A good rule of thumb for managing your investments is to allocate your total investment portfolio among lower-risk, medium-risk, and higher-risk investments. Using this method, as well as choosing different asset classes (stocks, real estate, bonds, and cash investments), may help you to maximize your earnings potential.
In addition, if you have several mutual funds, make sure their investment objectives are different from each other. There are many categories of funds. Some stock funds invest in big companies, for instance; others seek out small companies. Funds also may differ in the types of industries and sectors of the economy they invest in. Some bond funds hold government bonds, some hold corporate bonds. Funds may invest at home or abroad.
When you spread your investments across a variety of categories, you are establishing what is called a diversified portfolio. By not putting all your financial “eggs” in one basket, you help to minimize the risk that all your holdings will lose value at the same time.
Looking at Investment Options
As a young investor, you have a variety of investment options to choose from. Following is some general information to help you understand how mutual funds, stocks, and bonds differ:
- The mutual fund purchases shares of stocks and bonds in a number of different companies, using money pooled from many investors. A portfolio manager is in charge of overseeing the choices of investments within the fund, sparing you the time required to research individual companies you may want to invest in.
- The value of the mutual fund may go down if the fund’s holdings go down in value. The opposite is true, too. Changes in value may result from factors such as an overall economic change or a shift in investor confidence in a particular sector of the economy.
- The amount you earn in a mutual fund is not guaranteed, unlike a deposit you make in a savings account with a certain guaranteed interest rate.
- Stock mutual funds tend to be better suited for long-term goals. The stock market is unpredictable over the short term, but historically it has produced earnings over the long haul that outpace inflation.
Be sure to research a mutual fund before investing in it. Start with the fund's prospectus, a document for investors that every mutual fund is required to issue.
- You become a part owner of a company when you buy stock in it. If the company does well, the value of the stock increases. You make money by selling stock when it’s worth more than you paid for it.
- You may receive a dividend as a result of the company's profit. A dividend is the sum of money the company pays to its shareholders out of its earnings. Companies usually disperse dividend checks quarterly or yearly. Not all companies pay dividends; instead, they may decide to apply the profits in ways designed to help grow the company and make it more attractive to investors.
- There is no guarantee that stocks will increase in value. In fact, some stocks lose most of their value because of factors such as bad business decisions by the managers of the company, bad timing bringing a product to market, or unfavorable publicity.
- It is important to diversify your stock purchases. A diverse portfolio helps you spread the risk of a market downturn over a range of investments, helping you reduce how susceptible your collection of investments is to losses.
- You are essentially loaning your money to the bond issuer—a corporation or government—when you buy a bond.
- Your goal is to earn favorable interest rates and any available tax advantages. With certain types of bonds, you won't be taxed on the interest you earn from them.
- Bonds are called "fixed-income" investments because you receive a set rate of interest over the life of the bond. The bond issuer returns the amount you loaned (your original investment) when the bond "matures" at the end of the bond agreement.
- The safety of a bond depends on the issuer. Credit-rating agencies assign ratings to bond issuers based on their analysis of an issuer’s ability to meet the terms of the loan. U.S. Treasury bonds are considered safe because they are backed by the federal government.
- Buying individual bonds typically is riskier than buying shares of a bond mutual fund. Whichever approach you take, it’s smart to diversify your bond investments to help manage risk.
For additional information on investing, check out the American Association of Individual Investors, the Financial Industry Regulatory Authority (FINRA), and the Alliance for Investor Education.
Retiring—the Day Will Come
Even though your retirement is a long way off, investing just a small amount of money each month (perhaps automatically from your paycheck) now will allow many more years for you to grow your investment portfolio. The earlier you start saving for retirement, the greater you can build your income cushion to support you in your retirement years.
Educate yourself about saving for retirement by using online resources such as www.investoreducation.org. For additional information, visit the Planning for Retirement section of this website.