Investing can be a great tool for saving if you understand a few key points.
Spend an hour watching one of the Wall Street or stock market TV channels and you’ll think investing is crazy complicated. That confusion can keep you from taking advantage of investing as a long-term way to prepare for big goals. In fact, the basics you need to get started are pretty simple. Here are four fundamentals.
- Understand the terms. Companies sell slices of ownership in the form of shares of stock, the values of which go up or down over time depending on the success of the company. You make money with stocks when you sell after the price has gone up, and sometimes also in the form of dividends, which are regular payments where companies give a little of their earnings to shareholders. Companies and governments can also borrow money using bonds, for which they agree to pay interest as they repay the debt. That interest is paid to the bond-holder (that’s you!) and, unlike stocks, the amount you make is more fixed over time.
- Invest broadly through funds. Individual stocks can grow or fall in value or even become worthless, so many investment companies package stocks together to try to smooth out the risk in what are called mutual funds. Funds might focus on an industry, geographic region or company size. You buy a share of a fund just as you do a stock and make or lose money as the fund’s value rises or falls. Investment companies charge fees for managing mutual funds. Index funds and exchange-traded funds (ETFs) are similar but typically have much lower fees because they don’t depend on experts picking stocks; they simply follow an index, or group of stocks, like the S&P 500.
- Reduce your risk. All investing involves risk because the markets rise and fall. So investors use a technique to try to reduce risk: diversification. It means having a variety of products in your portfolio (collection of stocks, bonds, funds) of varying levels of risk. U.S. government bonds, for example, are considered a relatively low-risk investment. International stocks allow you to diversify outside the U.S. And so on. You generally would want a mix of investment types, and generally as you get older, you want less risk in the mix.
Diversification can be simple, using the funds mentioned in paragraph two above. “You can get considerable diversification with just three funds: a total stock market index fund, which covers the entire U.S. market; a total international index fund, which covers the rest of the world; and a bond fund,” explains Barbara O’Neil, Rutgers Cooperative Extension specialist in financial resource management and a professor at Rutgers University†. O’Neil is the author of Investing on a Shoestring.
- Pay Uncle Sam when you sell. When you sell part or all of your portfolio, you’ll pay taxes on the money you’ve made (hopefully after an extended period, as investing is a long-term strategy). But the amount of tax varies: it depends on your income as well as whether your investments are part of something like an IRA or 401(k) program, which have their own tax rules.
Even if it can be fairly simple, is investing worth it? Well, yes. Judging by the past, holding a portfolio of stocks and bonds offers the best chance to grow your money over time. Interest rates in a savings account are often lower than the rate of inflation, but the return on investments can be higher than inflation. According to Macrotrends.com, an investment research company, from 1918 to 2018, the Dow Jones Industrial Average, a measure of the earnings of a particular group of stocks, earned an average 9% each year‡. But those returns are over a span of 100 years, which included years when the stocks had negative returns—sometimes as much as low as -52.7%. Investing can increase your holdings over the long term, but risk of loss in any one- (or even five- or more) year period is real. And just because those growth rates were true in the past doesn’t mean they’ll continue.
Speak with a Huntington Financial Advisor, who can help you select the investments that work for you, based on your specific goals, your risk tolerance and your need for income.