Basic Finance 101
Investing your money is all about options. The end goal is to get back more money than you started with. Different investment options offer different probabilities that this will happen. It is important that you understand the basic differences in these types of investments before you decide what to do.
Interest bearing accounts provide you with a guaranteed rate of return that you’ll receive after your money has been deposited for a certain amount of time. For example, if you deposit $100 at a bank at 2.5% interest for 1 year, your balance will be $102.50 after that year.
Purchasing stocks allows you to become a shareholder, or part owner of a company. You could buy $100 worth of stock in the company that makes your computer, for example. The risk with stocks is that their value (or how much you’ll earn) depends on several factors that are not in your control. If the computer company releases a new model that everyone wants to buy, the stock may rise dramatically in value and your stocks could now be worth $120. If the new model is a failure, the stock value could go lower than the price at which you bought it, causing your stocks to be worth only $80.
Historically, the stock market has earned higher returns than bonds or savings deposits; however, investing in stocks carries a greater risk, with no guarantee your money will be returned, so purchasing them requires careful research.
A bond is like loaning money to a bank, corporation or the government. Bonds are usually sold with a set amount of interest the borrower will pay (the interest rate). The borrower also sets the period of time they will pay interest before returning the money you loaned. This is known as the "life" of the bond. If you hold the bond until maturity, you will receive the original amount invested (par value). If you sell the bond before it matures, you may receive a little more, a little less or precisely the same amount that you put in, depending on what interest rates other borrowers are currently paying.
A mutual fund is a collection of stocks or bonds, using pooled resources from many investors and managed by professional stock or bond traders. Since there are many different stocks and bonds making up a mutual fund, the return on all your money is not directly tied to the performance of one particular stock or bond. This is called diversification. But being composed of stocks and bonds still means there is no guarantee of return, and the possibility of losing money still exists.