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Investing definition
Investing involves putting your money to work by buying assets — such as stocks or bonds — to generate profits (often called returns) beyond your initial investment. When speaking about investing, people often refer to financial markets where investors connect to buy and sell assets, such as stocks or bonds.
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Investing vs. saving
Once you've got extra cash, the first choice is where to put the money. Then it's determining your risk tolerance. In other words, how much of that money are you willing to potentially lose? The answer to that question will decide whether or not you're saving or investing. Saving typically requires you to take on no risk with low or no returns. However, with investing, you take on more risk in anticipation of higher returns.
Risk in investing refers to the likelihood of losing some (or, rarely, all) of the money you've invested. Investments exposed to low risk tend to generate low or moderate returns; investments that carry high risk offer the potential for higher rewards.
One way to identify how much risk to take is to focus on the particular financial goal you're working toward. According to Jay Zigmont, a Water Valley, Mississippi-based certified financial planner and founder of ChildFree Wealth, you can think about this as the "job" you've assigned to your money. And, as in life, there are different tools for different jobs.
For short-term goals — such as a pending home or car purchase or setting up an emergency savings account — you generally want to save, not invest. So having money in a safe and easy-to-access place matters most. Savings, money market or certificates of deposit accounts covered by the Federal Deposit Insurance Corp. allow cash to earn interest without exposing it to risk.
However, returns on these accounts could still be lower than the long-term return you'd earn investing — even in an environment with higher interest rates like we're currently experiencing. So if you're worried that your savings may not keep pace with inflation, Zigmont says to remember the job you assigned to that money, which is to be there when you need it and not earn a high return.
Once you're ready to take on some risk to grow your money over the long term, investing in the stock market is one of the most common places to do so.
» Learn more: What is the stock market and how does it work?
Investing terms, simplified
You may already know stock markets are places where shares of ownership in a company, stocks, are sold. Here are other investing terms to get you beyond the basics.
Asset classes: Categories of investments — including stocks, bonds, cash, commodities and real estate — that have a monetary value.
Bonds: Loans made from an investor to corporations or governments. The investor receives interest while the corporation or government uses the loan to fund its operations.
Diversification: a financial strategy that spreads your investments across assets to reduce risk and exposure to market volatility.
Funds: Pooled investments, or investment "baskets," filled with hundreds or thousands of assets. Index funds and exchange-traded funds offer easy diversification at many price points and are popular among all types of investors.
Investing doesn't require regularly trading any of the assets above. While some advanced, active investors participate in a form of speculative investing called day trading, many investors buy and hold assets for the long term and can reap similar or even higher rewards doing so.
» Learn more: Key investing definitions to know
Investing through retirement and brokerage accounts
Once you've decided to invest, your next steps depend on your financial goals and whether you need to open an account.
If managing for retirement is the job assigned to your money, retirement accounts, such as a 401(k) or an individual retirement account, offer access to financial markets and provide tax advantages. There are a variety of retirement accounts; the main differences concern the payment of income taxes, whether you can open the account independently or through an employer and contribution limits.
If your employer offers a 401(k) or other retirement plan and you're contributing, you're likely already investing. However, if you don't have a retirement plan at work or you want to supplement that plan, you can open an individual account such as IRA.
If you're investing for a non-retirement goal, brokerage accounts also offer access to stocks, bonds, funds and other investments.
You can open an IRA and a brokerage account at an online brokerage firm, then transfer money from a bank or savings account. Some people prefer to transfer a lump sum, while others prefer to set up regular contributions. Once the account is funded, you'll need to pick and choose your investments.
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Next steps
How to choose the right retirement account for you
How to invest in stocks
How to invest in mutual funds
How to invest in bonds
