Investing Basics 101
6 min read •
30 sec brief
Investing is not the same as saving. It is for a long-term goal, that is at least 10 years or so off into the future.
With thousands of stocks and even more mutual funds and exchange-traded funds (ETFs) to choose from, investing can be confusing. And perhaps
Some good news is there is no need to devote endless hours to
Investing is not the same as saving. You need to save and you need to invest. But those are two different goals with two very different strategies. Investing is for a long-term goal, that is at least 10 years or so off into the future. Saving is for immediate needs.
An emergency savings fund is the foundation of financial security. It is money you can tap at any time—tomorrow!—and know that 100% of what you have saved will be there for you. Savings belongs invested in bank accounts that will not lose value. Sure, that means they don’t earn much other. That’s okay; savings is all about quick access to money without having to worry that it’s down 30% in a bear market.
An investing account is for money you want to grow over years to help you reach a goal, such as retirement. An investing account is money you don’t expect to need for at least 10 years, and often much longer. With that long-term focus, investing is where stocks come into play. More on this in a sec.
Aim to Invest at least 10% of your salary for retirement. Chances are your big investment goal is retirement. At a minimum you want to save at least 10% of your salary; 15% is even better if you waited until your 30s to get serious about retirement investing.
Stocks are the best investment for long-term investments. There are three broad types of investments: stocks, bonds and cash. Over decades, stocks have historically produced the highest gains.
But there’s a tradeoff to consider: stocks will go through periods –corrections and bear markets – where values fall. A lot. Bonds rarely lose value and when they do it’s more a scratch than a deep cut. Cash is pretty much guaranteed to not fall, though it also won’t gain much either.
When you are investing for a long-term goal, the challenge is to not panic when stocks hit one of their rough patches. That’s where owning some bonds and cash can help you stay the course. That brings us to asset allocation…
Own a mix of stocks, bonds and cash. If you have a workplace retirement plan, you may have access to a free asset allocation tool that will help you figure out how much you want to invest in stocks (for long-term growth potential), and how much you want to invest in bonds/cash (to help you stay calmer when stocks are falling in value.)
As a general rule of thumb, if you are investing for retirement, subtract your age from 100 or 110; that’s a good target for how much you might want to invest in stocks. For instance if you are 40, you might consider a 60% to 70% investment in stocks, and keep the rest in bonds or cash. If you are sure you won’t get upset during bear markets, you can consider investing even more in stocks.
You can get some professional allocation insight, but checking the stock/bond/cash mix used by a target date fund to get some insight. A target date fund is a single investment you make that then owns a mix of stock and bond funds (or ETFs) based on your expected retirement age. With a target date
Diversify, diversify, diversify. Owning one stock, or a few stocks is way too risky. Sure, you might feel like a rich genius when that stock is doing well. But you are going to be in for a whole lot of hurt if it hits hard times. Mutual funds and exchange traded funds are the best way to invest. With every share you become an owner in hundreds –maybe even thousands – of stocks or bonds held in that one fund or ETF. (Target date funds own a mix of mutual funds or exchange traded funds.)
Focus on Fees. Perhaps you’ve heard that past performance is no guarantee of future performance. Indeed, chasing hot performers is typically going to be a big mistake. There is no crystal ball that can predict what the market will do over any short period, and who the winners will be. That’s why diversification is so important.
But Morningstar Direct, a data research firm, has found that the fees you pay does have a predictive quality. Investing in the lowest-cost funds and ETFs increases your odds of doing well.
Every fund and ETF collects an annual fee, called the expense ratio. The lower the expense ratio, the better. Every fund and ETF will list its expense ratio on its website, or you can call customer service and ask.
Keep investing in bear markets. When you still have decades to go before you reach a goal, a bear market – when stocks fall – is actually a terrific opportunity. If you’re methodically investing part of every paycheck into a retirement plan, your money will buy more shares of a fund when stock prices are lower. Then, because you have years, if not decades to go, you have time to wait for the market to rebound. The more shares you own, the more your investment will eventually be worth.
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