There are plenty of resolutions that make for admirable New Year’s goals: spending more time with family, resolving to cook wholesome meals, or learning a new language, to name a few.
But how about investing?
Investing can mean different things for us all. Some may dream of buying a home, a new car, or putting our money in stocks or mutual funds for the future.
If you are trying to reach a financial goal in 2021, understanding what investing is and the many options available is a great place to start. Taking the first step can often be overwhelming—but no need to fear, we are here to help!
What Is Investing?
From a definition standpoint, investing is the process of allocating money with the expectation of financial gain, commonly known as a return. The goal of an investment is to own an asset (i.e., something that holds value like stock or property) that can increase in price over time. The idea is to have your money work for you so that it can bring you closer to achieving your financial goals.
One of the most critical factors in deciding which investments are right for you is your potential financial return. This return often comes from interest payments or a price increase, and it’s calculated as a percentage of the initial investment. Take a simple stock, for example. You buy the stock at $100 and it goes to $120. Congrats! You’ve just collected a 20% return.
When familiarizing yourself with returns, it’s important to keep in mind that returns on investment are not guaranteed. Typically, the chance for greater returns also comes with a greater risk of losing some (or all) of your money.
If you know how to choose your investments wisely, you can lower your overall risk of loss (and ideally, maintain your financial security).
Generally speaking, there are two ways to invest: short-term and long-term.
Short-term investing is generally riskier. Because of the high risks associated with it, short-term investing is often less suitable for beginners. Even financial professionals who track the market daily have trouble predicting short-term market movements.
Long-term investment strategies, on the other hand, are good for both beginners and seasoned investors. You may have heard the term “buy and hold” strategy, which allows investors to purchase, then ride out the shorter-term shock waves like news events and pandemics.
Why Investing Works
Financial returns are particularly powerful because of a principle called compounding. Compounding means that the money you invest earns a return, and that return also earns money, which accumulates over time. Returns can come from interest payments, dividends, or increasing prices, all of which help your investment portfolio grow.
Higher returns on your investments not only exploit the power of compounding but also protect your money from inflation. Often viewed as the constant enemy of your hard-earned cash, inflation refers to the rising costs of goods. It can vary, but as of recently, money has been losing value by about 1.2-1.4% per year, on average.
To put that percentage in perspective, money that loses 1.2% each year loses about 22% over 20 years. Imagine you have $100 now. In 20 years, that same amount of cash will be worth the equivalent of $78. Essentially, if your uninvested money is just sitting in your bank account, this is what inflation is doing to it.
According to the Federal Deposit Insurance Corp, the national average interest rate for savings accounts is around 0.06%. This means that the rate of devaluation of your money is often greater than the interest rates on savings accounts offered by banks.
So, what do you do?
Long-term investing can combat inflation and help build wealth for your retirement. Investments can expand or shrink in the short-term, but the long-term tendency of the stock market is upwards.
In fact, over the last 100 years, the average stock market return rate is about 10% annually—beating both inflation and your savings account gains.
Common Types of Investments
We know, finance is full of different terminology and it can often feel overwhelming. A good way to start feeling comfortable is to familiarize yourself with a few types of popular investments.
Stocks or shares become available during an initial public offering (IPO), where they are listed on a stock exchange. During this process, corporations sell shares to raise funds and a company goes from being owned by founders and early investors to being available for public ownership.
Think of every stock as a tiny piece of the corporation. The two main ways to profit from these stocks are by selling shares for a profit or receiving dividends, which are payments made to shareholders at the company’s discretion.
Anyone can buy stocks. However, because of their volatility, they are typically considered a relatively aggressive investment. If you’re interested in stocks, buying a portfolio of stocks can often be less risky than buying stock in one single company (that’s because if one company plummets, you’ll have the others to hopefully balance it out). You can purchase stocks through a FINRA registered brokerage platform and start to build up that diversified portfolio.
Bonds are considered relatively safer investments and are commonly issued by corporations or governments. When you purchase a bond, you’re lending money to the issuer in return for interest payments. Terms of the bond include the interest rate paid to the bondholder, and the time by which the loan must be paid back (otherwise known as the maturity date). Bondholders can trade their bonds in the secondary market with other investors.
Bonds are typically classified into three categories:
- short-term (one to three years)
- medium-term (10 years or more)
- long-term (typically 30 years)
As an example, the current interest rate of a 30-year U.S. treasury bond is 2.05%. You can buy bonds directly from the government or a brokerage. Corporate bonds tend to have higher yields (interest rates), but they also come with more risk. The main scenario where you would lose your entire investment is if the issuer can’t pay back its debt.
Stock market and bond market indices are portfolios of assets that represent a broader category. For example, the S&P 500 Index is a U.S. index created by Standard & Poor’s with 500 stocks meant to represent the 500 largest publicly traded companies. Indices allow you to build a diversified portfolio without needing significant research. You can trade indices using exchange-traded funds (ETFs) or mutual funds.
ETFs are exchange-traded funds that track index funds. They are well suited for beginner investors because of their abundant liquidity, low expense ratios, diversification, and a range of investment options across assets. You often find ETFs in managed portfolios (a pool of different investments) with different investments across industries and assets.
A mutual fund is a diversified investment fund that manages money for investors. Mutual funds can be both active and passive. Active funds have more flexibility to choose investments that the fund manager thinks will perform well. Passive funds tend to track a selected index. Mutual funds are not directly available on an exchange, but you can buy them through brokerage platforms.
Real estate investing involves purchasing an asset (or assets) such as a house, apartment building, or land. You may need more capital in the form of a down payment to buy property, but securing a mortgage loan can help with the purchase. Real estate returns are a good way to go as they tend to be relatively stable in the long run.
When it comes to real estate, there are multiple ways to invest. Investors may trade physical property by buying a house priced below the market, renovating it, and then selling at a higher price. This is an active investment that requires market knowledge and experience. Investors may also buy and then rent out a property as another way to profit off of real estate.
You can also invest through real estate funds or Real Estate Investment Trusts (REITs). These allow you to start investing in real estate on a stock market exchange, with far less capital than you would need to buy a single property. If you’re thinking about going this route, know that the return rates and levels of risk of different funds and trusts can vary.
A commodity is a raw material that can be traded with other similar goods. Anything from gold, silver, oil, natural gas, grains, or even livestock are considered commodities. Commodities are often used in the production of other goods or services.
When these commodities are traded, they must meet specified standards to be exchanged in the market. Within your portfolio, commodities tend to help with diversification and can help fight inflation. During inflationary times as the demand for basic goods increases, commodities tend to do well. Also, if central banks print money, investors tend to see gold as a store of value.
How to Get Started
Before you start, look at your monthly budget and determine if and how much extra you have available to invest. Then, it’s a good idea to build up an emergency fund. Ideally, this will cover three to six months’ worth of expenses and should be set aside for unexpected events.
Once your emergency fund is set, determine your investment goals. For example, if your goal is to save for retirement, you can maximize your contributions to retirement accounts like a 401(k) or IRA. Shorter-term investments can be made in brokerage accounts that are easier to access when needed. Knowing your goal will give you a good idea of what type of investments you need and what your risk tolerance is.
After you plan your investment strategy, the next step is to open up an investment account. You can usually open a brokerage account online and transfer funds from a bank account.
Once you're ready to invest, the best advice is to “never put all your eggs in one basket.” You may be passionate about a company and want to invest in it for the long run. However, predicting the future is impossible, and taking a risk on only one single company may leave you with lasting regrets.
If you’re considering investing, it’s better to start sooner rather than later because you’ll benefit from time and compound interest.
As we like to say at Teachers, investing now will help set you up for a better tomorrow.
Personal Financial Management Guidance
The unique thing about investing is that there are endless opportunities to learn and grow. Investors can always use financial planning support. If you’re interested in investing and need some help getting started, we offer resources that put you on the right track.
Our Teachers Trust & Financial Services team provides personalized consultations to analyze your current financial situation and your future goals followed by specialized recommendations.
We also offer educational workshops to help with things like investment planning, retirement, annuities, mutual funds, and life insurance. Our managed account service puts a professional investment manager at your service so you can learn how to thrive.
No matter who you are or what your goals are, we’re certain there’s an investment path to help you get where you want to be. We’ll do all that homework; you just reap the rewards.