Investing means spending money today with the expectation that it will have a higher value at a later date, either by accruing interest or by gaining profit. Investing is a means toward an end, as opposed to an end in and of itself, although people can certainly derive satisfaction from the success of their investments.
Investing is different than saving because it comes with risk. With investing, there is always a possibility that you will not reach your goals, and that self-induced, external, or a combination of factors will cause you to lose your money instead of growing it. That said, investment options can range for low- to high-risk.
Outright saving, or the “cash under the mattress” approach, is generally a safe bet, but you will likely not end up with any more money than what you put in. If you want to have more money than you put in at some point in the future, and don’t mind taking on a bit of risk, then investing might be the right option for you.
What is investing?
There are three common ways that investments make money: appreciation, interest, or dividends. Appreciation is when the cost of something goes up. Say you bought a painting for $100 and now it’s worth $500. That’s appreciation. Now say you bought a bond, which is basically a loan made to a government or corporate entity, and then you make money as your loan is paid back. That’s interest. Finally, say you buy stock, which is a share of a company, and then that company does well and issues you more payments. Those are dividends.
Savings vs. investing
Even though you can make a return on your savings due to interest, there’s a fundamental difference between investing and saving. Investing is done with the intent of growing money. Saving is done with the intent of having money available to spend.
Liquidity is a term you’ll hear often in financial services, and it means the ability to make use of an asset without drastically altering the value of the asset. Investments have less liquidity than savings because the money you’ve invested needs to stay invested to generate a return. Additionally, some types of investments, such as 401(k)s, have penalties for early withdrawal.
On the other hand, savings have higher liquidity because they exist for the purpose of being used in the case of an emergency or toward the fulfillment of a particular goal.
One exception is a certificate of deposit, or CD. A CD is a savings account with a fixed interest rate and a predetermined withdrawal date. CDs are federally insured and offer a higher interest rate than most savings accounts because you’ve committed savings for a particular amount of time.
Things to consider before investing
Prior to investing, it’s important to understand the concept of budgeting. This will allow you to understand whether you have the extra money needed to invest, and if so, how much.
There are two popular methods of budgeting. The first is called the zero method, which entails accounting for every dollar you have until you’ve run out of dollars. There is also something called the 20/30/50 Rule, a concept that has been popularized by Senator Elizabeth Warren. In this framework, a person would manage their budget by spending 50% on needs, 30% on wants, and 20% on savings.
Credit card debt
High-interest credit card debt can hamper your ability to maneuver financially, especially since your credit score will impact your ability to take out loans in the future. For this reason, a good rule of thumb is to maintain little to no credit card debt.
If need be, you can use a balance transfer card, allows you to pay off one debt with another card. The advantage of this approach is that you can consolidate debts for a fee that is a small percentage of your debt. If you have a mortgage, you can attempt a cash-out mortgage refinance, which is when you refinance your mortgage (meaning you get a loan with different constraints) for a sum that’s greater than your original mortgage. With these additional funds, you can pay off your credit card debt.
In both cases, keep in mind that getting out of debt is a two-step process. The first step entails stopping the bleeding by tackling the debt you have head-on. The second step, of critical importance, is to identify the habits that got you into debt in the first place and correct them for the future.
Before beginning your investing journey, it’s wise to accumulate savings for an emergency fund. How much should be in this rainy day fund? Experts suggest three to five months worth of living expenses. Emergency funds make tough times easier to weather and will allow you to invest elsewhere without the stress of wondering what happens if you suddenly come into hard times.
How to invest with little money
Investing might feel like something that is out of your reach, especially when you’re first starting out. However, recent innovations have made investing more accessible than ever.
Many brokerages have dropped their commission fees to $0, and modern investing platforms like Public make it possible to purchase stocks and exchange-traded funds (ETFs) in slices, meaning you can own a portion of a share of any company, for any amount of money.
Another option would be to invest with a Dividend Reinvestment Plan (DRIP), which allows you to buy a single share at a time. The strategy would be to continuously invest in the same company regularly, especially if you’re earning dividends.
Investment risk tolerance
Risk tolerance is how much risk you’re willing or able to take on as an investor. Setting aside how much risk you can stomach emotionally, if you’ve got very little financial wiggle room then you’ve got low-risk tolerance. Some factors used in calculating risk tolerance include how much time you have for your investments to grow, how much you expect your income to grow, your current and future forecasted expenses, and your health status. If you have a big salary and years until retirement then you have a high-risk tolerance; if you’re living paycheck to paycheck you have low-risk tolerance.
How to diversify your investments
The idea behind diversification is that having a variety of investments will yield a greater return while assuming lower risk.
One way to practice diversification is to create your portfolio of stocks. You can do this by investing in companies you believe in, and using a combination of first-hand knowledge on a category, additional research, and insights gleaned from trusted friends and experts.
Public is the first social investing app, which means that its users can see investments made by people in their network and start conversations and learn from the people they trust.
Beyond individual stocks, there are commodities, ETFs, and real estate investment trusts (REITs). Another option is investing in fixed-income funds, which are funds that focus on broad indexes rather than particular sectors. As a plus, these funds don’t cost a lot of money to invest in because they require less management by virtue of focusing on broad indexes.
Types of investments
A stock is a small piece of a company. Stocks are measured in shares, and shares are assigned values based on buy and sell value. Some stocks, like penny stocks, have very low prices per share. Other stocks, like those of blue-chip companies like Amazon and Google, can cost more than $1,000 per share.
It used to be that an investor could only buy into a company if they could afford an entire share. That has all changed with fractional investing, which is the process of slicing shares into tiny bits so people can buy in at different financial levels.
A bond is a loan made to a company or governmental entity. Bonds are one of the most common types of investments because they are relatively low risk compared to traditional stocks. They also differ than stocks because they do not come with ownership rights.
A mutual fund is a bundle of investments. Mutual funds are managed by analysts (and therefore cost a premium), whereas index funds are not (and therefore are more affordable). An index fund will invest in companies that belong to particular indexes.
An option is a contract that gives you the option to buy or sell a stock at a particular price by a given date. Importantly, you are buying the contact and not the stock. You can follow through on the contract, sell them to a different investor, or just let them expire. Options make money when the market rate of the stock becomes less than what it was when you entered the contract. If the stock costs more, you don’t actually have to buy the stock.
Stock investing basics
Putting your investments on autopilot can be useful because you’ll remove the possibility of your decision making being guided by your emotions rather than strict adherence to overall goals and benchmarks. Plus, you don’t have to worry about forgetting to actually invest.
Of course, the downside to this is that you could throw off your finances if your income becomes irregular during a given time. Investing is an ongoing balance of “set-and-forget” and active management. It’s important to understand your goals and the financial realities that will dictate the cadence of your contributions.
Many investors are also diligent about tracking their performance so that they can optimize over time. This is a tricky balance for long-term investors, who might not want to make frequent trades, even when their investments appear to be losing money in the short-term.
Watch out for fees
Investments often times come with fees. These fees can be front-end loads or back-end loads. A front-end load is a fee you pay up-front; a back-end load is a fee that’s charged after you make your investment, which may occur one or more times.
“No-load” funds mean that you are investing commission-free and these are increasing in popularity. Keep in mind that you could still rack up maintenance fees for things like hands-on advising, mutual fund management, and administrative fees.
Investing tips for beginners
You know how to budget and you have an emergency fund, so let’s get started.
How to start investing
If you’re just getting started, you might try a free investing app like Public. Within Public, you can start building a portfolio of the companies you believe in for whatever amount of money you have to get started. Public offers 1,000s of public stocks and ETFs available in slices. What this means is that if you want to invest in Amazon, but only have $100, you can do that despite Amazon’s share price is well over $1,000 as of the date of publication.
You might also see if your employer offers to match a percentage of your contribution to your 401(k). If this is the case, then you would be wise to contribute and reap the free money that comes your way via your employer.
Understand your financial objectives
It’s important to have goals before you start investing so that your decisions are based on how closely they help you get to your goals (as opposed to emotional factors).
Invest for the long-term
Don’t just invest in a car, vacation, or even a home. Plan for your retirement, which might last upwards of 30 years. Do you remember all the stuff you did before your 25th, 30th, or even 40th birthdays? Save wisely and you can do all that all over again, or something else entirely different, during your retirement.