buy a stock that pays dividends to shareholders. Dividends are a company’s earnings, which it pays out to its owners, or shareholders.
What’s the difference between a stock and bond?
Stocks are ownership investments – you’re buying a piece of a company. Bonds, on the other hand, are a lending investment. You give the bond issuer money, and they pay you interest in return, just like you pay interest to a creditor. In general, bonds are considered safer than stocks since the bond issuer has a legal obligation to pay them. They are not, however, risk-free.
What is an index?
An index is a measuring device for investments in the stock market. Stock market indexes are used by investors to decide which markets they want to invest in and how much of their money to put into each one. An index fund is used to put the plan in place.
What are first steps to getting started?
- Determine your asset class mix.
- Decide how much you want to allocate between high-risk and lower-risk investments.
- Establish whether you will be an active or passive investor. Passive investing is more popular among investors, but there are arguments to be made for both styles.
a. Active investing: A hands-on approach to investing that requires confidence in knowing exactly the right time to buy or sell.
b. Passive investing: Investing for the long haul and requires a buy-and-hold mentality. Passive investors limit the amount of buying and selling within their portfolios which makes it a very cost-effective way to invest. - Choose whether you will pick stocks yourself or pay a professional to do it. There will be fees involved either way, so do some homework before committing.
- Set it and forget it. You may panic every time an investment moves, but don’t touch it.
What is diversification and why is it important?
Diversification simply refers to the practice of spreading your money among a variety of investments to balance risk. It’s important because nobody can know for sure exactly how different types of investments will perform at any given time. A diversified investment portfolio has lower risk because if one type of investment is down, it can be balanced by others that may be doing better.
Research before you buy.
Even if you trust your broker or advisor completely, it is important to do your own research before you purchase any security. After all, it is your money on the line – win or lose, the person or company who sells you the investment product earns a commission. Remember too, to have realistic expectations. Don’t take “hot” stock tips that promise a huge payout, particularly if you hear about it through an anonymous email.
The best place to begin your research is the internet. Visit the company’s website and read all about it – including a history of its stock price, financial position, breaking news about products or services, and management. Whether you are buying stocks or bonds, it is important to know what you are getting into.
This article was originally shared via our education partner, Balance Pro.
