It’s never too soon to start thinking about investing. Investing means putting your money to work earning more money. Done wisely, it can help you meet your financial goals. They might be buying a home, paying for a college education, enjoying a comfortable retirement, or whatever is important to you.
You don’t have to be wealthy to be an investor. Investing even a small amount has the potential to produce considerable rewards over the long term, especially if you do it regularly.
But investing means you have to make decisions about how much you want to invest and where to invest it. That means you need to know what choices you have and what risks you take when you invest in different ways.
Stocks are ownership shares that investors buy in a corporation.
Cash and cash equivalent investments include money in bank accounts, certificates of deposit (CDs), and US Treasury bills.
Bonds are loans that investors make to corporations, governments, and agencies.
There are three basic investment categories: stocks, bonds, and cash. You can invest directly in any or all of them, or indirectly by buying mutual funds that pool your money with money from other people and then invest it. Stock mutual funds, for example, buy stocks, while money market funds make cash investments designed to maintain the value of each share at $1.
If you want to invest, you have a wealth of opportunities. In the United States alone there are thousands of stocks and mutual funds, and millions of corporate and government bonds to choose from. You can invest in markets around the world, in developed or emerging economies. You can work with one of the thousands of brokerage firms, banks, or financial advisers in the United States. You can even invest directly with the issuer, whether corporation, investment company, or government. And you can invest online using your computer.
CHOOSING THE BEST INVESTMENT
Selecting the best investments for your portfolio depends on your financial goals and your timeframe. For example, a smart investment for a long-term retirement plan may not be a good choice for college savings. In each case, you’re seeking a different balance of three things: liquidity, safety, and return.
How accessible is your money?
If your investment money must be available to cover financial emergencies, you’ll be concerned about liquidity, or how easily it can be converted to cash without loss of value. Money market funds and savings accounts are very liquid. So are investments with short maturity dates like CDs. But if you’re investing for longer-term goals, liquidity is not as much of an issue. What’s more important is increasing the value of your portfolio so that it can provide future income and perhaps assets to leave to family, friends, or charities.
What’s the risk involved?
Investing means taking some risks. To many people, the biggest risk is losing money, so they look for investments they consider safe. Usually that means putting money into bank accounts and US Treasurys. The opposite but equally important risk is that your investments will not provide enough growth or income to offset the impact of inflation, the gradual increase in the cost of living. One solution may be choosing a variety of investments with different levels of risk, to provide both safety and growth.
What can you expect to get back on your investment?
Relatively safe investments often promise a specific, though limited, return. Those that involve more risk offer the opportunity to make — or lose — more money.
You can find many other things to invest in, such as gold, real estate, or private partnerships, if you’re looking for more variety or can afford to take added risks. But most experts agree that the basic three — stocks, bonds, and cash — should be the core of any investment portfolio. High on the list of reasons for that advice are their easy-to-understand structures and the regulatory requirements that govern these standard investments.
In addition, if you need to liquidate your assets quickly, you can sell these investments easily although you may not necessarily sell at a profit. Selling other types of investments may be slower or more difficult.
Securities, by definition, are written proofs of ownership, like stock or bond certificates. But as electronic records replace paper ones, the term survives as a way to describe stocks and bonds, even though it now refers to investments that are secured as computer files.
WAYS TO INVEST
Just as there are different types of investments, there are different types of investment accounts.
You can put as much money as you wish in a taxable account each year and choose from a full menu of investments. You pay tax on any earnings your investments produce and on any gain in value you realize for selling an investment for more than you paid to buy it. Qualifying dividends and long-term capital gains are taxed at a lower rate than your regular income.
You may also have one or more tax-deferred retirement accounts. You can postpone taxes on investment earnings in a tax-deferred account until you withdraw them. In some accounts you can also defer taxes on the amounts you invest. When you do withdraw, the tax that’s due is figured at the same rate as you pay on other income. There are some limitations: The annual investment is often capped, and in some plans the investment menu may be limited. You may also owe a penalty if you withdraw early, which is usually before 59½.
Tax-exempt accounts are designed to help you pay for specific goals, such as retirement or education. If you follow the rules of the specific account you’re using, no federal tax is due on any earnings in the account, either as they accumulate or when you withdraw. You do pay tax on the amounts you invest, and there may be limits on the amounts you can invest each year.