5 Things Every Investor Should Know

What we’ll cover:

• Stocks, bonds, ETFs, and mutual funds are the basic building blocks of many investment portfolios.
• Investing involves risk, and it’s important to focus on the long term.
• Diversification can help manage investment risk.
• How you choose to invest depends on your goals, time horizon, and risk tolerance.
• Different types of investment income are taxed differently.

Investing can offer opportunities to help you build wealth and reach your financial goals. If you have a retirement or brokerage account, you’re probably already familiar with the basics.

But no matter where you are in your financial journey, it’s a good idea to review the fundamentals of investing from time to time, so that you can feel confident as an investor and make informed decisions about your money.

Here are five points to keep in mind.

1. Stocks, bonds, ETFs, and mutual funds are the basic building blocks of many investment portfolios

The number of investment choices out there can be overwhelming, especially if you’re still somewhat new to investing. But stocks, bonds, ETFs, and mutual funds are the basic building blocks of many investment portfolios. Do you know the differences between these assets? Let’s do a quick review. 

• Stocks. When you purchase a stock, you own a piece or a “share” of a company. Stocks are also sometimes referred to as “equities.” When the company makes a profit, they typically distribute dividends to their stockholders. Dividend payments may come in the form of cash or additional shares.
• 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.
• Exchange-Traded Funds (ETFs). An ETF is a type of financial product that’s made up of a large collection of stocks, bonds, or other types of securities. For example, an ETF can contain a variety of bonds (bond ETF), stocks (stock ETF), or a mix of both (multi-assets ETFs). 
• Money Market Mutual Funds. A mutual fund is where investors pool their money together to invest in a portfolio of securities. A money market mutual fund typically invests in high-quality (in other words, low risk of default) debt instruments, such as certificates of deposit (CDs) and U.S. Treasury notes with short maturity dates. 

2. Investing involves risk, and it’s important to focus on the long term

Some people might feel unsure about investing in the financial markets because it’s generally riskier than keeping your money in deposit accounts like a savings account or CD where you can earn interest.

And that’s understandable. After all, investing involves risk, and no one likes the idea of potentially losing money to a bad investment or market fluctuations. So why do people invest at all?

That’s because while there’s potential for losses with investments, there’s also the possibility that you’ll see some nice gains. A large part of investing is about figuring out how to properly balance risk and reward and which risk management strategies make the most sense for you.

Sure, watching financial markets go up and down can be nerve-racking, but keep in mind that periods of market turmoil are normal and expected. That’s why it’s important to take the long view with investing and not let short-term market volatility distract you from your long-term financial goals (e.g., retirement, wealth building, etc.). Generally speaking, staying invested for the long haul puts you in a good position to reach your goals.

Learn more: New to Investing

3. Diversification can help you manage investment risks

When it comes to deciding where to invest your hard-earned money, it would be great if we could invest in a “sure thing.” But there’s no such thing as a “safe” investment, so it’s important to learn how to manage risks in a smart way.

One common risk management strategy that you’re probably familiar with is diversification. This is where you divide up your money across different types of investments or assets to help spread out your investment risks. You may know the saying: Don’t put all your eggs in one basket – that’s the basic idea behind diversification.

While it might sound like a basic strategy, it’s a powerful one. By investing in a mix of assets, like bonds, stocks, and ETFs, if a certain class of assets isn’t doing well, other assets in your portfolio might be able to help offset some of the losses.

In other words, diversification can help limit your exposure to the risks of any one particular type of investment. Think about it this way – if you only invest in the stocks of one company, you risk losing your entire investment if the company goes under.

An important note here: While diversification can help minimize risk, it can’t eliminate all risks. Just as diversification doesn’t guarantee gains, it also doesn’t completely shield you from losses. There’s no such thing as a perfectly safe investment, and if anyone tries to tell you otherwise, be wary.

Learn more: What Does Diversification Mean Anyway?

4. How you choose to invest depends on your time horizon and risk tolerance 

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

Time horizon is simply the amount of time you’re planning on staying invested. Your time horizon typically depends on your age, investment strategies, 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.

If you already have a time horizon in mind, another question you should ask yourself is how much risk are you willing and able to take on in your investments?  In other words, what’s your risk tolerance?

Risk tolerance varies from person to person, so it’s important to understand your personal level of comfort when it comes to investing your money.

For instance, near-retirees are likely more risk-averse than someone who is still decades away from retirement. This is because near-retirees may need to start withdrawing from their retirement account soon, so their investment portfolio might hold more low-risk or stable assets such as bonds.

On the other hand, an investor who is farther out from retirement and has a higher tolerance for risk may choose to hold more stocks than bonds in their portfolio. The rationale is that investors with a longer time horizon would have more time to weather the stock market’s short-term fluctuations in hopes of earning higher returns over the long term.

Now this isn’t to say bonds are better than stocks or vice versa – both have a role to play in your portfolio. How you split your money between bonds and stocks (or other types of assets) will depend on your financial goals, time horizon, and risk tolerance.

5. Investment income may be taxable

Be aware that different types of investment income are taxed differently. As an investor, it’s important to understand that there are tax management strategies you could use to help minimize your tax bill. When it comes to tax planning discussions, it’s best to work with a financial or tax advisor to find an appropriate strategy for your goals.

Good to know: Each year your investment firm or account provider will send you any relevant tax information about your holdings so that you can file your taxes. Keep in mind that investment taxes can be complex. Don’t hesitate to ask for help from a tax professional to understand which rules may apply to you.

Learn More: Investing and Taxes: Some Basics to Know

Recap

Whether you’re a long-time investor or a relatively newcomer, it’s important to understand your investment goals. What are you investing for? How long do you want to stay invested, and how much risk are you willing and able to undertake? These are just a few basic questions you should ask yourself periodically as an investor.

Your answers could help you choose an investment plan that’s best aligned with your needs. And if you have questions, enlist the help of a professional advisor who can go over what we’ve covered here in more detail and help you to invest confidently for your future.