Investments

Investing is the process of buying assets that increase in value over time and provide returns in the form of income payments or capital gains.

Investing works when you buy an asset at a low price and sell it at a higher price. This return on your investment is called a capital gain. Earning returns by selling assets for a profit—or realizing capital gains—is one way to make money investing.

When an investment gains in value between purchase and sale, it’s also known as appreciation.

In addition to profits from capital gains and appreciation, investing works when buying and holding assets that generate income. Instead of realizing capital gains by selling an asset, the goal of income investing is to buy assets that generate cash flow over time and hold on to them without selling.

Historically, the longer the time horizon, the less impact the short-term ups and downs of the market have on investment returns.

Timing the market is virtually impossible. Therefore, time in the market is more important than timing the market.

Invest the maximum you can comfortably afford, after setting aside an emergency fund, paying off high-cost debt, funding daily living expenses, and saving for any short-term goals. By investing on a regular basis, over time you can potentially achieve greater returns through compounding.

Stocks

Stocks (equities) represent ownership in a company.

As a shareholder, you can achieve returns in two ways:

1. The price of the stock may increase, allowing you to sell at a profit.

2. The company may distribute some of its earnings to stockholders in the form of dividends.

Stocks are considered relatively risky, because the stock price may also decrease and there is no guarantee you’ll be paid dividends.

Bonds

A bond represents a loan you make to a government, municipality or corporation (issuer).

In return, that issuer promises to pay you a specified rate of interest and to repay the face value after a certain period of time, barring default.

Bonds can provide a predictable income stream because they generally pay bondholders interest twice a year. They’re also useful for preserving capital, as they promise to repay the original loan amount upon maturity. As with any investment, bonds have risks such as default risk and reinvestment risk. Bonds tend to be less volatile than stocks, but an issuer could potentially default on its loan.

Mutual funds

A mutual fund pools money from many investors and then invests that pool in a broad range of investments, such as stocks, bonds and other securities.

The fund is managed by an investment advisor. When you buy a mutual fund, you buy a stake in everything the fund invests in and any income those investments generate.

Exchange-traded funds (ETFs)

An exchange traded fund (ETF) is an investment fund that holds assets like stocks, bonds or commodities.

Most ETFs track market indexes, which means that they’re trying to replicate the performance of a certain part of the market. For example, an ETF that tracks the S&P 500® Index is trying to mirror the performance of the broad stock market. ETFs trade like stocks on an exchange and their price changes throughout the day, as shares are bought and sold.

Commodities

Commodities are agricultural products, energy products and metals, including precious metals. These assets are generally the raw materials used by industry, and their prices depend on market demand. Investors buy commodities using futures and options contracts. You can also invest in commodities via other securities, like ETFs or buying the shares of companies that produce commodities.

Commodities can be relatively high-risk investments. Futures and options investing frequently involves trading with money you borrow, amplifying your potential for losses.

Real Estate

You can invest in real estate by buying a home, building or a piece of land. Real estate investments vary in risk level and are subject to a wide variety of factors.

People looking to invest in real estate without having to own or manage real estate directly might consider buying shares of a real estate investment trust (REIT). REITs are companies that use real estate to generate income for shareholders. Traditionally, they pay higher dividends than many other assets, like stocks.

Different investments come with different levels of risk. Taking on more risk means your investment returns may grow faster—but it also means you face a greater chance of losing money. Conversely, less risk means you may earn profits more slowly, but your investment is safer.

Deciding how much risk to take on when investing is called gauging your risk tolerance. If you’re comfortable with more short-term ups and downs for the chance of greater long-term returns, you likely have higher risk tolerance. If a more moderate rate of return, with fewer ups and downs is more appealing, you may have lower risk tolerance.

Whatever your risk tolerance, one of the best ways to manage risk is to own a variety of different investments. This concept is called diversification, and the right level of diversification makes for a successful, well-rounded investment portfolio.

By owning a range of investments in different asset classes, you can buffer the losses in one area with the gains in another. This keeps your portfolio steadily and safely growing over time.

Successful investors typically build wealth systematically through regular investments, such as payroll deductions at work or automatic deductions from a checking or savings account. Regularly investing helps you take advantage of natural market fluctuations. When you invest a consistent amount over time, you buy fewer shares when prices are high and more shares when prices are low. Over time, this may help you pay less on average per share, a principle known as dollar-cost averaging.

Over the last 30 years, an investment in the S&P 500 would have achieved a 10% annualized return. Missing the 25 best single days during that period would have resulted in only a 5% annualized return. That’s a reminder not to sell your investments in a panic when the market goes down. It’s hard to predict when stock values will increase again, and some of the biggest days of stock market gains have followed days of large losses.

Good investing begins by investing in yourself. Learn about the types of retirement accounts. Get your emergency savings squared away. Create a strategy for paying down your student loan debt. And with those key financial tools in action, you can start investing with confidence—putting the money you have today to work securing your future.