Investing for beginners starts with understanding fundamental investing terms and acronyms and how they can apply to your financial life. Learning the language can help take away the intimidation factor and build the confidence you need to get started on developing a solid investing strategy.
“Knowledge is power,” says Bright Dickson, Truist’s resident expert on happiness and co-host of the Money and Mindset With Bright and Brian podcast. “Knowing more about investing allows you to take intentional action and have more control.”
The more we know and do, the more our financial confidence grows, which has a direct impact on our well-being.
Read more: How your money habits can impact your well-being
When it comes to investing for beginners, here are terms everyone should know, starting with a few basics:
When a company is publicly traded, shares of the company are offered to investors—and pretty much anyone is eligible to purchase those shares. When you invest your money in one or more shares of a company, it’s commonly referred to as “buying stock.” If you buy shares of Apple or Microsoft, you own stock, which represents owning a small percentage of that company.
An important investing tip for beginners: The current value of a stock represents a market-based estimate of the current value of the company. Stock prices can go up or down based on predictions about where a company is headed in terms of profitability, but they’re not guarantees of the outcomes.
When you buy bonds, you’re actually lending money to an entity for a typically small, fixed return over a specific period of time. While the returns on bonds are typically small, they’re easily predictable, unlike the returns on stocks. Bonds can be offered by governments and corporations alike as a means to raise money.
Your portfolio is your collection of investments. It can include a mix of stocks, bonds, cash, and other types of investments like commodities (e.g., gold or silver) or even cryptocurrencies (e.g. Bitcoin).
The types of investments that make up your portfolio and the weight of each investment is often referred to as your asset mix. For example, your portfolio could consist of a mix of 70% stocks and 30% bonds.
If you’re an aggressive investor with many years for your investments to grow, you can still be diversified and mostly invested in stocks. Or, for a more conservative short-term approach, consider diversifying by investing more in bonds.
Speaking of asset mixes and being diversified, diversification in investing refers to the idea of not putting too much money into the same investment, like one specific stock. “Don’t put all your eggs in one basket” is a common phrase in the world of financial advising—and when people say it, they mean to diversify. If done properly, this can help mitigate some of the risk of investing for beginners—if one stock in your portfolio underperforms, it’s only a small percentage of your total investments. Plus, economic events that can cause some stocks to decline may sometimes cause other stocks to rise.
If you’re a full-time employee, there’s a good chance you have access to an employer-sponsored 401(k) retirement savings plan, which is what many companies offer today in place of pension plans.
A 401(k) allows you to invest part of every paycheck—before taxes are taken out—to gradually build your retirement savings. Many employers also offer additional 401(k) benefits, like matching up to a certain percentage of your contributions.
Read more: 7 tips for hitting your retirement goals
Retirement accounts like a 401(k) or IRA are often called “tax-advantaged” because—unlike a personal brokerage account—your investments grow tax-free. With a traditional 401(k) or IRA, however, you may, depending on your income tax bracket at the time, pay income tax on your withdrawals after your retire and (unless certain exceptions apply) additional taxes may be imposed if you withdraw funds prior to age 59 ½.
Similar to a 401(k), an Individual Retirement Account (IRA) is the retirement savings vehicle of choice for many Americans—more than 1/3 of American households have one.1 Anyone can open an IRA to save for retirement—you don’t need to go through an employer to start investing in one. And like a 401(k), your IRA contributions grow on a tax-deferred (traditional IRA) or tax-free (Roth IRA) basis.
A concept introduced in 1997 and named after Senator William Roth, a Roth IRA or Roth 401(k) is simply another option for retirement accounts in which you go ahead and pay taxes on your contributions. The potential advantage? Your investments still grow tax-free, and you don’t have to pay taxes on your withdrawals in retirement, including any growth in the amounts you contributed to your Roth IRA.
While nobody can predict the future, some financial pros argue that your income tax rate in the future could be higher than your income tax rate today, which is why some retirement savers opt for a Roth account. Some savers even choose to invest in both a Roth account and a traditional account. While not a practical concern for most retirement savers, the IRS does impose limits on how much of your retirement savings you can invest on a tax-deferred or tax-free basis. Information concerning applicable contribution limits can be obtained for your IRA or 401(k) plan provider or a tax professional.
Whether through a retirement or brokerage account, if you earn 5% on an investment over the course of a year and keep your earnings invested, earning 5% the next year will mean even more. Over a long period of time, this concept can prove powerful for your finances—and it’s a concept Brian Ford, Truist’s head of financial wellness, says is crucial for saving for retirement.
“If you were to save 10% of your income for 30 years without earning interest, how many years of income will you have saved? Only three,” he says. “The point is, it’s difficult to save your way to retirement without investing—we need the power of compound interest over time.”
To illustrate the power of compound interest, let’s say you start with $10,000 and assume you earn a constant 5% on that investment each year. After one year, you’ll earn $500 and have $10,500 invested. That second year, you’ll earn $525 instead of just $500. The more years the investment has to grow, the bigger the difference this can make—over 20 years at that same rate, your $10,000 investment would turn into $27,126. And that’s not even factoring in additional contributions.
Explore more: Retirement savings calculator
Since the inception of the U.S. stock market, a few different tracking indexes have been created as a way to gauge the health of the market. One of the most commonly used indexes today is the Standard & Poor’s 500 Index (S&P 500), which tracks and measures the performance of the 500 largest publicly traded companies in the U.S. Over time, records show the average return of the S&P 500 since it was started in 1926 is between 10 – 11% each year.2
Many retirement savings plans can be invested in a fund that closely tracks the S&P 500, but you can also invest outside of your retirement plan by purchasing a fund that tracks the S&P 500. In doing so, you’re essentially buying a small stake in each company in the S&P 500 with each share. That means you’re also automatically building a diversified stock portfolio.
The Dow Jones Industrial Average, commonly referred to as the Dow, is another major U.S. stock market index; however, it focuses on just 30 large publicly traded companies. Even older than the S&P 500, the DJIA was introduced in 1896. Since 1921, it’s seen average annual gains of about 7.7%.3
Nasdaq actually stands for the National Association of Securities Dealers Automated Quotations, which was the first electronic market for buying and selling stocks. However, the term Nasdaq is more commonly used to refer to the Nasdaq Composite Index, which is perhaps the third most-known U.S. stock market index. Even bigger than the S&P, the Nasdaq index tracks more than 3,300 stocks. Over the last 15 years, this index has seen average annual returns of more than 10%.4
Short for exchange-traded funds, ETFs are becoming one of the most popular ways to invest today and perhaps overtaking mutual funds in popularity. Like mutual funds, an ETF is a basket of stocks or bonds—so if you buy one share of an ETF, you could be buying a small percentage of dozens to even hundreds of different companies. You can buy ETFs that track major indexes like the S&P 500, DJIA, or Nasdaq—or you can buy thematic ETFs that focus on specific industries, like clean energy, telecommunications, or real estate.
Starting to feel like you know a bit more about the world of investing? Like Bright says—knowledge is power. So, take this newfound knowledge and look for ways to apply it toward your own financial goals.