5. Index funds are a kind of mutual fund that include investments chosen to reflect the performance of indexes2 such as the Standard & Poor’s 500.
6. Target-date funds, also called lifecycle funds, may adjust their mix of investments, gradually reducing the level of risk as you get closer to the end of your time horizon. The target date is the approximate date when the investor plans to start withdrawing assets from the fund. The principal value of these funds, is not guaranteed at any time, including the target date.
7. Exchange-traded funds (ETFs) are similar to mutual funds but with important differences. For example, ETFs can be bought and sold like stocks while markets are open and may have lower costs than mutual funds. Mutual funds trade only once a day, after markets close.
The plain-language guide to investing
Like many pursuits, investing has its own language, with terms and concepts that may at first be unfamiliar to you. But it doesn’t have to be intimidating. Understanding some of the core ideas can help give you the confidence to get started.
Why you invest
First, think about the goals you’re trying to achieve. Investing is a means to an end, and your objectives could range from paying for our children’s college or funding your retirement to simply building a nest egg. As you consider your plans for the future, two key factors will help guide your investment decisions:
- Your time horizon: Knowing when you’ll need the money you invest means looking beyond today to goals that may be months, years or even decades in the future. In general, a longer time horizon may enable you to take more risk, since you have more time to recover from a market downturn.
- Your tolerance for risk: Risk is a normal part of investing, and there are many types of investment risk. While investing offers the potential for your assets to grow, you could also lose money. When considering how much risk is right for you, consider these two factors; your personal comfort with risk and whether you can absorb market fluctuations.
Ways to invest
Once you have a clear sense of your goals, the time you have to potentially reach them and the level of risk you’re willing to tolerate along the way, you can plan a mix of investments to help you get there.
Asset types: As you build an investment portfolio, you need to know the different categories, including stocks, bonds, cash equivalents and funds that combine them. Each has unique characteristics and risks.
1. Stocks are shares of ownership in a company that give you a direct stake in its success or failure. Stocks tend to offer the highest potential for return but may also carry higher risk than other investments.
2. Bonds are loans to a company or government that promises to pay you back, usually with interest, over a period of time. Bonds generally offer modest potential for return but with moderate risk. However, certain high-yield bonds pose higher risk.1
3. Cash equivalents are often money market mutual funds that invest in short-term bonds. These bonds are usually paid back within a year and are readily convertible to cash. Their potential return is typically low, as is their risk.
4. Mutual funds combine diverse investments, which may include stocks, bonds and other assets. Financial professionals choose the investments and manage the funds, so they may have higher fees than similar exchange-traded funds (ETFs). Mutual funds offer convenience – you don’t have to research those individual investments yourself – as well as diversification (see the “Staying diversified” section). Before investing in any mutual fund, request the prospectus associated with that fund for more information.
Stay diversified
Diversification involves spreading your money across different kinds of investments so that losses in one investment may be offset by gains in others. While diversification doesn’t ensure a profit or protect against loss in declining markets, it can help you manage risk. Diversified investments may suffer less dramatic ups and downs during volatile times than more concentrated holdings. They may even perform better in the long term.
Keeping your balance
Your financial goals are likely to change as your life changes, whether you’re getting married or divorced, having a child, buying a home or switching careers. Meanwhile, the value of your investments—individually and as a whole—will likely be constantly in flux. As a result, it’s important to revisit your investments regularly to rebalance and help you move toward your goals.
When different investments gain or lose value, you may need to buy or sell some of them to keep your asset allocation where it needs to be, a process called rebalancing. Major life events or career changes could also call for adjustments to your investments.
Whether you DIY your investments, use online apps or tools for guidance, or work directly with a financial advisor, it’s important to understand investing terms and concepts so you can know where you stand and plan for the future you want.
Keep researching and learning as you determine the best ways to invest for your goals.
- Investing in fixed-income securities may involve certain risks, including the credit quality of individual issuers, possible prepayments, market or economic developments and yields and share price fluctuations due to changes in interest rates. When interest rates go up, bond prices typically drop, and vice versa.
- It is not possible to invest directly in an index. Indexes are unmanaged.
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Asset allocation, diversification and rebalancing do not ensure a profit or protect against loss.
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