Investing Basics

The world of investing can be intimidating at first, but once you understand the basics, you’ll find it’s not that daunting. Before you start investing, it’s important to pinpoint the reason why you want to invest.

Are you setting yourself up for a comfortable retirement? Is your goal to start a college fund for your children or take a dream vacation? Do you want to save for a down payment on a new home or car? Identifying your goal(s) will help you determine the timeframe for your investment.

Then, you’ll want to set aside enough money to cover three to six months’ worth of living expenses in an emergency fund to cover unexpected short-term needs. Keep this money in an easily accessible, interest-bearing account like a checking, savings, or money market savings account. With a safety net in place, you’re ready to leap into the world of investing.

We’re going to teach you how to make smart choices to help you reach your financial goal.

Investing means putting your money to work in the market rather than saving into, say, a bank account. You should consider investing because, historically, it’s been far more effective at growing your money over time. Even if you’re able to invest only a small amount today, your earnings from the investments can begin to add up, yielding potentially big results in the future. Wealth accumulates through the cycle of compounding. Here’s what this might look like.

Variety’s the spice of life. The same can be said of your investment portfolio. We’ll delve a little deeper into why you want variety (or diversification) later, but first, here’s a quick overview of investment types to consider.

Stocks (equities) represent ownership in a company.

When you buy stock, you purchase a share of the company. As a shareholder, you can achieve returns in two main ways:

1. Selling the stock at a profit when the price of the stock increases.
2. Receiving periodic dividends if and when the company distributes some of its earnings to stockholders.

Stocks are relatively risky (compared to other types of investments) because the stock price may decrease, and there’s no guarantee you’ll be paid dividends.

When selecting a stock, you’ll want to consider how long you intend to own it. For a longer-term investment, you can use fundamental analysis to research stocks based on factors like a company’s earnings or management structure. For a short-term trade, you might rely on technical analysis, which looks at trends to determine the right time to purchase a given stock.

Once you know which stock you want to buy and are ready to place an order, look up its ticker symbol by typing the name of the company in the box on the Research page. You would then place your trade by entering the number of shares you’d like to buy and selecting the order type:

• Market order, if you want your order to go through immediately
• Limit order, if you want to buy the stock at a designated, maximum price
• Stop order, if you want to buy once the stock hits a certain price
• Stop-limit order, if you want to buy once the stock hits a certain price and at a designated, maximum price

Just as with limit orders, there is no guarantee that a stop-limit order, once triggered, will result in an order execution. There is no guarantee that execution of a stop order will be at or near the stop price. The stock will show up in your account if the order executes.

Fractional shares are a piece (or fraction) of a stock share.

As a new investor, you might be eager to own stock in popular companies like Amazon, Tesla, and Apple. Owning a share of stock in such companies can be pricey, with individuals shares costing hundreds or even thousands of dollars. If your budget doesn’t allow you to purchase whole shares, you can buy a fraction of stock depending on the amount you can afford.

Here’s an example of how fractional shares work:

1. A company’s stock is selling at $1,000 share.
2. You only have $200, so you can purchase 0.2 (or 20%) of a share.
3. Your earnings and losses will be based proportionally on your fractional share. For example, if the stock price falls to $900 a share, your holding will be worth $180. If the stock rises to $1,100, your fractional share will be worth $220.
4. If the company pays dividends to shareholders, you’ll receive an amount proportionate to the stock slice you own. So, with a quarterly dividend of $40, you would receive $8.
5. A stock split will multiply your holdings. For instance, a split of four additional shares would give you 0.8 (or 80%) of a share.

As you can see, fractional shares carry the same rewards and risks as whole shares of stock—it’s just proportional to the dollar amount you invest.

Fractional shares are a terrific way for new investors to get a feel for trading without risking a lot of money. The process of buying fractional shares is the same as purchasing a whole stock share: You’ll want to do your research first. With Schwab Stock Slices™, you can purchase fractional shares, or “slices,” from any company in the S&P 500®.

Purchasing fractional shares is similar to buying stock. Once you determine how much you want to spend, you’ll need the ticker symbol for the stock(s) you want to invest in. Then, log in to your account and select Schwab Stock Slices to start trading.

You can purchase between one and 30 stocks at one time with a minimum investment amount of $5 per stock slice. If you’re buying multiple fractional shares at one time, the amount will be divided evenly among your selections. (Any remaining cents will be allocated to one of the slices.) The total investment amount can’t exceed $50,000. You can only use Market Orders for fractional shares.

Your fractional shares will appear in your account if the order executes.

An exchange-traded fund (ETF) is an investment fund that pools together individual assets like stocks, bonds, or commodities. Buying one ETF can provide broad, diversified exposure to an asset class, region, or specific market niche without having to buy scores of individual securities. This makes ETFs a popular option for diversifying your portfolio. You might even consider building an all-ETF portfolio if you are looking for tax efficiency.

Most ETFs track market indexes, which means they try to replicate the performance of an index. For example, an ETF that tracks the S&P 500 Index is trying to mirror the performance of the S&P 500.

ETFs trade like stocks on an exchange, and their price changes throughout the day as shares are bought and sold. Generally, your minimum investment will be the price of one share of the ETF. Also, ETFs are usually more tax efficient than mutual funds because they often generate fewer capital gains. Keep in mind that market volatility may affect the price of ETFs.

Don’t get overwhelmed by the number of ETFs on the market. Familiarize yourself with the common types of ETFs and their benefits, risks, and costs. When looking at costs, you should consider the ETF’s operating expense, bid-ask spread, trading commissions, and potential discounts and premiums to its net asset value (NAV).

Then, look for funds that represent the asset class you want to invest in.

You can use your brokerage account to buy and sell an ETF like you would stock. All you need is the ETF’s ticker symbol, quantity, and order type to place your trade.

There are many ways to round out your portfolio. Two common investment types are mutual funds and bonds.

Mutual funds are an easy way to build a diversified portfolio. A mutual fund pools money from many investors, and then a fund manager invests that pool in a broad range of assets—such as stocks, bonds, and other securities. Like ETFs, you buy a stake in everything the fund invests in and any income those investments generate. You don’t have to worry about researching, buying, and tracking every security in the fund because a fund manager will manage the fund for you.

Unlike ETFs, you generally purchase a mutual fund at a flat dollar amount regardless of share price, and trades are executed only once a day at market close.

Mutual funds are managed either actively or passively. With an actively managed fund, the fund manager attempts to outperform the market by selecting investments based on a particular investment objective and strategy.

A passive, or index, fund seeks to track a specific market index (like an ETF) instead of trying to outperform it. This means that if the market is down, the index fund is likely to perform as poorly as the index it follows. Compared to an actively managed mutual fund, an index fund typically has lower costs and is more tax efficient.

A bond is like an IOU—a promise to pay back money you’ve loaned, with interest. Cities, states, the federal government, government agencies, and corporations issue bonds to raise money for purposes such as building roads and improving schools or technology. This makes the bond market much larger and more complex than the stock market.

Because of their fixed repayment schedule and less-volatile prices, investment grade bonds are often considered to be fairly stable investments. However, it is possible for the bond issuer to default—that is, not pay back the loan. To guard against such a scenario, you’ll want to look for bonds with a high credit rating. You can research bonds rated from BBB- to AAA by Standard & Poor’s and from Baa3 to Aaa by Moody’s Investors Services (AAA and Aaa being the highest ratings) using Schwab BondSource® under the Research tools on your dashboard.

Your financial goals and your risk tolerance should drive your investment strategy. If you have multiple goals, categorize them into short-term (less than one year), medium-term (one to five years), and long-term (more than five years). You can use our tools and resources to determine how to reach your target amount.

The next step is to build your portfolio with a combination of stocks, bonds, cash, and other investments through allocation and diversification. Allocating your money among various investment types in different ways can help reduce your portfolio’s overall risk. Stocks generally carry the highest risk, cash the lowest, and bonds can be somewhere in between.

Diversification within each asset class also can help protects your portfolio from extreme market activity. Each asset class—and even the individual investments within them—can react differently to changing market conditions, so you’ll want to include a variety of investments to meet your goals.

In general, the more time you have to reach your goals, the more aggressive your approach can be. A heavier allocation in stocks can provide greater growth potential than a portfolio focused on bonds, other fixed-income assets, and cash investments that offer predictable income and stability.

Stocks and bonds can be broken down further into different types. For example, you can invest in stocks that represent large companies (large-cap), small companies (small-cap), international companies, and everything in between.

You can segment your investments even further. For example, with large-cap stocks, you can invest in different sectors (like technology, health care, and communications). Within each sector, you can also invest in different industries. For example, within the health care sector, you could consider pharmaceuticals, biotechnology, or equipment industries.

The first time you experience a huge loss in your portfolio, you might be tempted to sell off your investments to salvage what’s left. Instead of panicking over a short-term market downturn, focus on the progress you’re making toward your goals.

Most importantly, you should check your portfolio regularly (but not overly frequently) to ensure your investments remain aligned with your original allocation. Rebalancing your portfolio quarterly, semi-annually, or yearly will help you stay on track of your goals. By rebalancing, you will keep your overall portfolio aligned with your target asset allocation. You may also want to make adjustments when you experience a major life event, such as a new job, birth of a child, marriage, or divorce.