What is investing?
March 14, 2023 7 min read
According to Gallup, nearly 6 in 10 Americans owned stocks in 2022—one of the most common ways to invest money. But investing goes well beyond stocks. Other types of investments include bonds, mutual funds and exchange-traded funds (ETFs).
Investing involves buying assets with the goal of earning returns over time. Investing can help someone achieve long-term financial goals like buying a house, sending kids to college or living comfortably in retirement. It’s worth noting that investments can vary in terms of risk. Read on to learn about the different types of investments.
- Investing is a way for someone to grow their money so they can achieve financial goals and build wealth.
- Investments carry risk, and higher risk tends to correlate with higher returns.
- Common types of investments include stocks, bonds, mutual funds and ETFs.
- It’s possible to start investing by choosing an investment style, setting a budget, determining the risk level and speaking with a financial adviser.
How does investing work?
Investing works by putting money into securities—financial assets used for investment—in hopes of increasing the amount that was originally invested. For instance, if the investor can sell the asset at a higher price than they paid for it, that becomes profit. Securities might include stocks, bonds, mutual funds, exchange-traded funds (EFTs), annuities, certificates of deposit (CDs) and hedge funds. It’s also possible to invest in nonfinancial assets like real estate and intellectual property.
Risk vs. returns
Investing can come with both risks and rewards. Just like a stock or other investment can gain value over time, it’s also possible for it to lose value. That’s why investments can be considered low risk versus high risk, depending on the likelihood of loss on investment. It might help for an investor to assess their risk tolerance—how willing they are to risk losing money to potentially earn higher rewards.
4 types of investments
A variety of investments are available for investors, with some offering low risk and others offering high risk. Four common investments are stocks, bonds, mutual funds and ETFs.
When someone buys a share of stock, they’re buying a stake in a company. Stocks are traded on exchanges, like the NYSE and the NASDAQ. But investors typically buy stock through brokers, which can often be done online.
An investor generally makes money from stocks by:
- Owning a stock whose value goes up. If the price of the stock rises, they can turn a profit by selling the stock for more than they paid for it.
- Holding a dividend stock. Companies distribute dividends, often in the form of cash or additional stock in the company, as a way to share profits with their stockholders.
Governments, municipalities, corporations and other organizations sell bonds to investors to raise money. Bonds can help fund special projects, debt repayment or cash flow for the organization. In effect, a bond buyer is lending money to the bond seller.
In exchange, the bond buyer regularly earns interest. Most bonds expire—or mature—on a certain date, like five years from when a bond was purchased. When that date rolls around, the buyer usually receives the last interest payment plus the face value of the bond.
As with stocks, bonds come with some risk. For example, a corporation may default on its bonds by failing to pay interest and the original principal. Bond prices go up and down, although generally not as much as stock prices do.
Overall, bonds are considered less risky than stocks. However, the investment returns on bonds are normally lower than they are for stocks.
When someone invests in a mutual fund, they’re investing in a portfolio of securities, such as stocks, bonds and short-term debt. A mutual fund company pools money from investors, picks the securities that make up the portfolio and manages the fund. Each share of a mutual fund represents partial ownership of the portfolio.
Individual investments within a mutual fund may pay dividends or interest as the value increases, allowing investors to generate returns on their money. Investors can buy shares in a mutual fund through a mutual fund company or an investment broker.
Mutual funds generally offer less risk than stocks because they invest in an array of securities, rather than investing in a single company.
The four types of mutual funds are:
- Money market fund: This kind of fund invests in short-term investments issued by U.S. corporations, as well as federal, state and local governments.
- Stock fund: As its name implies, a stock fund invests in stocks.
- Bond fund: A bond fund invests in bonds and other kinds of debt.
- Target date fund: A target date fund owns stocks, bonds and other investments. The blend of investments changes over time in conjunction with an investor’s projected retirement date.
As with mutual funds, ETFs enable someone to buy into a portfolio of stocks, bonds or other assets. But unlike shares of a mutual fund, shares of an ETF are sold on a stock exchange in the same way that stocks are.
Most ETFs track the performance of a market index like the S&P 500, Dow Jones Industrial Average or NASDAQ Composite Index. These ETFs generally purchase some or all of the securities represented in that index.
ETFs tend to be less risky than stocks because they hold a variety of securities, rather than a stake in just one company.
How to start investing
If you’re considering investing, it’s important to do more than just think about financial goals and potential benefits. Remember, all investments involve some degree of risk.
With that in mind, knowing more about how others approach investing might help too. That includes investment styles, investing budgets and risk tolerance. And like any financial decision, talking with a qualified expert before making any decisions could also help.
There are several different approaches to investing:
- Active investing: Involves taking a hands-on approach to investments, including finding undervalued stock and trying to beat the market. While it might score better returns, it also takes time, research and skill to succeed. And even that might not be enough. According to S&P Dow Jones Indices analysis, “actively managed funds have historically tended to underperform their benchmarks over short- and long-term periods.”
- Passive investing: A more hands-off approach to investing. It’s meant to achieve long-term gains through a buy-and-hold strategy, such as purchasing shares of an ETF and hanging on to them. While passive investing may yield lower returns than active investing, it may be less risky and more affordable.
- Growth investing: Involves buying stocks and other assets in companies that are growing quickly. When successful, it typically comes with high returns and low dividend payouts.
- Value investing: A value investor hunts for stocks that are undervalued but expected to grow in value and may produce a high dividend yield.
- Quality investing: Focuses on buying stocks in companies that are profitable or financially stable.
An investment calculator can be a helpful tool in determining how much to invest, how often to invest and what rate of return is necessary to reach investment goals.
While all investments carry risk, some are riskier than others. Here’s a quick refresher on the relative risk level for the types of investments discussed above:
- Stocks: Higher risk, depending on the type of stock and fluctuation of the stock market
- Bonds: Lower risk, especially when issued by the U.S. government
- Mutual funds: Lower risk than stocks, but still fluctuate with the stock market
- EFTs: Lower risk, similar to a mutual fund
There’s no shortage of financial professionals out there that might be able to help cut through the jargon and settle on an investment strategy. But the Securities and Exchange Commission (SEC) says it’s “really risky” to invest with someone who’s not licensed with it or a state securities regulator. It has a search tool you can use to look up investment professionals:
- Financial adviser: A financial adviser might help choose investments, establish financial goals and create a plan to meet those goals. The term refers to a number of financial professionals, including certified financial planners and investment advisers.
- Certified financial planner: A certified financial planner (CFP) might offer an array of advice about financial matters such as investing, retirement planning and tax planning. A CFP must meet specific education, experience and ethical standards.
- Investment adviser: An investment adviser—also known as a wealth manager or investment counselor—supplies investment advice and might manage individual investment portfolios. Some investment advisers are also stockbrokers.
- Stockbroker: A stockbroker, or broker-dealer, gives advice on investments and may buy and sell stocks and other investment products on behalf of their clients. Many of these professionals work for brokerage firms or investment banks. They typically must register with the U.S. SEC and the Financial Industry Regulatory Authority.
In addition to looking up any potential investment help, you can also learn more from the SEC about working with brokers and advisers.
Investing in a nutshell
Investing in financial products, such as stocks, bonds, mutual funds and ETFs, can help investors achieve financial goals like retiring comfortably or paying for a child’s college education. But there are also risks to consider. High-risk investments might have the potential to deliver higher returns, but they also are more likely to result in losses. If you have questions or are interested in getting started, consider contacting a qualified professional.