New to Investing?

Investing can offer opportunities to help you build wealth and reach your long-term financial goals. However, investing involves risk, and investors should be aware of some important investment basics before getting started.

If you’re new to investing, here are five key points to keep in mind (with links to additional resources to learn more).

1. Investing involves risk

Investing involves taking risks. Generally, when you invest, you take cash to buy securities or other investments with the hope of earning a return over time.

But investments can fluctuate in value, which means you could lose money or make money. This fluctuation or volatility in the market makes investing riskier than keeping your money in a savings account or other traditional deposit accounts, where you may earn interest on your deposits and your money is protected by federal deposit insurance up to certain dollar limits.

So, why do people invest?

Because while there’s potential for losses with investing, there’s also the possibility for gains. Historically, over long periods, financial markets have generated higher returns than interest earned in bank accounts.

In other words, investing offers an opportunity for you to potentially earn a better return than what you could get through your savings accounts. And this matters because while your money may earn interest in a bank account, inflation can gradually erode the value of your savings. On the other hand, investing your money gives you a chance to keep up with the pace of inflation, protecting the value of your money as the cost of living increases over time.

Good to know: While investing provides the opportunity for greater returns, it also introduces the risk of market fluctuation. An important thing to keep in mind is that periods of market turmoil are normal and expected.

A large part of investing is about figuring out how to properly balance risk and reward based on your willingness to take on risk, your capacity or ability to afford losses, and the time horizon over which you are comfortable having your assets invested.

2. Bonds, stocks and ETFs are the basic building blocks of many investment portfolios

There are many different types of investment products out there for investors to consider. The three common ones we’ll go over are bonds, stocks and ETFs, which are the basic building blocks of many investment portfolios.

Bonds. A bond is a loan from an investor to an organization or entity (like a corporation or the government) that’s looking to raise money to help pay for certain projects – think of it as an IOU. Bonds are a type of fixed income investment because they typically provide a predictable rate of income in the form of interest payments.

Stocks. Stocks are also sometimes referred to as “equities.” When you purchase a stock, you own a piece or a share of a company. In general, while stocks are higher in risk than bonds, they also have higher expected long-term returns.

Exchange-Traded Funds (ETFs). An ETF is a type of financial product made up of a basket of assets like stocks or bonds. For example, an ETF can contain a variety of bonds (bond ETF) or stocks (stock ETF). ETFs are traded like common stocks on an exchange, and their prices fluctuate during the day while they’re bought and sold. When you own shares of an ETF, you own a stake in a fund that may hold hundreds or even thousands of individual stocks or bonds.

Now, let’s put this information in context: Given that stocks are higher risk than bonds, individuals who won’t need to tap into their investments for a long time (for instance, people who are early in their careers and are saving for retirement) might want to consider the potential benefits of putting most of their portfolio in stocks (or stock ETFs). The rationale is that these investors have time to weather the stock market’s fluctuations in hopes of earning higher long-term returns than those of bonds.

Individuals who have a shorter time horizon - say, people who are approaching retirement - may want to hold fewer dollars in stocks and more in bonds. That’s because generally, bonds are less volatile than stocks. And for investors who may not have as much time or flexibility to weather the ups and downs of the market, bonds could offer a greater degree of stability than stocks.

3. Diversification can help manage investment risks

As we mentioned, investing involves risk. A key to success is learning how to manage that risk in a smart way.

One common strategy is diversification. Broadly speaking, this is where you divide up your money across different investments to help spread out your investment risks. For example, you can diversify your holdings between different asset categories and within a particular asset category.

While it might sound like a basic strategy, it’s a powerful one. By investing in a mix of assets, like stocks and bonds, if a certain class of assets isn’t doing well, other assets in your portfolio might be able to help offset the losses with gains. In other words, diversification can help limit your exposure to the risks of any one particular type of investment.

You may know the saying: Don’t put all your eggs in one basket – that’s the basic idea behind diversification.

Asset allocation is another strategy that’s closely related to diversification. Specifically, this is how you divide up your portfolio among different assets, such as stocks and bonds. How you go about allocating your assets depends largely on your personal goals, time horizon and risk tolerance.

4. Your time horizon and risk tolerance are key factors to consider

Time horizon simply refers to the amount of time you’re planning on staying invested. This typically depends on your age and financial goals.

People who won’t need to tap into their investments for a while – for instance, those who are a long way from retirement – would generally have a longer time horizon than, say, people who are investing money for a home down payment that’s five years down the road.

Another question to ask yourself when you open an investment account is what’s your risk tolerance? Put another way, how much risk can you afford and how much risk are you willing to take on in your investments?

Risk tolerance varies from person to person, so it’s important to understand your personal capacity and willingness to take on certain risks when investing.

Both your time horizon and risk tolerance help determine the appropriate mix of investments in your portfolio.

For instance, near-retirees are generally more risk-averse than someone who is still decades away from retirement, so their investment portfolio might hold assets such as bonds or bond ETFs, which, depending on their asset class, can be lower risk and less volatile than stocks or stock ETFs.

On the other hand, investors with a long time horizon may have a higher tolerance for risk, so they may choose to hold more stocks (or stock ETFs) than bonds (or bond ETFs) in their portfolio. The rationale is that investors with a longer time horizon have more time to weather the stock market’s fluctuations in hopes of earning higher returns over the long term.

5. Income from your investments may be taxable

There are different tax regulations and rates for different types of investment income. Consult IRS Publication 550 or a tax professional for more information on which rules may apply to you.

Each year, your investment firm or account custodian will send you relevant tax information on your holdings to help you file your taxes.