Saving & Investing Basics

Whether its scrolling on TikTok, watching the news, or even just speaking with friends or family, you’ve probably heard about the importance of investing.

Investing can be thought of as putting your financial resources to use through certain endeavors or opportunities with the intent that those activities bring in some type of financial return or profit. In its simplest terms, investing means using your dollars in such a way that the money you have earned is in a position to start producing its own earnings- its money that is working for you!

Younger adults in particular, such as students and newer professionals, tend to be in a position to benefit significantly through investments due to the Time Value of Money and the power of compounding interest. The Time Value of Money is a financial principle in which money today and in the now has the potential to be of more value than the same sum of money in the future since the dollars you have in the present have a possibility of gaining interest when invested. As your money begins to gain interest, the interest earned can be reinvested and begin to earn its own interest. This results in a compounding effect and the value of the money you invested will oftentimes see exponential growth as time goes on.

The following figure produced by CNBC in partnership with Acorns, demonstrates the Time Value of Money and the power of compounding interest. An individual who invests earlier and with less money will out earn an individual who starts investing later, even if that person will invest more money over time comparatively.

Image

With estimates for ideal long-term savings and retirement funds landing between $1 million and $2 million, the power of compounding interest can help you prepare for the future and foster your financial well-being for years to come.

Allowing your money to work for you in an investment is a critical component of your personal finance foundation. For decades, the typical long-term investment has generated an average, annual interest return of around 8%, while money stored in a standard savings account through a bank or credit union generally produces less than .50%. Yet as economical as investing can be, not all of our dollars are designed for growth. Some of your dollars are better suited for stability, such as the money you use to pay your bills and buy your groceries. Other dollars should be used for security, like savings in your emergency fund or rainy-day fund.

Moreover, investing your money never comes with a 100% guarantee of return or profitable earnings. Countless of individuals have entered into an investment with hopes of making money only to walk away with less than what they started with. So how do you know when your dollars are in a position to take on the risk for the potential of growth and earnings while making sure your most immediate and short-term financial needs are being met? A great place to start is by examining the type of savings goal you are pursuing and considering that goal within the context of the relationship between time, risk, and liquidity needed before the goal comes to a head. 

balancing saving & investing Goals

Before committing to saving your money through investments alone, it's important to realize that not every dollar we put away for the future is designed to work for us through growth. In some instances, you need dollars that are designed to stabilize your finances or provide a certain degree of security as you navigate life. Money that you use to pay rent and buy groceries for example, isn't suited for the investment track as you know you will be using it within the week or the month. Similarly, funds that you need for an emergency aren't the ideal kinds of dollars to be investing- you don't know when an emergency might hit, and you can't afford to make these funds inaccessible, let alone take on the risk that your dollars might actually lose value in a traditional investment. 

Reflect on the current status of your traditional savings and ask yourself the following: 

• Do I have enough money in a standard savings account to cover 2-3 major bills or unexpected events that might come up in a given month? 
• If I am in the workforce or rely heavily on an outside income stream, do I have enough funds saved up to survive several months of unemployment and a loss of that income stream before I might be able to reestablish a wage source?
• Do I have any significant financial responsibilities or changes coming up within the next 6 months-1 year? 
• Have I taken the time to separate out and articulate all of the emergencies or events my current savings could cover? Or am I more so "double-dipping" in a sense and mentally covering these different costs with the same lump sum of money? 

Depending on how you respond to these prompts, you may find that you aren't able to prioritize saving through investing as much as you thought, and that you still need to focus on simply building up your savings foundation, especially if you are nearing the end of your time as a student and will be preparing for even more financial responsibilities that come with graduating and entering the workforce. 

If you still aren't sure whether or not you can prioritize saving through an investment or if you are more so at a place to simply save outright in a more basic sense, there are additional considerations to review that help you make that informed decision. 

TIME

After you have taken an assessment of your savings situation, you will want to take a deeper dive and reflect further on the time horizon before the goal that your possible investment would be supporting comes to fruition. Historically, long-term investments of any kind go through significant cycles of ups and downs, growth and decline. The longer you can spare to have your money in an investment, the greater the odds that your funds can weather the tumultuous movements of the economic market and persist with returns rather than losses. This is one of the reasons why it is suggested to save for retirement through investments, rather than pursue growth with something like a rainy-day fund or savings for a trip you plan on taking in just a short time away. Life events in the immediate or short-term future do not have enough of a time horizon to warrant saving for them through an investment vehicle.

RISK

Hand in hand with considerations related to time are reflections on the risk you inevitably take through an investment. Generally speaking, the more time you have to allow your money to grow before needing it to meet a specific financial need or goal, the more risk you typically can afford to take. In the world of investing, the greater the risk that is involved with your endeavors to gain growth, the more potential for greater rewards and higher earnings. For students and new professionals, creating an investment portfolio designed for your retirement savings can probably start out with assets that are deemed riskier and with the potential for more growth than someone in their 50s who is getting closer to actually retiring. As you think about what to actually invest in, your risk tolerance, time horizon, and level of need for growth versus maintenance will impact your decisions and overall investment strategy.

LIQUIDiTY

Finally, the level of liquidity or access you need to your dollars will influence your investment decisions. Certain investment vehicles and assets can tie up your money for days or even years. For example, there are several types of government bonds, a form of investing where you serve as a lender of sorts to the federal government, that require you to maintain your deposit for a year minimum; 5 years minimum if you want to avoid any penalties or fees. Using these types of government bonds to save for something like relocation after graduation probably wouldn’t make sense since most academic programs last between 2-4 years. You aren’t going to be able to push of relocation, so in that instance you’d be forced to take on a financial penalty just to gain access to your money. Reflect on your timeline of need and access date of your dollars when deciding on an investment approach.

Due to the relationship of time, risk, and liquidity and the nature of investing, many students and younger professionals will not have the means to set aside hundreds or thousands of dollars every month to meet growth goals and save for the future. You'll probably need to prioritize your emergency and short-term savings significantly first. But that doesn't mean there won't be room to start investing as well! Take the time to think about your financial reality and your immediate as well as short-term needs. Maybe a bulk of your savings will need to focus on providing you with security first and foremost, but even $25 or $50 dollars put towards in an investment vehicle can grow tremendously over time. Need an example? Check out the video we have featured in our Additional Resources section on the power of time and saving for retirement by Better Money Habits!

After reviewing your financial reality within the context of an investment approach and time, risk, and liquidity, the first step you’ll need to take is to decide what type of investing account you will use. There are two main types of investing accounts to consider:

• Retirement Accounts
• Brokerage/ Non-Tax Advantaged Investing Accounts

Retirement Accounts 

As the name suggests, retirement accounts are investment accounts specifically designed to save for retirement. These types of accounts generally offer additional financial incentives on top of the potential to achieve growth via interest earnings. Depending on what type of retirement account you are using, these perks include tax breaks and/or possible matching contributions on top of what you are putting into the account. Within the umbrella of retirement accounts, there are two subsets: individual arrangements and employer-sponsored accounts. 

Individual Retirement Arrangement

Individual Retirements Arrangements or IRAs are retirement savings account created by the federal government. These accounts are designed to help individuals save for their retirement years and are not connected to any employment or work obligation. Since most college students do not have access to Employer-Sponsored retirement options while in school, IRAs are a great way to save for retirement at a young age.

The following chart outlines important information to know for investing through an IRA: 

Overview of IRAs

Employer-Sponsored Accounts 

While generally not a viable option for students, another way individuals can oftentimes save for retirement is through accounts sponsored by their employers. The most common types of employer-sponsored retirement accounts are: 

• 401k Accounts
• 403b Accounts 

The following chart outlines important information to know for investing in the most common types of employer-sponsored retirement accounts: 

Overview of 401k & 403b Accounts

For more information on retirement accounts, visit the IRS Website! 

Brokerage/ non-tax advantaged investing accounts

The other main type of investing account is called a brokerage account or a non-tax advantaged account. These types of accounts let you freely invest at will without contribution limits, age for withdrawal restrictions, and without a connection to an employer. While brokerage accounts come with far more flexibilities compared to retirement accounts, they do not have the same types of financial incentives or tax breaks. In fact, maintaining a brokerage account comes with unique tax implications that depend on the type of investment you hold and for how long. To learn more about the tax implications on investing through brokerage accounts, check out this article by Vanguard, an investment firm and broker platform.

Individuals interested in investing in both retirement accounts and brokerage accounts can do so without penalty. If you are unsure which account is right for you, reflect on the purpose of your savings, the timeline of your financial goal, and whether you desire financial benefits or financial freedom more. 

After you've determined the type of account you want to invest through, your next step is to open the account. 

For any employer-sponsored accounts you choose to participate in, you'll be given account access through the respective plan holder, brokerage firm, or investment company that your employer is working with to offer their 401k or 403b. 

For IRAs and brokerage accounts, you will need to decide what company or platform will hold your account. If you use a large financial institution or bank for your everyday finances, that same entity may offer different investing accounts or be part of a larger parent company that has an investing firm component. If your financial institution does not offer investing opportunities or you aren't satisfied with the choices they provide, a simple internet search for "Setting up an IRA" or "How to open a Brokerage Account" will also give you an overview of who you can work with to open your account and the process they use for setting up your access. Be mindful that sites you encounter during this search, like Nerd Wallet and Bankrate, generally receive compensation for featuring firms and companies on their platform. That's not to say that those particular investing firms and brokerage sites aren't suitable options for you to consider, however it does mean that you may need to do additional research and think critically before deciding on who is holding your account. 

Now that you have identified the type of investing account you will use and where the account will live, what will likely be the most challenging step for first time investors awaits: what will you actually invest in? 

what's considered an asset?

The growth your investment account will experience first and foremost depends on the types of assets you choose to invest in. The Personal Finance Extension Initiative sponsored by the USDA defines an investment asset as "...tangible or intangible items obtained for producing additional income or held for speculation in anticipation of a future increase in value". 

The most common types of assets are money market instruments (ex. Certificate of Deposit), equities (ex. Stocks) and debt (ex. Bonds). For the purposes of your investment account, this section will focus on equities and debt. To learn more about money market instruments, check out this article by Investopedia! 

equities & stocks 

Investing in equities means that you purchase shares or stakes in a company, giving you a percentage of ownership in the company. As an owner, you may be able to share in the financial successes that company experiences. The larger your stake in the company, the more ownership you possess, which in turn, means a greater amount of growth and financial benefit you could be entitled to.

The type of financial success or earnings you may realize through your equity can come in one of two forms: 

• Capital Gains 
• Dividends 

Capital Gains 

A capital gain occurs when there is an increase in the value of a stock or share compared to the price you originally purchased it at. For example, if you bought a share of a company for $100 in the Summer, and the cost of that respective share rose to $150 in the Fall and you decided to sell at that time, you would realize a capital gain of $50. 

Dividends

Another way you could see financial growth in an investment in equity is through dividends. Dividends are essentially payouts of profit to shareholders by companies to the investors that own stake with them. Dividends typically have a set payout schedule, oftentimes on a quarterly basis. Say you own the equivalent of 10 shares in a company. Based on the company's performance during the year, they were able to pay out $5 per share on a quarterly basis. The profit you would realize in this example would be $200 ($5 x 10 shares x 4 payouts).

 

It is possible to receive both dividends and capital gains for the same investment. However, it is also possible that your share in equity will result in a capital loss if the value of the company's stock declines, and it is possible to not receive a dividend if the company you invested in does not realize profit or has significant increases in operating costs that prevent the company from sharing profits. Additionally, your earnings will be impacted by your tax responsibility, which can depend on the type of equity payout you receive and for how long you held your equity before generating income. Learn more about taxes and investments for Capital Gains and Dividends on the IRS website!

debts & Bonds

Investing and debt may not seem like financial concepts that you want used together, however debt in the form of buying bonds and serving as lender is another very common investment asset. A bond is an investment vehicle wherein you serve as a lender, typically to to a government or corporation. Similarly to the way a student loan lender makes money off of you borrowing educational loans, when bonds are part of your investments, whoever you lend to agrees to pay back your principal lending amount as well as pay you a set amount of interest. Oftentimes, the interest you are set to receive is paid out in fixed intervals, such as on a semiannual basis. For example, if you decided to purchase a U.S. Treasury Bond, you may agree to lend the government $1,000, at an interest rate, also called coupon rate, of 5% that is paid out every six months. You would receive $25 per interest pay out. 

Likewise to other investment assets, bonds do not come with a guarantee of profit or return, however the risks with a bond asset tend to be less, especially if you are lending to an entity that is deemed to be a trustworthy borrower. To help communicate the level of risk to investors, bonds will receive ratings based on the likelihood that you will be paid back according to the terms of the bond agreement. To learn more about bond ratings, check out this resource on Fidelity's (an Investment Firm) website!

Balancing the mix of stocks & bonds

While you may consider adding other assets to your investment vehicle, most beginning investors will focus their efforts on finding the right balance between equity and debt, stocks & bonds. Generally speaking, those looking for more growth and who can afford to take more risk will put a bulk of their assets behind equities, specifically domestic or U.S. equities. Those whose main goal is to preserve their investing  capital due to smaller growth goals or limited time constraints may shift their investing assets behind debts through different bonds. Vanguard, an investing firm based in the U.S., provides a general example of how investors with different goals, risk tolerances, and time horizons may structure their investment assets accordingly. Check out their educational topic page on their website!

If you need additional help identifying the best asset allocation and investing strategy for you, reach out to a financial advisor or customer service rep through your broker, retirement account plan holder, or investing firm.

The world of investing is a dynamic and ever-evolving environment. Whether your are looking to achieve significant growth or you are interested in a steadier increase in your funds while preserving overall capital, you may find that your investment strategy needs to change and adjustments to your assets are warranted. While over-monitoring your investments can lead to impulsive decision making and anxiety over planning for the future, there are several factors that may indicate it's time to revisit the drawing board and make changes to your investment strategy: 

• You've had a change in your financial circumstances 
• Your tolerance for risk has changed 
• The time horizon for your goal has changed 
• There has been a significant and/or longer-term change in the economy 

Read more on reevaluating your investment strategy with Wells Fargo's education center! Remember, it is also okay to ask for help when you need it and seek professional advice accordingly. 

Along with the basic overview of how to start investing- knowing your account options, how to open the account, and what your asset choices are- there are several other terms and concepts that are helpful to know as you think about putting your money to work for you: 

Dollar-Cost Averaging 

An investment approach in which you deposit a fixed amount in your account on a regular schedule, oftentimes monthly basis, as means to average out purchase amounts and share prices as opposed to waiting for the "ideal time" in the market to make a lump sum deposit and buy when share prices are lower. 

Read more about the benefits of Dollar Cost Averaging on the Charles Schwab resource center!

Diversification 

An investing strategy used to minimize risk by allocating dollars across different assets as opposed to solely investing through one asset. For example, choosing to purchase $100 in equity across 100 companies instead of purchasing $100 in equity through one individual company. By spreading out your investments across multiple assets, you may be able to mitigate the impacts of poor performance as different assets, like equity in companies from a variety of sectors and industries, will likely have different ups and downs or growth and decline cycles from one another. 

Read more about the benefits of diversified investment portfolios on Finra's Learn to Invest topic pages!

Index Funds 

Index funds can be thought of as a pool of assets that are compiled to closely mimic or perform similarly to an existing benchmark or collective sector in the broader economic market. For example, an Index fund that was created to mirror the performance of the S & P 500, a market index used to gauge the performance of the top 500 companies in the U.S., would essentially spread your investment across the same companies. If the S & P 500's performance ended the year up 15%, your investment would most likely have a rate of return close to the same percentage that year as well. Index funds are oftentimes thought of as a better option for beginning investors to consider as determining asset allocation is essentially done for you. With a more passive approach to deciding what your asset allocation will be, investors tend to see lower costs and fees associated with this type of investment vehicle. 

Learn more about Index Funds on Investopedia! 

Mutual Funds 

Mutual funds are another type of pooled or compiled asset allocations that are owned and operated by companies and fund managers. Mutual funds are actively managed by professionals- the specific combination of assets that the fund invests in are determined by these individuals. There is significant variety in the types of mutual funds offered as well as how earnings can be realized- such as through capital gains or dividends. Mutual funds may also have higher fees compared to other types of funds due to the active management associated with this type of investment vehicle. 

Learn more about Mutual Funds on investor.gov, an educational resource center created by the U.S. Securities and Exchange Commission!