Read time: 8 to 9 minutes
Stocks, bonds, mutual funds ... what does it all mean? We explain the fundamentals of investing and show you how to—and how not to—choose your investments.
Decide what you’re investing for
Investing doesn’t have to be hard. It all begins with one fundamental question: What do you want to do with the money you're investing? Pay for college? Buy a new car? Fund your retirement? Then ask how long it will be until you reach your goal.
Investing for long-term goals
Some goals, like retirement, may be more than five years away.
When you have time on your side, consider investing in stocks and bonds.
It’s true that stocks can lose value, sometimes dramatically. But they also hold out the greatest hope for growth over the long run. And growth can be vital to reaching expensive goals like affording retirement.
When stocks have their worst years, bonds often do better by comparison. That’s one reason Vanguard suggests that long-term investors consider owning stocks and bonds together. That tends to smooth out the bumps in the road.
Investing for short-term goals
You may also have goals you hope to achieve within the next five years, such as:
- Buying a home.
- Paying for a vacation.
- Purchasing a new car.
For short-term goals, consider investments unlikely to lose value. These can include a money market fund, a savings account, or a certificate of deposit.
You may not earn a big return, but neither are you likely to suffer a big loss. So the money should be there when you need it.
Bond funds are made up of IOUs, primarily from companies or governments. These funds risk losing value if the debt isn’t repaid on time. Also, bond prices can drop when interest rates rise or the issuer’s reputation suffers.
Choose your investment mix
The most important investing decision you make isn’t what fund to buy. The decision that will most affect your investing outcome is this: What percentages of stocks and bonds will you own for any given goal?
Research has shown that the proportion of stocks and bonds that you own is responsible for 91% of a diversified portfolio’s returns over time. Just 9% of returns could be explained by the specific investments selected, or when investors bought and sold.*
Why would your mix play such a large role in your investment results? Stocks have had a 10% average annual return over the long run, with a lot of ups and downs along the way. Bonds have returned roughly half as much annually, on average,* although with fewer bumps in the road. That means that, all things considered, a stock-heavy mix is likely to return more than a bond-heavy mix over the long run.
How to get a suggested mix
Vanguard will suggest an asset mix for your goals if you take our Investor Questionnaire. This tool takes your risk tolerance, investing experience, and time horizon into account to offer a suggestion.
Resource:
Vanguard’s Investor Questionnaire
*Source: Vanguard calculations, using data from Morningstar.
Consider diversified investments
You can greatly reduce the risk of investing by owning dozens or even hundreds of stocks or bonds. That way, if one stock or bond falters, it may have only a small effect on your account.
Many retirement savers invest in mutual funds that combine hundreds—or even thousands—of different investments. Here are two ways to be broadly diversified:
1. Consider an all-in-one investment
All-in-one investments combine stocks and bonds and other investments into one fund. These types of investments are growing in popularity. Two of the most common ones are:
- Target-date investments. These blend investments in proportions suited to your estimated retirement year (the target date).
- Age-based funds offered in 529 college savings plans that blend investments suited to when a child is scheduled to attend college.
Both of these fund types become more conservative as the savings goal approaches. That way there’s less chance of a large loss just before retiring or your child starting college.
2. Assemble your own portfolio
You can combine different types of funds to create your own diversified investment holding. To be broadly diversified, Vanguard suggests spreading most of your money for long-term goals among:
- U.S. stocks.
- International stocks.
- U.S. bonds.
- International bonds.
Once these basic holdings are covered, you can consider a sprinkling of more specialized investments. These can include real estate investment trusts or emerging market stocks. Some of these investments tend to be riskier, so they should represent a smaller share of your total holdings.
Keep your costs low
It pays to be price-conscious when you go shopping. Well, the same is true when choosing an investment.
Research has established that when investments are the same otherwise, lower-cost investments can do better than higher-cost ones over time. That’s because every dollar you pay to own the investment is one less dollar earning a potential return for you.
See what you’re paying
To see what an investment costs, look to its expense ratio—the percentage of the fund’s average net assets used to manage the fund—in the fund’s prospectus.
A fund with an expense ratio of 1.00% costs 1% of your balance annually. So if you had $10,000 invested, the fund would subtract $100 in expenses a year.
That may not sound like a lot. But many funds charge far less. Many funds offered today have expense ratios of 0.05% or less. If you had $10,000 to invest, only $5 a year would be subtracted for expenses.
Which would you rather pay—$100 or $5?
Commit to a long-term strategy
There will be days when the headlines are all about a sharp market drop. When you look up your balance, you may feel disappointed and set back.
Eyes on the prize
Giving up on a long-term strategy when things are at their worst can keep you from your goals. Plus, staying the course can eventually pay off.
For example, the U.S. stock market lost roughly half its value between 2008 and 2009. But the market didn’t stay down forever. From its bottom, the market nearly tripled over the next decade. People who sold at the bottom missed out on the rebound.
GET HELP WITH CHOOSING INVESTMENTS—AND MORE
If your retirement plan offers advice, turn to our pros. They can select your funds, invest your money, and help you live your best financial life.
See my advice options
Whenever you invest, there’s a chance you could lose the money.
Target-date investments are subject to the risks of their underlying funds. The year in the investment name refers to the approximate year (the target date) when an investor would retire and leave the workforce. The investment will gradually shift its emphasis from more aggressive investments to more conservative ones based on its target date. Target-date investments are not guaranteed at any time, including on or after the target date.
Non-U.S. stocks or bonds have risks tied to the political and economic stability of their country or region. And if the value of the foreign currency falls, the value of the stocks or bonds would also fall. In emerging markets (less developed countries), these risks may be even greater. Funds that focus on a narrow part of the economy—for example, real estate or health care—can fluctuate sharply in price. This makes them riskier than broadly based stock funds. Past performance is no guarantee of future results.Diversifying means having different types of investments. It doesn’t guarantee you’ll make a profit or that you won’t lose money.
Bank deposit accounts and CDs are guaranteed (within limits) as to principal and interest by the Federal Deposit Insurance Corporation, which is an agency of the federal government.
