07 Investing Basics

Goals and time horizons

Investing means putting money into assets with the goal of earning a return over time. Unlike a bank deposit, an investment can lose value. Investing is most useful when connected to a clear goal, such as retirement, and to a plan for how much risk, cost, and short-term fluctuation you can tolerate.

A Time horizon is how long you expect to invest before using the money. Money needed soon generally belongs in safer, more accessible savings. A longer horizon may allow more time to withstand market ups and downs, but no investment mix is right for everyone, and a longer horizon does not make an investment safe.

Returns and investment risks

Return is the gain or loss on an investment, including price changes and any income it pays. Returns may come from price appreciation, interest, or dividends. Risk is the possibility that the result will differ from what you expect. Investments with higher potential returns generally involve greater risk, but taking more risk does not guarantee a higher return.

When earnings remain invested, they can themselves earn returns over time through Compounding. This can support long-term growth, but it cannot ensure a profit.

Forms of risk

• Market risk: The possibility that prices will fall.

• Inflation risk: The possibility that money's purchasing power will decline.

• Liquidity risk: The possibility that an investment will be difficult or costly to sell when cash is needed.

• Credit risk: For bonds, the possibility that the issuer will not repay.

• Interest-rate risk: Bond prices can fall when market interest rates rise.

Allocation and diversification

Asset allocation is how investments are divided among broad categories, often stocks, bonds, and cash or cash-like holdings. Diversification means spreading investments across and within those categories. Holding different kinds of investments can reduce the harm that one company, industry, or asset class has on the whole portfolio, but it cannot eliminate market risk or guarantee against losses.

Owning shares in one company concentrates the outcome in that company. A broad fund holding many companies spreads that company-specific risk across more investments. However, a fund focused on one industry—or one that owns many of the same securities as another fund—may still leave an investor concentrated.

The mix that fits an investor depends partly on the goal's time horizon and the investor's ability and willingness to tolerate losses. Over time, investments can drift from their intended mix; Rebalancing means adjusting holdings to bring them back toward the plan.

Common investment types

Different investment types have different characteristics and risks. A fund's risk depends on what it owns, so its name alone does not show whether it is broadly diversified.

• Stocks: Shares represent ownership in a company. Investors may benefit if the share price rises or the company pays dividends, but prices can fall sharply and a company can fail.

• Bonds: Bonds are loans to governments or companies. The issuer generally promises interest payments and repayment of principal, but it may fail to pay. Bond prices can also change with interest rates and credit conditions.

• Mutual funds and exchange-traded funds (ETFs): These funds pool investors' money to hold a portfolio of assets, which may include stocks, bonds, or both. Mutual funds generally transact at a price calculated once each business day; ETF shares trade on an exchange during the day.

• Index funds: These mutual funds or ETFs aim to track a market index and provide a way to invest in a basket of securities. They still carry the risks of their holdings. Fees and expenses reduce the return that remains for investors.

• Cash equivalents: Savings deposits, money market funds, and short-term government securities are examples. They are generally more stable and accessible than stocks, but their returns may not keep pace with inflation. Money market funds are investments, not bank deposits, and are not FDIC-insured.

Retirement accounts

A retirement account, such as an employer-sponsored plan or an individual retirement account (IRA), is an account type, not an investment itself. It may offer tax advantages, but the money inside it must still be invested or held in cash. Tax rules and plan options vary, so check current details with the plan or an authoritative tax source.

Building a beginner plan

1. Set a goal and timeline. Decide what the money is for and when you expect to need it.

2. Build financial resilience first. Keep accessible savings for emergencies and consider paying down expensive high-interest debt before taking substantial investment risk. Avoid investing money you may need immediately.

3. Learn your account and its costs. Compare account fees, fund expense ratios, trading costs, and any employer plan match. Read a fund's summary or prospectus to understand its holdings, risks, and fees.

4. Choose a diversified mix you can stick with. A broad, low-cost index fund or a diversified target-date fund may simplify investing for some beginners, but neither is guaranteed to profit or appropriate for everyone. Target-date funds differ in their investment mix and fees; review what the fund holds and how its mix changes over time.

5. Contribute regularly and review periodically. Dollar-cost averaging means investing equal amounts at regular intervals. It can make contributions consistent, but it does not prevent losses or guarantee a better result than investing a lump sum. Check occasionally whether your plan still matches your goal; frequent reactions to market news can undermine a long-term strategy.

Be cautious of promises of high, certain returns, pressure to act immediately, and investments you cannot explain. Research investments and verify the registration and background of any investment professional before handing over money.