Investing: You know you should but feel overwhelmed by information and choices whenever you look into it; or perhaps you do invest but are worried you’re not doing it “right.” Either way, it’s most certainly understandable. Investing is complicated—and doing it “right” also makes it unique, meaning a one-size-fits-all approach won’t work. That said, grasping some basic concepts can help you lay a strong foundation to make more informed decisions or dive deeper into a specific topic. This guide sets out to help you do just that.

The difference between saving and investing

First of all, what exactly is investing—and how does it differ from saving? The latter involves setting aside a portion of your income or other funds for future use, typically in low-risk, liquid assets such as savings accounts, certificates of deposit (CDs), or money market accounts. Its primary objective? To preserve capital and provide a financial cushion for emergencies, unexpected expenses, and/or short-term financial goals (e.g., purchasing a car, funding a vacation, or covering medical expenses). While savings accounts offer stability and security, they typically yield modest returns in the form of interest—which may not keep pace with inflation over the long term.

Investing, meanwhile, involves allocating funds to ultimately generate a return or profit over time by purchasing assets such as stocks, bonds, mutual funds, real estate, or other financial instruments. These strategies call for a long-term outlook, as asset values may fluctuate in the short term but tend to appreciate over time.

The primary goal of investing is to grow wealth on a long-term basis, outpacing inflation and achieving financial objectives such as retirement planning, wealth accumulation, or funding major life milestones.

Should you save or invest?

In an ideal world, you’d have both savings and investments; but if you currently lack an emergency fund to help cover unexpected financial shocks, building one should probably be your first priority. Why? Check out this example to see how not having an emergency fund can cost you…

Let’s say you receive a $1,000 tax refund, don’t currently have any savings or investments, and find a savings account that offers 4% interest. In this case and after a year, you’d earn $40 (1,000 x .04). Yet, you read news that Company XYZ has seen 20% returns so far in the current calendar year (which is only halfway over)—meaning that if this company sees the same returns during the second half of the year, you could earn $200 (1,000 x .2) in six months rather than $40 with the aforementioned savings account. With investing seemingly shining through as the smarter financial choice, you invest your $1,000 in Company XYZ and pat yourself on the back.

One month later when your car breaks down, you learn repairs cost $1,000 and then check the value of your investments: seeing Company XYZ shares have experienced a sharp decline and realizing your $1,000 is now only worth $600. You withdraw this $600 and use your credit card to cover the additional $400 necessary to fix your car. The next month when Company XYZ rallies but your money is no longer invested, you miss out and must also pay interest as you slowly pay off your $400 credit card balance. Should any other unexpected expenses arise, you’d need to put these on your credit card as well and pay them off in addition to accumulating interest.

As you might imagine and given a situation like this, it’s easy to fall further and further into debt—though you could’ve avoided this altogether had you put your $1,000 into a savings account instead. While this is obviously just an example and it’s possible the investment could have seen better returns than the savings account, the bottom line is that investing—especially in the short-term—is a gamble, with an emergency fund so valuable given inevitable emergencies that will undoubtedly arise.

The power of compounding

While investing may sound too risky given the previous example, keep in mind one incredibly compelling reason to invest: compounding, the process by which investment returns generate additional returns over time and lead to exponential wealth growth. As investment gains are reinvested and earn further returns, the compounding effect magnifies to speed up the accumulation of wealth.

The key to harnessing the power of compounding? Time. The longer your money remains invested, the greater the impact; by investing early and staying invested over the long term, individuals can leverage the full potential of compounding to build substantial wealth.

Consider two individuals, A and B, who each invest $10,000. While Individual A begins investing at age 25 and earns an average annual return of 7%, Individual B earns the same return but begins investing 10 years later at age 35; by age 65, individual A's investment would have grown to over $76,000 while individual B's investment would ring it at $38,000. This stark difference underscores the importance of starting early and allowing time for compounding to work its magic.

While it’s perhaps tempting to delay investing due to fear, uncertainty, or lack of knowledge, the cost of waiting cannot be overlooked. By taking action and beginning early, investors can overcome inertia and forge a path toward financial success. Consider talking to a financial advisor who can help you create a portfolio suited to meet your unique needs while also offering a sense of accountability.

Types of investments

We’ve all seen the benefits of investing, but knowing you should invest and knowing how to invest are two totally different things—partly because there are simply too many investment options in the marketplace, which is often confusing and overwhelming. One option isn’t necessarily better than any other, and each asset class presents its own unique opportunities and risks. Here’s a brief summary of each…

Stocks

Also known as equities, stocks represent ownership stakes in publicly traded companies. When you buy shares of company stock, you become a partial owner and are thus entitled to a portion of company profits. Stocks offer the potential for capital appreciation as companies grow and increase their earnings but are also more volatile than many other investments (meaning their price can fluctuate significantly in response to market conditions, economic factors, and company-centric news).

Common stock and preferred stock are the two primary types. While the latter doesn’t give shareholders voting rights, the former does—but its holders are last in line for payouts, behind creditors, bondholders, and preferred shareholders.

One other noteworthy aspect of stocks is that they sometimes pay out dividends, portions of a company’s earnings paid out to shareholders. Most stocks, however, don’t do this; those that do tend to be well-established companies with more financial stability than their peers.

Bonds

Bonds are debt securities governments, municipalities, or corporations issue to raise capital. Buying a bond is essentially lending money to the issuer in exchange for periodic interest payments and the return of principal at maturity.

Corporate bonds and municipal bonds are the two primary types, with the former issued by corporations to finance operations, expansion, or acquisitions and typically offering higher yields than government bonds (but with a higher credit risk). Municipal (muni) bonds, meanwhile, are issued by state and local governments to fund public projects (e.g., infrastructure and schools) and may offer tax advantages as interest income is often exempt from federal and state taxes.

Mutual funds

Mutual funds pool money from multiple investors to invest in a diversified portfolio of stocks, bonds, or other securities managed by professional portfolio managers. Fund managers make investment decisions on behalf of investors, aiming to achieve investment objectives, and one of their biggest advantages is that they offer far more diversification (a benefit we’ll discuss shortly) than an individual stock or bond.

Exchange-traded funds (ETFs)

ETFs are investment funds that pool money from multiple investors but are traded on stock exchanges, similar to individual stocks. As with mutual funds, ETFs offer diversification by holding a basket of securities within a single investment: typically tracking a specific index, sector, commodity, or asset class. ETFs often have lower expense ratios compared to mutual funds, making them cost-effective investment vehicles, and can be bought and sold throughout the trading day at market prices to give investors liquidity and flexibility.

Real estate investment trusts (REITs)

REITs are companies that own, operate, or finance income-producing real estate properties, giving investors an opportunity to invest in real estate without directly owning physical properties. They also provide exposure to a diversified portfolio of real estate assets across various sectors such as residential, commercial, and industrial properties.

As for their benefits, REITs generate rental income from properties (distributed to shareholders via dividends) and trade shares on stock exchanges, offering liquidity to investors who want to buy or sell.

Alternative investments

Alternative investments encompass a broad range of non-traditional asset classes—including hedge funds, private equity, commodities, and cryptocurrencies—and offer diversification benefits by providing exposure to assets less often correlated with traditional stocks and bonds. While they often carry higher risk and may be subject to less regulation compared to traditional investments, alternative investments have the potential to generate attractive returns over the long term.

Retirement accounts

Retirement accounts such as individual retirement accounts (IRAs) and 401(k) plans offer tax-advantaged ways to save for retirement, with some employers offer matching contributions to the latter as an added retirement savings incentive. While retirement accounts are fantastic retirement-prep strategies, note they’re designed to encourage long-term saving and investing and thus penalize most early withdrawals taken before retirement age.

Annuities

Annuities are financial products designed to offer tax-deferred growth and a predictable income stream, making them attractive for retirement planning. Contracts between an individual and an insurance company—whereby the individual makes a lump-sum payment (or series of payments) in exchange for periodic disbursements that begin immediately or at a future date—annuities also come with many drawbacks such as needlessly complicated products and high fees. Several types of annuities include fixed, variable, indexed, immediate, and deferred options.

Asset classes and risk vs. reward

In general, asset classes with higher potential returns also have more risk and vice versa. This risk-reward connection is a basic rule of investing—and, arguably, life itself—but when we talk about risk from an investment standpoint we don’t just mean whether or not investors like to live life on the edge.

Risk tolerance (how much risk you can handle) is based on a few things, your time horizon—how long your money will be invested—in fact one of the most important. Consider the example of 30-year-old and 65-year-old investors and how their time horizons impact their risk tolerance.

The younger investor has no major purchases planned in the near future and is investing for retirement. With a thirty-five-year time horizon, she has a high risk tolerance and therefore chooses an asset allocation (how her investment portfolio is divided across different assets) of 80% stocks and 20% bonds: a fairly risky portfolio given the high percentage of stocks, which typically see long-term appreciation but with short-term volatility. Since the 30 year old doesn’t need the invested funds any time soon, this volatility likely won’t negatively impact her.

What about the 65 year old? He recently retired and is living off Social Security and his investments. Since his portfolio won’t have time to recover if the market declines, he has a lower risk tolerance and thus chooses an asset allocation of 25% stocks and 75% bonds: hopefully still benefitting from historically higher stock returns but with considerably less risk.

Which asset class is best?

As highlighted in the example above, one asset class is not necessarily better than another—it all depends on your unique financial needs. One tool, however, applies to almost every investor as one of few instances where minimizing risk doesn’t come at the cost of potential returns: diversification.

Diversification refers to the practice of spreading investments across a variety of assets, geographic regions, and sectors to reduce risk. In other words, it’s the practice of not putting all your eggs in one basket. The corresponding rationale is that different assets often perform differently under various market conditions. For example, while stocks might decline during a market downturn, bonds or real estate investments might remain stable (or even increase in value!). This balance helps stabilize portfolio performance over time, ensuring not all investments are affected by the same economic events, and also provides opportunities for growth in various areas. While diversification doesn’t guarantee against loss, it’s a fundamental strategy for managing risk and achieving long-term investment goals.

Common investment strategies

While entire books have been written about various investing strategies, dollar-cost averaging and portfolio rebalancing shine through as two fairly straightforward foundational methods.

Dollar-cost averaging

Dollar-cost averaging (DCA) tasks investors with dividing the total amount to be invested across periodic target asset purchases to reduce the impact of volatility on the overall purchase. Purchases occur regardless of asset price, buying more shares when prices are low (and vice versa) as a method that aims to lower the average cost per share over time and reduce the risk of investing a large amount in a single investment at the wrong time. DCA is often used for investing in volatile markets, helping to smooth out the effects of market fluctuations.

Portfolio rebalancing

Portfolio rebalancing is the process of adjusting investment portfolio asset weights to maintain a desired asset allocation. As various portfolio investments potentially perform differently and the initial asset allocation can drift from its target over time, rebalancing involves buying and selling portions of the portfolio to realign it with the original (or desired) allocation: helping to manage risk and ensure alignment with investor goals and risk tolerance. Many financial advisors and roboadvisors include portfolio rebalancing in their slate of services.

Still unsure? Consider working with a financial advisor

If you get sick, you go to a doctor. If your car breaks down, you go to a mechanic. Your finances, which are no less important than your body or car, deserve professional care and attention too!

There are many different types of financial advisors: the right one for you will depend on what exactly you’re looking for. Whether you need personalized guidance, a financial plan, or simply accountability, the right financial advisor can help guide you—with no need to go it alone!

How Vision Retirement can help you make sound invest choices

Our various solutions can help you meet your investing goals, such as our automated investing service that provides new investors with a low-cost solution and the benefit of financial advisor guidance. Moreover, our advice subscription package gives you ongoing access to a financial advisor per your needs and includes a portfolio review for any existing investments as well as a customized investment roadmap. Schedule a FREE discovery call with one of our CFP® professionals today!

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Vision Retirement is an independent registered advisor (RIA) firm headquartered in Ridgewood, New Jersey. Launched in 2006 to better help people prepare for retirement and feel more confident in their decision-making, our firm’s mission is to provide clients with clarity and guidance so they can enjoy a comfortable and stress-free retirement. To schedule a no-obligation consultation with one of our financial advisors, please click here.

Disclosures:
This document is a summary only and is not intended to provide specific advice or recommendations for any individual or business.

There is no assurance that the techniques and strategies discussed herein are suitable for all investors or will yield positive outcomes. Investing involves risks including possible loss of principal.

Preferred stock dividends are paid at the discretion of the issuing company. Preferred stocks are subject to interest rate and credit risk. As interest rates rise, the price of the preferred stock falls (and vice versa). They may be subject to a call feature with changing interest rates or credit ratings. Dividend payments are not guaranteed and may be reduced or eliminated at any time by the company.

All investing involves risk including loss of principal. No strategy assures success or protects against loss. There is no guarantee that a diversified portfolio will enhance overall returns or outperform a non-diversified portfolio. Diversification does not protect against market risk.

Fixed and variable annuities are suitable for long-term investing, such as retirement investing. Gains from tax-deferred investments are taxable as ordinary income upon withdrawal. Withdrawals made prior to age 59½ are subject to a 10% IRS penalty tax, and surrender charges may apply. Variable annuities are subject to market risk and may lose value. Riders are additional guarantee options that are available to an annuity or life insurance contract holder. While some riders are part of an existing contract, many others may carry additional fees, charges, and restrictions, and policyholders should review their contract carefully before purchasing. All guarantees are based on the claims-paying ability of the issuing insurance company.