By many estimates, there are more people investing than ever before. The markets are at all-time highs, and there are more ways to invest than ever before, with easy access to online brokerage accounts, exchange-traded funds (ETFs) and a host of new trading apps.
But would-be investors should keep a few vital lessons in mind before they put their money on the line.
Lesson 1: All Investing Includes Risk
When you invest, you take on some level of risk. And investments that have the possibility of a higher return—such as stocks—come with a higher chance that you could lose some or all of your money. Among stocks, investors can choose between growth and value stocks. Growth stocks are generally newer companies in emerging sectors, such as technology. Value stocks are typically shares of established companies in industries with long track records, such as natural resources, consumer products or manufacturing.
Other investments, such as government bonds, have much lower levels of risk but also offer lower yields. Cash equivalents, such as certificates of deposit (CDs) and high yield savings accounts offer some yield but also come with FDIC protection. Just remember that there is a risk to keeping money exclusively in cash equivalents. This is because your savings could lose their spending power over time as a result of the prices of products and services going up, which is called inflation.
Lesson 2: Establish Your Goals
When you invest, you’re setting aside money that you will need in the future, whether to support your family, buy a home, pay for a child’s education or fund the retirement of your dreams.
Investing just to turn a profit is like taking a trip without a map. Your goals are the key to making the right decisions with your money. Are you investing for a goal that’s five years away or 25 years away? How much of the money you’re investing do you expect to need in the near future?
Setting your goals is also vital to understanding how much risk you’re willing to take. Knowing your time horizon and your risk tolerance can help you decide your investment mix.
Lesson 3: Are You Trading or Investing?
At first glance, trading and investing look the same. They each involve buying and selling stocks. So, what’s the difference?
The main difference is the time frame. Traders buy a stock with a plan to sell it within a short period—between a few hours and a few months—for a quick return. Investors buy the stocks of companies they believe will grow over a span of years or decades.
Typically, investors will favor a diversified approach, getting into the markets through mutual funds and ETFs, which offer exposure to many stocks at once. While traders may use ETFs to bet on sectors or the broader markets, they will often make trades of single stocks. To be successful, traders have to devote a great deal of time to researching the markets as well as individual companies.
Lesson 4: Research Stocks Before You Buy
To understand what you’re investing in, you need to do your homework. For an individual stock, that could mean looking at the annual and quarterly earnings reports of the underlying company and studying its competitors and the trends of the sector the company operates in. For a mutual fund, research could involve looking at the fund’s holdings, its historical performance and volatility, as well as its investment philosophy.
Research can also protect you from getting caught up in the madness of crowds. Often, the stocks and sectors in the news are getting all that press because of past performance and are nearing their peak valuations.
Lesson 5: Investing Can Impact Your Taxes
If your investments work out and you earn money on them, then you will have to pay taxes. As an investor, your earnings come in two forms: yields and returns.
Yields include any interest payments from bonds or cash equivalents and any dividend payments from stocks you own. They are taxed as personal income, and you have to pay taxes on them every year.
Returns are the profits you make when you sell an investment. And those are taxed as capital gains, but only in the year you sell the investments. There are two capital gains tax rates: short-term rates for investments held less than a year and long-term rates for investments held for more than a year. The short-term rates are higher than the long-term rates. The good news is that you can sell investments that have experienced losses at the same time to offset those gains on your tax bill.
At the same time, investments you hold in an IRA or 401(k) offer unique tax benefits because you can fund them with pretax dollars. And Roth IRAs come with their own tax advantages in retirement.
Lesson 6: Stay Invested Through Downturns
If you invest for any period of time, you’ll eventually live through a market downturn in which you’ll lose money, at least on paper. But if you’re investing for the long term, then you’ll see those downturns as short-term setbacks and even opportunities to buy quality stocks at low prices.
Lesson 7: Investing Isn’t Just for the Wealthy
With the rise of online brokerage accounts, investing apps and easy access to ETFs, the markets are open to more people than ever before. At the same time, IRA or 401(k) accounts allow you to invest now and save money at tax time. And the ability to create a smart, targeted portfolio of investments to support long-term goals is no longer something accessible to the wealthy.
No one knows what the markets will do. But the sooner you start investing, the more time your money has to grow.
Bonus Lesson: Mistakes Happen
Every investor loses money at some point. And investing always involves risk. But over the long term, the markets have historically rewarded investors. So, keep going!
Colin Dodds has written for preeminent media and financial companies. He is the author of several acclaimed books, including Ms. Never and Watershed. He lives in New York City with his wife and children.
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