Investing basics: FAQs
If you're new to investing, you probably have a lot of questions, like:
- What is the difference between saving and investing?
- Why should I invest?
- When should I invest?
- How do I invest?
- How much should I invest?
- Is investing risky?
- What are some common types of investments?
- How can I invest without paying a lot of fees?
Saving is putting money aside for future use. It's important to save so you can cover fixed expenses, like mortgage or rent payments, and to make sure you're prepared for emergencies. Generally, people put their savings in bank accounts, where up to $250,000 is insured by the Federal Deposit Insurance Corporation (FDIC).
Investing is when you put your money to work for you. You buy an investment, like a stock or bond, with the hope that its value will increase over time. Although investing comes with the risk of losing money, should a stock or bond decrease in value, it also has the potential for greater returns than you’d receive by putting your money in a bank account.
The goal of investing is to grow your money over time
In this example from 2000 to 2020, Diego put $3,000 each year in a bank account to fund his short-term spending needs. The interest he received on his money averaged 1% over 20 years, which was relatively low. But the trade-off was that it was safe and accessible. Diego had 67,083 after 20 years.
Over that same period, Alexis was planning for her retirement, so she invested $3,000 each year in a moderate portfolio, which returned an average of 6% over 20 years. Alexis had $140,407 after 20 years.
Source: Schwab Center for Financial Research. The moderate model portfolio (allocated 35% large-cap stocks, 10% small-cap stocks, 15% international stocks, 35% fixed income and 5% cash investments) may not be suitable for all investors. Returns assume reinvestment of dividends and interest. Fees and expenses would lower returns. This chart represents a hypothetical investment and is for illustrative purposes only. The actual rate of return will fluctuate with market conditions. Past performance is no guarantee of future results.
This opportunity to earn more money comes with additional risks—including the loss of some or all of your investment. Different types of investments have different levels of risk, so it's important to understand your Tooltip —or your appetite for risk. If you're working toward a long-term goal, it’s a good idea to consider investing as opposed to saving. Recently, savings rates haven't kept up with the rate of inflation. This means that if you put all your cash in savings, the actual purchasing power of your money could shrink over time.
Inflation can severely erode your purchasing power over time
This chart shows the impact of inflation on the purchasing power of a fixed, annual $50,000 pension. It’s important to understand the effects of inflation because it decreases the amount of goods or services you can buy (purchasing power), all else being equal. Here we see that with a hypothetical 3% inflation rate, the fixed, annual $50,000 pension can purchase only $37,200 worth of goods or services at the end of 10 years (a 26% loss of purchasing power) and only $27,684 worth of goods or services at the end of 20 years (a 45% loss of purchasing power).
Source: Schwab Center for Financial Research. The “nominal” amount is the stated value. The "real" amount is the value adjusted for the effects of inflation. Inflation is represented by the change in the Consumer Price Index for AII Urban Consumers (CPI-U). From 2001 to 2020, inflation averaged 2.1%. But during some periods in the past, the average was much higher: It averaged 6.2% from 1970-1989. Past performance is no indication of future results.
Investing can help you achieve financial goals, like buying a home or funding your retirement. By investing, you're putting your money to work to reach these goals. Let’s see how it works.
The power of compounding: A little goes a long way
Alexis invests $3,000 a year for 40 years and receives an average annual return of 6%. At the end of 40 years, her portfolio is worth $492,143. This amount consists of $372,143 in total earnings and her principal investment of $120,000. How did her portfolio grow so much? It’s because every year, Alexis's 6% return is on a new, larger balance (made up of her initial investment, her subsequent yearly investments, and the money she’s earned from dividends/interest and capital appreciation on the investment). That's the power of "compound returns."
Source: Schwab Center for Financial Research. The chart above is hypothetical and for illustrative purposes only. Earnings assume a 6% annual rate of return including the reinvestment of dividends and capital appreciation and do not reflect the effect of fees or taxes which would reduce the overall amount.
Generally, sooner is better. Historically, the longer you invest, the less impact the short-term ups and downs of the market have on your return.
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.
Early beats often
Alma invests $10,000 when she’s 31 and lets the money grow for 20 years. Dave invests $2,000 a year on the same day each year, starting at age 41, for only 10 years. By the time they both reach age 50, Alma has nearly 15% more than Dave even though she invested half as much. Alma has an ending balance of $32,071 compared to Dave’s balance of $27,943.
Source: Schwab Center for Financial Research. The chart above is hypothetical and for illustrative purposes only. Returns assume reinvestment of dividends and capital appreciation. Fees and expenses would lower returns. Earnings assume a 6% annual rate of return and do not reflect the effect of fees or taxes which would reduce the overall amount.
It depends on how much you have, as well as your goals and timeline (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, funding daily living expenses, and saving for any short-term goals. By investing on a regular basis, over time you can potentially achieve greater returns through Tooltip .
Have questions? Schwab can help.
Investing has risks. The goal is to manage them. We believe the best way to do this is to have a plan, know when you’ll need the money, and diversify your portfolio.
Diversification spreads your money around different types of investments, so you're not putting all your eggs in one basket. You want to divide your money among stocks, bonds, and cash investments based on your risk tolerance and timeline. Dividing even further, you could include different types of stocks, such as Tooltip , Tooltip and international. And within those divisions, you could have stocks representing different sectors (for example, technology and health care). The ultimate goal is to own investments that don’t historically move in tandem.
Investment types perform differently
We believe it's a good idea to own a variety of investment types—like stocks, bonds, or cash investments—as they can perform differently over time. In this chart, we see the variation in performance of stocks, bonds, cash, and a moderate portfolio that includes all three, over a 20-year time horizon.
The indexes used are: S&P 500® Index (large-cap equity), Russell 2000® Index (small-cap equity), MSCI EAFE Net of Taxes (international equity), Bloomberg Barclays U.S. Aggregate Bond Index (fixed income), Citigroup 3-Month U.S. T-Bills (cash equivalents). The Moderate Allocation is 35% large-cap equity, 10% small-cap equity, 15% international equity, 35% fixed income, and 5% cash, using the indexes noted. Past performance is no guarantee of future results. The example is hypothetical and provided for illustrative purposes only. It is not intended to represent a specific investment product. Dividends and interest are assumed to have been reinvested, and the example does not reflect the effects of taxes or fees. Indexes are unmanaged, do not incur management fees, costs and expenses, and cannot be invested in directly.
Every dollar you pay in fees is one that can’t generate compounding returns. That said, investing generally costs money. So what can you do?
- Look for brokers that charge low trading Tooltip .
- Consider funds with low Tooltip .
- Look for Tooltip , no transaction fee mutual funds that allow you to buy and sell shares without paying these common fees.
For more on this, read Fees and Minimums.
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