A guide to understanding investments

Sure, investing can be a complex and confusing topic— but learning how to invest doesn’t have to be complicated! In this guide, we’ll break down the essentials of investing so that you can feel confident about making investment decisions about your money. So stick with us, and you’ll be on your way to understanding investments like the pros. 

What is an investment?  

An investment is an asset or item purchased to generate income or appreciate (grow) in value over time. 

There are a variety of investments, including stocks, bonds, real estate, and collectibles. Many people invest in different investments to diversify their portfolios and reduce risk.  

In other words, it’s best not to put all your eggs in one basket when investing. That way, if one area of your investment portfolio goes belly up, you can balance out your losses with assets still growing in value and hopefully recover your losses over time.  

Why do people invest?  

Imagine you’re presented with a choice. You could either claim $5,000 right now and spend it all in one day, partying like a rock star (tempting, right? We get it!) 

Or, you could have $1,000 deposited into a savings account with a 5% interest rate compounded monthly for ten years and deposit $100 extra on top of that every month. (Okay, it’s a mouthful to explain, and it seems so much more complicated than spending $5k having the best day ever). 

So which do you choose?  

If you chose the first option, you cheated yourself out of thousands of extra dollars!  

After just one year, your modest sum of $1,000 would have more than doubled to $2,279.04, thanks to your regular contributions and the magic of compounding monthly interest (alright, it’s not really magic—it’s math, and there’s a formula behind it).  

After five years, your account would be worth a whopping $8,083.96. And after the full ten, when you’re allowed to withdraw it, you’d be looking at $17,175.23! 

What if you decided to leave it in there for ten more years? You’d have $43,816.00! All thanks to the magic (but not really magic) of investing.  

More about compound investments

You can even use this nifty compound interest calculator to do all the heavy lifting if you want to experiment with some investment ideas. This same concept applies to rates of return, which we’ll cover as we get into different investments like stocks. 

Everyone has an end goal when it comes to making smart investments. Some people want to buy a house, pay for college, and save for retirement—depending on where you are at this stage in life, there’s something that investing can help you afford. 

Studies have revealed that setting short-term and long-term financial goals makes people more likely to stick to their financial plans over time. So reflect often on what you hope to achieve with your finances—knowing what you’re aiming for can set you up to succeed. 

Understanding investments 

Once you understand how investing can benefit you, you may be wondering how the heck you can get started. The answer is: it depends! Each person’s needs are different, and a wide array of asset classes offer unique benefits that you should carefully consider.  

By understanding the different types of investments, you can start strategizing an investment plan that caters to your specific needs and financial goals. First, let’s look at the most common types of investments. 

Types of investments: asset classes 

When it comes to investing, there are several different asset classes that you can choose from. Each asset class has its own risk and return characteristics, so selecting the right mix of asset classes for your portfolio is essential.  

Stocks 

Stocks represent ownership in a company and can provide the potential for capital gains as the company grows. Investing in individual stocks can be risky but also has the potential to be lucrative depending on the consistency with which you invest and the rate of return that comes with your investment.  

Bonds 

When you purchase a bond, you essentially lend money to a government, corporation, or other organization. In return for your loan, the entity promises to pay you periodic interest payments and return your principal when the bond matures. As a result, bonds offer stability and are typically less volatile than stocks. 

Mutual funds  

A mutual fund pools money from many different investors and then uses that money to buy a portfolio of stocks, bonds, or other assets. Investing in a mutual fund offers diversification, a way to hedge against risk. In addition, mutual funds are managed by professional money managers, which further reduces the risk for individual investors. 

Exchange-traded funds 

An exchange-traded fund (ETF) is a type of investment fund that trades on a stock exchange. ETFs are similar to index funds, but they’re more flexible – investors buy and sell ETFs throughout the day and often have lower expense ratios than traditional index funds.  

ETFs are an attractive option for investors looking to minimize costs. ETFs also offer greater diversity than index funds.  

Certificates of deposit (CDs)  

Certificates of deposit, or CDs, are a type of savings account offered by banks and credit unions that pay a fixed interest rate over a set period. CDs typically have a higher interest rate than a regular savings account, but there’s usually a penalty for early withdrawal. A CD is an excellent option if you want to grow your savings and don’t need immediate access to your money. 

Real estate 

Real estate investing can be a great way to earn passive income and build long-term wealth. First, however, you’ll need to know how to find good investment properties, finance your purchase, and manage your rental property once you own it. You’ll also need to be aware of the potential risks involved in real estate investing, such as vacancy rates and tenant turnover. 

Hedge funds  

Hedge funds are investment vehicles that pool together capital from accredited investors and use various strategies to generate returns. Hedge funds are typically more aggressive than traditional investments and employ leverage to boost returns. While hedge funds can offer the potential for high returns, they also come with a higher level of risk. 

Private equity funds 

A private equity fund is a type of investment fund that pools the money of many experienced investors to invest in companies that are not publicly traded. Private equity funds typically invest in businesses undergoing a period of change, such as a new management team, a merger, or an expansion. 

Commodities 

Commodities investing involves buying and selling goods that are considered essential to the economy, such as metals, energy resources, and agricultural products.  

Because commodities are essential to the economy, their prices are often more stable than other types of investments, but anything that disrupts international trade can cause market volatility. So it’s critical to research the commodity market before investing in it. 

Cryptocurrencies 

Cryptocurrency investing is buying and holding digital currencies, such as Bitcoin, in the hope of earning a profit on your investment. Cryptocurrencies are digital tokens that use blockchain technology to secure their transactions and control the creation of new units. 

Cryptocurrency investing is risky, as prices can be volatile and susceptible to manipulation. However, some believe cryptocurrencies have the potential to become more stable over time. 

Individual retirement account (IRA) 

An individual retirement account, or IRA, is a way to save for retirement. There are two main types of IRAs: traditional and Roth. With a traditional IRA, you contribute pre-tax dollars and pay taxes on withdrawals in retirement.  

A Roth IRA works in reverse: you contribute post-tax dollars, but withdrawals are tax-free in retirement. Both IRAs have annual contribution limits, and you may be eligible for a tax deduction if you meet specific criteria. 

401(k)  

A 401k is a retirement savings plan sponsored by an employer. It allows employees to save and invest for their retirement on a tax-deferred basis. Employers may also make matching or non-elective contributions to their employees’ 401k accounts.  

Employees who participate in a 401k plan can typically choose to have their contributions deducted from their paycheck each pay period and invested in various investment options, including stocks, bonds, and mutual funds.  

403(b) 

A 403(b) plan is a retirement savings account available to employees of public schools and certain tax-exempt organizations. Like a 401(k) plan, a 403(b) plan allows employees to defer a portion of their salary into an investment account. You can then use the money in the account to purchase annuities, mutual funds, or other investments. 

Educational savings account (ESA)  

An educational savings account, or ESA, is a tax-advantaged investment account that you can use to pay for qualified educational expenses. The money in the account grows tax-free, and withdrawals are tax-free as long as they are used for qualified expenses. 

529  

A 529 investing account is a tax-advantaged savings account designed to encourage saving for future college costs. Anyone can open a 529 account, and the account owner controls how the funds are used.  

You can use the money in a 529 account to pay for tuition, fees, and other qualified expenses at any eligible college or university. States sponsor 529 accounts, and each state offers its unique benefits.

How to start investing 

With so many investment options, it can be tough to know where to start. But the most important thing is to start somewhere. The sooner you begin investing, the sooner you’ll start reaping the rewards. 

To get started, take a look at your overall financial picture. What are your goals? How much risk are you willing to take on? Once you have a better idea of what you’re looking for, you’ll have a more straightforward path. 

Save up some money 

One of the first things you need to do is save money to invest. This doesn’t mean you need to have thousands of dollars just sitting in your bank account—even a few hundred dollars can get you started.  

Once you have some money saved, you can open up an account with an online broker. There are numerous brokerages out there, so it’s essential to do your research and find one that best suits your needs. 

Make a plan to fit your goals

The most important thing is to have a plan. Figure out your goals and how much risk you’re comfortable with. Once you know that, you can start looking at different investment options. Starting out, you might want to consider something like a savings account or a CD.  

These low-risk options won’t make you a lot of money but can help you get started. If you’re willing to take on more risk, you might want to look into stocks or mutual funds. These can be more volatile but also have the potential to yield higher returns.  

With a little bit of planning, investing can be a great way to reach your financial goals. 

Do your research and know your risks 

Remember that all investment involves a certain amount of risk, but you can minimize your risk with a diversified portfolio of low- or medium-yield long-term investments. 

As you build your portfolio, continue researching your options and expanding your market knowledge.  

Be cautious and consistent

Time is just as important as money. So be patient and don’t expect an overnight fortune. Instead, aim to maximize the amount of time you invest and don’t make rash decisions based on natural market fluctuations. Medium and low-yield investments are the key to success over a long period. 

As you continue investing throughout your life, you’ll have a considerable amount of capital built up by the time you retire, so be consistent about financial planning. You may even consider hiring a financial advisor to help you.  

What investments do well during recessions and inflation?  

There’s no guaranteed way to make money in the stock market, but certain types of investments tend to do well during periods of recession and inflation.  

One approach focuses on companies that produce essential goods and services, such as food, healthcare, and utilities. These businesses tend to be less affected by economic downturns than companies in other sectors.  

Another option is to invest in companies with a strong competitive advantage. These businesses are better able to weather difficult times and emerge stronger than their rivals.  

Finally, you could consider investing in government bonds. These provide a fixed return, which can be helpful in an inflationary environment.  

Ultimately, there’s no surefire way to protect your portfolio from all economic risks, but diversifying your holdings across different asset classes can help to reduce volatility.