What Is Investing?

What Is Investing?

In basic terms, investing means buying financial assets with the goal that they'll increase in value over time. The term for this is appreciation, or the rise in value of an asset. Assets can be financial, such as stocks and bonds. They can also be items with monetary value, like real estate, jewelry and other property.

All investing involves some risk. On one end of the spectrum, you have assets like stocks, which are volatile and swing up and down in price constantly. On the other end of the spectrum you have bonds, which are conservative investments with fairly reliable, low returns over a fixed period of time.

How Does Investing Work?

When you invest in something, you buy it with the goal that it will appreciate in value over time. At that point, you can either continue to hold the asset or cash out your investment by selling it.

You may have a notion that investing is a high-stakes effort to buy and sell stocks at a fast pace to time the market and get rich quick. In reality, the best investment strategy is usually more boring than that.

When you're investing for a long-term goal, such as retirement, it's often wise to expose yourself to a measured amount of risk by investing in a diverse mix of assets across economic sectors and industries. Depending on your age and how long you have to go until retirement, this can take different forms, particularly when it comes to active and passive investing.

With active investing, the goal is to beat the market by actively buying and selling assets. It's typically riskier and has the potential for higher earnings and deeper losses. A passive investment strategy, on the other hand, is a buy-and-hold strategy that aims to match the market—managing risk while benefiting from long-term appreciation. The S&P 500, a stock market index that tracks the performance of 500 of the largest public companies in the U.S., is often used as a gauge of market growth. Money invested in the S&P has seen average annual returns of about 10% since 1928.

Investing vs. Saving

Saving and investing both involve setting aside money for the future. The key difference between saving money and investing money is risk. When you're saving for retirement, you want to expose yourself to some level of risk; you're prepared to ride out the highs and lows of the market in the hopes of seeing good long-term returns.

But what about money you could need at any moment, like your emergency fund? You don't want to risk tying it up in investments, only to have to take a loss if you need to use it. For that reason, it's better to keep these savings somewhere liquid and safe, like a high-yield savings account or money market account.

Types of Investments

While there are several asset classes and commodities you can invest in, these four main types of investment are among the most common:

• Stocks: A stock is an asset that represents shares of ownership in a publicly traded company. These tend to be volatile assets that go up and down in price constantly, and investors buy them because of their potential for high returns.
• Bonds: Bonds are a type of loan from an investor to a borrower, who may be a government entity or a company. They're typically low-risk with set investment periods and set returns.
• Mutual funds: Mutual funds are investment funds that allow you to pool your money with other investors to invest widely in stocks, bonds and other assets. They may be actively managed by an investment professional or passively managed as index funds that track specific economic indexes, such as the S&P 500.
• Exchange-traded funds (ETFs): ETFs are a type of pooled investment, similar to mutual funds. But unlike mutual funds, ETFs are traded through stock exchanges.

How to Start Investing

Regardless of where you are in your financial journey, you can start investing toward retirement or other long- and short-term goals now. Here are steps to get started.

1. Decide What Your Investing Goals Are

Getting clear on your goals for the money upfront helps you decide how much risk you're willing to take on. Then, you can pick the right investments accordingly. For example, say you're saving for the short-term goal of buying a home in the next five years. In that case, you might choose to save your down payment fund in lower-risk assets like bonds and certificates of deposit (CDs).

Your first goal as an investor may be saving for retirement. If that's your goal, you can invest the money using retirement accounts—see the next step.

2. Choose an Account Type

Once you know what you're investing for, you can pick an investing account that works best for your goals.

Tax-Advantaged Accounts

Tax-advantaged accounts are investment accounts that reward you for saving by giving you certain tax benefits. The tradeoff is that these accounts come with specific rules for when you can access your savings, and what you can use the funds for.

• Retirement accounts such as 401(k)s and individual retirement accounts (IRAs) let you defer taxes on income that you save for retirement.
• A 529 plan is designed to help you save for future educational costs—for yourself or for a beneficiary (such as your child).
• A health savings account (HSA) lets you save for qualified medical expenses, and you can invest some or all of the money in your HSA. Once you hit 65 years old, you can use the money in your account for anything, including non-medical costs.

Standard Brokerage Accounts

For other types of investing goals, you can open a standard brokerage account online. A brokerage account lets you invest in a range of assets, such as stocks, bonds and mutual funds. Unlike with a tax-advantaged retirement account, you sell your assets and cash out on your funds whenever you like without penalty. Keep in mind, though, that if you sell investments or earn gains from dividends, you'll need to pay taxes on those earnings.

Brokerage accounts allow you to choose investments on your own, work with a financial advisor or stockbroker, or use a robo-advisor to take more of the work off your shoulders. Robo-advisors automatically choose investments and balance your portfolio based on your investing timeline and risk tolerance. They are significantly less expensive than working with an investment advisor, though they don't have the human touch an advisor can provide. Keep in mind that investment advisors and stockbrokers often require minimum investment amounts to utilize their services.

3. Open Your Account

Now you're ready to open and fund your investment account.

If your workplace offers a 401(k) plan, you can open your account by talking to your HR department. If you don't have access to a 401(k), you can open up an IRA to start investing for retirement on your own.

Whether you're opening an IRA or a standard brokerage account, you'll need to shop around for a brokerage to invest through. Then you can usually open your account by simply following the on-screen prompts to complete the application process.

4. Fund Your Account

How do you know how much money you should invest? While there isn't one set number you need to stick with, there are metrics you can use to help guide you.

If you're investing for retirement with a 401(k), you should aim to contribute at least enough to exhaust any employer match that's available to you. A 401(k) is an especially convenient way to invest because you can set up payroll deductions to take contributions directly out of your pay.

Whether you're investing with a 401(k), IRA or another type of account, experts generally recommend aiming to invest around 15% of your pretax income each month. If you're investing with an IRA or a standard brokerage account, you can set up automatic transfers from your bank account into your investment account each payday.

5. Buy Investments

When it comes to buying assets, one of the most important things to keep in mind is diversification. Diversification is a way of putting together your portfolio so that your money is spread broadly across a range of investment vehicles.

Researching individual stocks and bonds is time consuming. Instead, you can buy mutual funds or ETFs that invest widely in a basket of assets based on certain criteria. For example, you could invest in an index fund that mirrors the performance of a specific economic index, such as the S&P 500. You can also enlist the help of a stockbroker or robo-advisor.

Why Should You Invest?

Investing is important because it can help you grow your money over time in order to reach large, long-term goals like retirement or funding a future education. While putting some of each paycheck into a savings account can help you amass a sizable sum of cash, keeping that money in savings won't allow you to earn much in interest.

On the other hand, investing that money gives you the opportunity to grow the value of your savings, potentially outpace the rate of inflation, and increase your income through dividends and compound interest. Overall, investing is an important piece of long-term wealth building.

Make a Plan for Your Financial Future

The average investor can get pretty far investing for retirement through a 401(k) or an IRA. While investing widely in managed or index funds may not be the most exciting strategy, it's a tried-and-true approach to passive wealth building.

If you need help devising a strategy for balancing long-term investing strategy with the rest of your financial life, consider financial advising. A financial advisor can help you personalize your financial plan to suit your individual needs, which can help you feel more confident as you set and reach new goals.