Investing 101

Basics of Saving and Investing Accounts

There’s a big difference between saving up money and investing money. While both can help you reach your financial goals – if you’re looking for long-term growth, you’ll want to add some investments to your savings strategy. Let’s start with a look at the different types of savings and investment accounts you can use.

Savings accounts and money market accounts, which you can set up at a wide range of financial institutions, are good for short- or medium-term financial goals (less than 3 years away). These types of investments offer small but steady returns and quick access to your money if you need it. If you’re saving for longer-term goals and require higher returns, however, consider these two types of accounts, which offer tax advantages and, in some cases, the ability to buy and sell stocks, bonds, exchange-traded funds (ETFs) and mutual funds: 

• Retirement savings accounts: Some are sponsored by your employer (like a 401k), while an individual retirement account, such as a traditional IRA or a Roth IRA, you open yourself at either a bank or a brokerage.
• College savings accounts: These help you save specifically for college, for yourself or a beneficiary, such as your child or grandchild. You can choose a tax-free 529 account or a Coverdell education savings account, depending on income and how much time you have to save.

You can also set up a brokerage account without tax advantages. Here’s how they work.

Full-service brokerage accounts:  With a full-service brokerage account, you work with a financial advisor. Financial advisors can help you build an investment portfolio, which is the group of investment products you hold. You want your portfolio to have a mix of stocks, bonds, mutual funds and certificates. Your financial advisor is legally and ethically bound to act in your best interests. Full-service brokerage accounts are very helpful if you’re new to making trades and other investment decisions. This kind of investment management is most often paid by a commission on your transactions. 

Low-cost options: Discount brokerages are a lower-cost option that allow you to take a more do-it-yourself approach. Their fees are lower, but they don’t offer investment advice.

You can also invest without a financial advisor at all. A Direct Stock Purchase Plan, or DSPP, lets you buy stock right from the company. You could go with an online brokerage, where you can use online investing tools to choose between a portfolio that’s already mixed and one that you build on your own. 

Features of a brokerage account:

• You can make investments in a wide range of financial products.
• You can earn higher returns than with deposit accounts.
• No limit on the money you can deposit or hold.
• Money isn’t insured, so there’s a risk of loss.

When to Use a Brokerage Account
Open a brokerage account once your finances are in order. You’re ready to invest if you:

• have an emergency fund.
• have saved money toward your short-term goals.
• are ready to take on risk in exchange for the possibility of higher returns.

Understanding Types of Investments

Contributing to an employer retirement plan or Individual Retirement Account (IRA) is the first step to a sound savings plan. The second is deciding how to invest your money.

An important concept when talking about investment options is risk versus reward. In general, investment products with more potential for growth (reward) pose a greater risk of losing money. Low-risk investments are less likely to lose money, but they tend to provide less growth. Let's take a look at some different types of investments.

Certificates 

Certificates, sometimes called share certificates or Certificates of Deposit (CDs), are short-term investments that are fairly liquid (easy to access). They’re popular with conservative investors who don’t want to risk their money, especially those nearly or already retired. Certificates are a great low-risk way to grow retirement savings safely. You won’t get a high rate of return, but you won’t lose any of your money either.

Stocks and Bonds

Stock is an equity, which means when you purchase a share of stock, you become a partial owner of that company. Since shareholders share in the company’s profits and growth, investors buy stocks because they offer a potential to increase in value and beat inflation. Moreover, some stocks pay dividends and can provide regular income to help fund retirement, or you can reinvest the dividend back into your portfolio.

Bonds are a debt, much like an I.O.U. Essentially, the investor is lending money to a bond issuer, such as a corporation, government agency or city. Government bonds are generally considered to have a lower level of risk than corporate bonds, but corporate bonds can offer higher returns. Investors buy bonds for income, safety and diversification. Retirement investors like them because, while they aren’t risk-free, they tend to have less dramatic price swings than stocks and can help smooth your overall rate of return when the stock market struggles. Also, investors get regular interest payments, usually based on a fixed annual interest rate, until a stated maturity date after a set period of time.  

Mutual Funds 

If you’re investing in an employer-sponsored retirement plan, you’ll probably be given a menu of mutual funds—rather than individual stocks and bonds—from which to choose. Mutual funds pool money from many people to purchase investments, which allows retirement investors to buy in at a lower cost than they could get on their own. Mutual funds are also considered to be lower risk than individual stocks because they are more diversified.

The most common types of mutual funds include the following:

• Stock Funds are baskets of many common stocks.
• Index Fund is a low-cost way to gain exposure to stocks in specific asset classes (like stocks, bonds and real estate). 
• Bond Funds are investments in corporate, government and municipal bonds, providing a fixed income in the form of regular dividends.
• Money Market Funds only purchase certain high-quality, short-term investments. The overall objectives of these funds are protecting your money and keeping it liquid. (Note: Money market mutual funds are not the same as money market deposit accounts, which are hybrids of checking and savings accounts and so are basically cash equivalents.)
• Balanced Funds invest in both stocks and bonds and strive to provide both growth and income.

Exchange-Traded Funds

Exchange-traded funds (ETFs) are similar to mutual funds in that they pool money to buy shares in individual stocks and/or bonds. You can buy and sell shares in an ETF during the trading day, and your price will be based on the price at the time of the transaction. (With mutual funds, the price is set at the end of the trading day.) Two of the main reasons retirement investors like ETFs is because fees are inexpensive and they can be more tax-efficient than other choices.  

Choosing a Fund

Choosing a mutual fund involves many factors, particularly your financial goals, risk tolerance and time horizon. The mutual fund’s prospectus is a document that describes the fund’s past performance, objective(s), management fees and allocation of investments. Read it before deciding on a fund to be sure its objectives match your own. A financial advisor can help you sort through the choices and design an investment strategy.¹