What’s Investing?

Investing is a way to save and grow your money. It can be used to reach goals such as paying for college or funding your retirement. There’s a wealth of options when it comes to investing strategies and products. Indiana MoneyWise aims to provide you with a solid foundation of knowledge so you can begin investing with confidence.

Five Keys to Investing Success

• Make investing a (good) habit. Start early and contribute regularly. An easy way to accomplish this is to make saving automatic. If you receive your paycheck via direct deposit, ask your employer if you can direct a percentage of each paycheck to a separate savings account that you will eventually invest. You should also consider investing options offered by your employer, such as a 401(k).
• Set SMART goals. SMART is an acronym that stands for Specific, Measurable, Achievable, Realistic, and Time-bound. Instead of vague goals like “financial security,” set clearly defined goals like “$500,000 net worth by age 60.” Put a price tag on your goals. Make them specific. This will help you develop a strategy to achieve them. SaveAndInvest.org can help you create your own SMART goals, and we have a worksheet you can print and display somewhere in your home as a reminder of your goals.
• Don’t take unnecessary risks. Risk is the chance you take that you will lose money or that your money will lose value by earning less than the rate of inflation. We all have different levels of risk tolerance, and you should be investing based on your personal preferences and financial goals.
• Keep time on your side. Ever heard of the concept called the “time value of money?” It relates to compound interest. Investing early gives your money more time to grow through the power of compound interest.
• “Don’t put all your eggs into one basket.” No investment performs well all the time, so you should spread your investments around to reduce risk and increase your overall return.

Now let’s take a deeper dive into some of these concepts.

Compound Interest

Compound interest is the whole reason investing works. It’s how you make the most of the time value of money. The longer your money is invested, the more opportunities it will have to grow. That’s because compound interest is interest calculated on the initial principal as well as the accumulated interest of previous periods. It benefits those who use it to build wealth, but it can also be a burden to those who accrue interest on loans and credit cards.

You can take advantage of compound interest by putting your savings into an account that pays some kind of return. The rate will depend upon the amount of risk taken. Higher rates of return are associated with a higher risk of loss, and lower rates of return are associated with a lower risk of loss.

To get the most bang for your buck, start early, contribute regularly, and be patient. To learn more, we encourage you to read our MoneyWise Matters blog post about compound interest and try a compound interest calculator to see how much your money can grow.

Risk Tolerance

Risk and reward go hand in hand. While the prospect of rewards in the form of high returns is appealing, such investing typically comes with an increase in risk. We all have different levels of comfort with the concept of possibly losing money, and your tolerance will be heavily influenced by how much you can afford to lose and your long-term financial goals. Financial professionals will often ask new clients to complete a questionnaire to help determine your risk tolerance, which helps the professional make recommendations that meet your comfort level while still achieving your goals.  

Are you an aggressive investor with a high risk tolerance? Or are you a conservative investor with a low risk tolerance? Many investment websites offer free quizzes to help you assess your risk tolerance, but keep in mind the results may be biased toward financial products or services sold by the companies or individuals sponsoring the websites.

Finally, your risk tolerance may change. Some investors start aggressive when they’re young and can afford to take more risks, but they switch to conservative strategies and products as they approach retirement. Additionally, changes in your financial situation and goals may influence your risk tolerance.

Diversification

You can manage risk by practicing diversification. This technique involves mixing a wide variety of investments within a portfolio. The rationale behind this technique contends that a portfolio of different kinds of investments will, on average, yield higher returns and pose a lower risk than any individual investment found within the portfolio. Diversification, coupled with long-term investing, can help you endure market volatility. Long term investors shouldn’t obsess over the minute-to-minute moves of stocks, but instead should develop long-term strategies to meet their financial goals. Be patient and try not to fret over daily gains and losses.

To learn some diversification strategies, check out Investopedia's page on the topic.