Contents
What’s an Investment?
Risk and Risk Tolerance
Asset Allocation and Diversification
Should You Be Investing?
How to Get Started Investing
How to Invest in Stocks
How to Invest in Bonds
How to Invest in Mutual Funds
How to Invest in ETFs
Investing and Taxes
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- Learn the basics of risk, return, compounding, and diversification
- Choose investments that are the right risk level for you
- Recognize the pros and cons of stocks, bonds, mutual funds, and ETFs
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What’s an Investment?
An investment is an asset—such as a stock or a bond—
that an investor buys in order to build wealth over time. The value of an investment can rise or fall based on a number of factors, from supply and demand to the state of the overall economy. Investors buy investments with the intention of selling them later for a higher price.
Some investments, such as real estate property, precious metals, fine art, and collectibles, are assets that the owner possesses and, in many cases, can physically use. The types of investments that this guide covers are investment products—nonphysical assets such as stocks and bonds, which for most investors are more convenient and easier to sell than physical assets such as real estate.
Why Invest?
Investing is the most effective way to build your wealth at rates that exceed those of inflation, the economic phenomenon that causes the prices of goods and services to rise over time. Inflation doesn’t change the amount of money you have, but it does erode your purchasing power, the amount of goods and services you can buy with your money. Since 1925 or so, inflation in the United States has averaged 3% per year, while the average savings account has paid an interest rate of about 2%. During the same period of time, the return, or the annual rate of growth, of U.S. stocks has averaged about 10%. If those trends continue:
- Due to inflation, in 30 years you’d need $2,427.26 to equal the purchasing power of $1,000 today.
- $1,000 kept in a savings account would grow to $1,811.36 after 30 years, trailing the effect of inflation.
- $1,000 invested in stocks today would grow to $17,449.40 over 30 years, easily allowing you to outpace the effects of inflation over that time period.
Types of Investments
This guide covers four major investment products:
- Stocks: Investments in a specific publicly traded corporation, such as Google or PepsiCo. Publicly traded companies issue shares of their stock to the general public. Each share represents a fractional percentage of ownership in the company.
- Bonds: Loans that investors make to corporations and governments. The corporation or government then makes fixed interest payments to the bond investor over a set period of time, called a term. At the end of the term, the investor also gets back the original investment amount, called the principal.
- Mutual funds: Investments that pool money from many investors and invest it in a specific set of stocks or bonds. A type of mutual fund called an index fund attempts to mimic the performance of a specific market index, a group of investments that serves as a benchmark for the performance of other investments. For instance, an S&P 500 index fund tries to replicate the performance of the S&P 500, a well-known index of 500 of the most widely held U.S. stocks.
- Exchange traded funds (ETFs): ETF are funds that track indexes (as index mutual funds do) but are bought and sold like stocks.
How Investing Builds Wealth
Investing builds wealth in two main ways:
- Growth: Growth investors aim to buy investments that will increase in value over time, so they can then sell the investments later for a higher price.
- Income: Income investors aim to buy investments that provide regular cash payments. These payments can take several forms. For instance, some stocks pay dividends, a portion of a company’s earnings paid directly to the company’s shareholders. Most bonds pay interest, periodic cash payments that investors receive in exchange for buying the bond.
Some investments provide only growth; others provide only income. Some, such as dividend-paying stocks, provide a mixture of growth and income.
Types of Investing Markets
Investment products are traded—bought and sold—on exchanges, also called markets. For instance, stocks are sold on various stock exchanges, such as the New York Stock Exchange (NYSE), the NASDAQ, and the American Stock Exchange (AMEX). Bonds are also sold on various exchanges; ETFs are generally sold on the AMEX.
Though professional traders and market makers at the exchanges facilitate some of the pricing and trading of investments, a substantial portion of trading occurs electronically. The U.S. government’s Securities and Exchange Commission (SEC) enforces strict legal standards that govern the investment products traded on each exchange.
How Investors Buy Investment Products
As an individual investor, you don’t buy and sell investment products directly on the various exchanges. Instead, you buy them through middlemen, such as brokers, brokerage houses, and other financial professionals who are called registered representatives. First, you set up an investment account and place cash in it. Then you can place orders through a broker or brokerage house to buy or sell specific investments. When these orders are executed (filled or completed), the cash in your investment account converts into a certain amount of the investment product bought, and investments sold convert back into cash in the account. As investments in the account rise or fall in value, the account balance adjusts accordingly, usually once per day.
Names and Symbols of Investment Products
All investment products have a given name and are represented by a symbol.
- The symbols used to represent stocks, mutual funds, and ETFs are called ticker symbols and consist of 1–5 letters. For instance, the ticker symbol for Starbucks stock is SBUX.
- The symbols used to represent bonds are called CUSIPs and usually consist of nine numbers and letters. For example, a bond issued recently by the New York City government had a CUSIP of 649660JR9. Stocks also have nine-digit CUSIPs, but these are rarely used since ticker symbols are simpler to remember.
Shares and Amounts of Investment Products
Some investments, such as bonds and mutual funds, are bought and sold in dollar amounts. Others, such as stocks and ETFs, have a specific share price that changes constantly as the supply and demand for the shares shifts throughout the trading day. Mutual funds also have a specific share price, but it changes only once per trading day—
after the markets close and the value of all the mutual fund’s holdings is recalculated.
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