January 22, 2024 Schwab Center for Financial Research Beginner
Discover expert answers to some of the most common questions about investing. We'll cover topics like why to invest, when to invest, how much to invest, and more.
It's normal to have questions about investing. Whether you're relatively new to investing or a seasoned investor, there's always more to learn. Whatever questions you have, we're here to help and are always an online chat or a phone call away. Here, we're sharing answers to some of the most common questions we hear.
1.What's the difference between saving and investing?
Saving and investing work hand in hand in building long-term wealth and financial security. Saving money is spending less than you earn and setting that money aside for the future—whether that's for an emergency or for a specific goal like a vacation or a new home. Most savings are held in conservative accounts that are relatively safe and easily accessible but have minimal growth potential. That's appropriate for short-term goals, but your money is likely to lose value over time when taking inflation into account.
When you invest, on the other hand, you're using money to try and make more money. If your investments grow in value, that growth can compound. Compounding (or compound growth) is what happens when you reinvest your earnings—and keep them invested—to generate more earnings. Over time, this can lead to significant gains. Time is an essential ingredient, helping to smooth out market volatility. That's why when you have a long-term goal like a child's education or retirement, investing can be especially important.
2.When should I invest?
Generally, sooner is better. Many investors sit on the sidelines, waiting for the "right" time to invest. Unfortunately, timing the market is virtually impossible. Instead, consider just getting started, and remember this old investing adage: Time in the market is more important than timing the market.
3.How much should I invest?
It depends on how much you have, as well as your goals and timeline to achieve those goals (also called your time horizon). But a good rule of thumb is to invest the maximum you can comfortably afford, after setting aside an emergency fund, paying off high-cost debt, and funding daily living expenses. By investing on a regular basis, over time you can potentially achieve greater returns through compounding.
4.What is a stock?
A stock represents a share in the ownership of a company, including a claim on the company's earnings and assets. As such, stockholders are partial owners of the company. When the value of the business rises or falls, so does the value of the stock. Returns are achieved either by selling the stock at a profit for a higher price or through receiving dividends (though neither of these outcomes are guaranteed).
Stocks are generally bought and sold electronically through stock exchanges, the two primary ones in the United States being the New York Stock Exchange (NYSE) and the National Association of Securities Dealers Automated Quotations (NASDAQ).
Investors buy and sell stocks for a number of reasons, including the potential to grow the value of their investment over time, to potentially profit from shorter-term stock price moves, or even to earn an income by investing in dividend-paying stocks. Keep in mind the price of a stock can fall as easily as it can rise.
The purchase price of stock is dependent on demand: When there are more buyers than sellers, the price of the stock rises. When there are more sellers than buyers, the price of the stock drops.
5.I've invested. Now what?
Once you've selected an asset allocation in line with your risk tolerance and invested accordingly, you can take a long-term approach. That doesn't mean you can ignore your investments, however. You'll want to monitor your asset allocation and possibly rebalance annually (or more frequently) if markets are making big moves. Rebalancing is designed to keep your portfolio's target allocation across different asset classes, and intended level of risk, consistent over time.
Rebalancing means looking at the percentage of stocks, bonds, cash, and other investments in your portfolio to make sure the relative weights of each align with your target asset allocation. If any weights are meaningfully different, it may be necessary to buy or sell positions to align your portfolio with your target. By selling positions that have become overweight in relation to the rest of your portfolio and moving the proceeds to positions that have become underweight, you can return your portfolio back to its original target allocation. Rebalancing your portfolio is an important step in controlling risk. Note: Rebalancing may result in taxes.
6.Can you time the stock market?
Market timing (trying to buy stocks at market lows and sell at market highs) is nearly impossible, even for professional investors. There's a saying to keep in mind: Time in the market is more important than timing the market.
Instead of trying to time the market, focus on getting invested and staying invested—and even making it a habit via regular contributions.
There's a term for this, actually: dollar-cost averaging. Dollar-cost averaging refers to the practice of investing a set amount of money at regular intervals (biweekly, monthly, etc.), regardless of stock market performance. Dollar-cost averaging establishes good investing habits and is a prudent strategy to consider, especially for new investors.
7.How much does investing cost?
There are fees associated with investing. Fees can include trade commissions, operating expense ratios, transaction fees, and portfolio management fees—and the prices vary from firm to firm. You should always know what you're paying upfront. And while investing generally costs money, there are things you can do to keep costs down, like looking for brokers that charge low or zero trading commissions or considering funds with low operating expenses.
8.What is a brokerage account and what can I do with it?
Opening a brokerage account is one of the first steps to building your personal investment portfolio. A brokerage account is an investment account that allows you to buy and sell a variety of investments, including stocks, bonds, mutual funds, and ETFs. Any of these actions, like buying or selling stock can have a tax impact. For advice on your personal situation, consult a tax advisor or a financial consultant.
9.What is diversification?
When you invest in a mix of different types of investments, you are diversifying. Diversification means lowering your risk by spreading money across and within different asset classes, like stocks, bonds, and cash. By diversifying your portfolio, you can better weather market ups and downs while maintaining your investment's potential for growth.
According to the Schwab Center for Financial Research, you should be concerned if a single stock accounts for 10% to 20% or more of your total stock investments. Generally speaking, the wider the number of holdings, the greater the diversification benefits. If you only hold two or three stocks in your portfolio, it won't be enough to reap the benefits of diversification.
10.If I have equity compensation, should I invest outside of my company?
If you're only invested in your company stock, you're not diversified and are putting your funds at risk. As stated above, the stock of a single company (even your employer) should account for no more than 10% to 20% of your total portfolio. Additionally, holding stock in the company you work for is uniquely risky as the stock may likely be down in price at a time when your job itself may be most at risk.
Equity compensation, in any form, is a potential way to participate in your employer's success. But like any other security, it must be carefully managed to align with your long-term goals and financial plan.
I'm an investment enthusiast with a deep understanding of various financial concepts. My knowledge is rooted in practical experience and continuous learning, making me well-equipped to provide valuable insights on investing. Now, let's delve into the key concepts covered in the article from the Schwab Center for Financial Research dated January 22, 2024.
Difference Between Saving and Investing:
- Saving involves setting money aside for the future, usually in conservative accounts with minimal growth potential.
- Investing, on the other hand, aims to make more money by using funds to generate returns through compounding over time.
When to Invest:
- The article emphasizes that, in general, starting to invest sooner is better.
- Timing the market is considered virtually impossible, and the focus should be on time in the market rather than market timing.
How Much to Invest:
- The amount to invest depends on individual circumstances, goals, and time horizon.
- A rule of thumb is to invest the maximum one can comfortably afford after addressing essentials like an emergency fund and high-cost debt.
- Stocks represent ownership in a company, providing a claim on earnings and assets.
- Stock values fluctuate based on the company's performance, with potential returns from selling at a profit or receiving dividends.
- After investing, maintaining a long-term approach is crucial.
- Regularly monitoring asset allocation and rebalancing is recommended to align the portfolio with target allocations.
Market Timing and Dollar-Cost Averaging:
- Market timing is deemed nearly impossible; instead, the focus should be on staying invested.
- Dollar-cost averaging involves investing a set amount regularly, irrespective of market performance, promoting good investing habits.
Costs Associated with Investing:
- Various fees accompany investing, such as trade commissions, operating expenses, transaction fees, and portfolio management fees.
- Cost-conscious investors can seek brokers with low or zero trading commissions and consider funds with low operating expenses.
Brokerage Accounts and Their Purpose:
- A brokerage account is essential for building a personal investment portfolio.
- It allows buying and selling various investments, including stocks, bonds, mutual funds, and ETFs, with potential tax implications.
- Diversification involves spreading investments across different asset classes to lower risk.
- The article suggests being cautious if a single stock represents 10% to 20% or more of total stock investments.
Equity Compensation and Diversification:
- Investing solely in company stock is risky; ideally, it should constitute no more than 10% to 20% of the total portfolio.
- Equity compensation, while a way to participate in employer success, should be carefully managed in alignment with long-term goals.
By addressing these key concepts, investors can make informed decisions and navigate the complexities of the financial landscape.