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Basics of Investing:

Reaching Your Financial Goals

Welcome to Society of Grownups. My name is Ariel Anderson, and I'm a certified financial planner professional.

Sometimes, learning the lingo is the best first step to trying something new. Investing is no different. We'll start with the building blocks of investing to help you get started. We'll answer questions like, how is a stock different from a bond? How much risk should I take? How does a mutual fund work? And what the heck is an ETF? This class will offer lots of tips and helpful information if you're considering taking the plunge and getting started.

You'll also see an attachment, which we will refer to periodically. Hopefully, you've been able to print it out, but if not, you can just use notepaper.

Before we jump in, think about your goals for investing. Are you trying to save for a big purchase down the line? Put away money for retirement or a child's college account? Or are you just getting started and you want to know whether investing even makes sense for you? Write down a few of your goals now. We'll pause the screen to give you a moment. Feel free to jump back in and unpause whenever you're ready.

Thanks for giving that some thought. By the end of this class, you will better understand how to determine whether or not investing is right for the unique goals you've just listed. We'll circle back to this after learning more about the mechanics of investing.

Sound good? Let's dig in.

We've all heard the word investing thrown around a lot, but what does it actually mean to invest, and why is this different than simply saving? Well, investing essentially means putting your money to work for you. You invest in something with the expectation of earning some benefit, income, or profit. But you take on risks that things will not pan out the way you anticipated them to. This is different than cash savings, which is very low risk with very low return. You're essentially just preserving your money, rather than trying to grow it.

Let's think of it in a way that's familiar to most of us-- investing your time. For example, let's say that you invest an entire day preparing multiple courses of an intricate dinner. The income or profit that you're hoping to gain is sharing a delicious meal with your friends; the risk is that you may burn the main course and feel as though all your efforts are wasted. Take a few seconds and think of an instance where you invested your time, money, and energy in your day-to-day life with the expectation of reaping some reward despite the risk. Scribble an example of each on a piece of paper and consider how the results made you feel afterwards. Did your risk pay off? We'll pause the screen now to allow you to collect your thoughts. Click play again once you're ready.

If you're like me, you're constantly investing your time and energy for an expected outcome. Investing your money is not all that different. You're still offering up something of value with the anticipation of some type of reward. As the financial industry makes us well aware, there are many different investment choices out there, which are referred to as investment vehicles. The collection of all your different investment selections is called her portfolio. However, there's a lot more to investing than just picking the best vehicles. Let's get started by defining some basic terminology.

Whether you call it equity or stock, it means the same thing-- that you have ownership in a company. As you acquire more stock, your ownership stake in the company increases. OK, so does this mean that if I buy a share of Starbucks stock that I can walk into a Starbucks start bossing everybody around and have my latte for free? That'd be nice, but no. It means I own a share in the success of Starbucks. As their business grows in value, the value of my share grows, too. But I also take part in their losses, which is the risk. Since you don't have a crystal ball, you can't predict with any certainty how a particular company will perform over periods of time. This is what makes stocks risky. And a portfolio with a large amount invested in stocks is typically riskier than one with less invested in stocks. Although we used Starbucks as an example here, you can easily invest in international companies, too.

This graph shows the S&P 500 Index, which is made up of the 500 largest companies in the United States. This is an industry-wide benchmark that is sometimes used to represent the stock market. You can see it looks very bumpy at points, but the important thing to take away from this is that the overall trend is up.

Bonds are issued by companies, the US government, states, and even municipalities to help finance a variety of projects. For example, when Southwest wants to buy a bunch of new airplanes, do you think that they run across the street for a loan from their local bank or credit union? Of course they don't. They issue bonds to borrow money from investors in the market. An investor who buys one of these bonds is loaning their money to Southwest for a set amount of time. In exchange, Southwest agrees to pay back the loan to the investor with interest. Because you're being promised your money back, bonds are inherently less risky than owning stock in a company. However, bonds are not entirely risk free, as there is always the chance that a company could default, which basically means they aren't able to make those interest payments.

Bonds are often represented by the Barclays Aggregate Bond Index in the same way stocks are represented by the S&P 500. You can see that bonds are generally a more conservative investment than stocks. They offer a much smoother ride. However, with less to lose, there's also less earning potential.

Beyond stocks and bonds, there are many other types of vehicles that you can invest in. These different vehicles are often referred to as asset classes. For example, types of asset classes include real estate, natural resources, commodities, and a number of others. The thing to keep in mind is that each asset class has its own level of risk, opportunity for reward, and complexity associated with it.

The mix of these different investment types is called your asset allocation and denotes the percentage you have in each asset class. For example, perhaps your portfolio is 50% in stocks and 50% in bonds.

By now, you're probably getting the sense that risk is a huge component of investing. Let's review some best practices for making sure you aren't taking on more risk than necessary.

You can minimize risk through something called diversification. Diversification is a fancy word for a mix of different types of investments. Let's break it down with an example:

Let's take that 50% stock and 50% bond asset allocation I mentioned a second ago. If we take a deeper look at a hypothetical example, we might learn that the 50% in stocks is comprised of technology, oil, food, and retail companies-- and maybe even a small chunk in an international company. By diversifying your investment across different sectors, industries, and geographic locations, you're aiming to reduce the overall risk of the portfolio. Each individual asset will perform differently, and the idea is that if one investment loses money, the other investments you chose will make up for the losses. This comes down to the classic notion of not putting all of your eggs in one basket.

You can diversify by owning many different types of companies or by investing in a mutual fund or exchange traded fund. Funds are great for investors with limited resources, limited time, or just limited interest in building their own custom portfolio. They can also be a great way to gain access to a particular asset class. So how do they work?

When you invest in a mutual fund, you buy shares of an existing investment portfolio. This means that rather than buying one share of Starbucks stock, you can invest in one share of a fund that owns a much larger portfolio of US companies, which may include Starbucks, but also several others. This enables you to diversify your investments in a way that may not have otherwise been possible given your available resources. Funds are managed by an expert called the fund manager who conducts research on the individual companies and makes changes to the portfolio as needed. In return, you pay a fee for their active management and administration.

Let's compare this to groceries. You can go up and down every aisle of the supermarket adding ingredients to your cart, or you can subscribe to a meal kit service like Blue Apron and have ingredients sent to your doorstep based on your preferences. In this example, going grocery shopping is like building your own portfolio-- selecting products based on your own research and tastes. Blue Apron, on the other hand, is like a mutual fund. You buy a box of premeasured, preselected ingredients designed for your preferences by a foodie expert. Since you don't have to go shopping, do research, or even measure the ingredients, Blue Apron is oftentimes more expensive than doing it yourself. In both instances, there is the opportunity for an amazing meal or the risk that you'll burn it.

Exchange traded funds, commonly referred to as ETFs or index funds, operate in a very similar way as mutual funds. The main difference is that they do not have a fund manager actively keeping an eye on the investments within the portfolio. Instead, these funds aim to deliver the same returns as an index, like the S&amp;P 500, for example. Consequently, they are usually cheaper than actively managed mutual funds. Back to our food example-- these folks are your frozen meals. If you buy a frozen lasagna, it aims to taste like lasagna, fill you up like lasagna, and be more time and cost effective than making an entire tray of lasagna from scratch. It's still based on your preferences, since you had many options, but chose the lasagna. But there's no acting manager there to adjust the recipe or the ingredients. It just is what it is.

Let's pause for a second. So far we've defined investing and reviewed some common investment terms like stocks, bonds, and mutual funds. We've also discussed the role that risk plays. The rest of this class will provide some tips for relating this information back to you and your specific circumstance.

Now that you know what your investment choices are, how do you determine where to invest your money? It ultimately comes down to your goals. Let's get started on an activity that will help you visualize how investing may or may not help you reach your personal financial goals. We'll be going through a few different steps, and we'll walk you through the activity slowly. We've attached a PDF handout that, if you're able to print it, may come in handy at this point. If you can't print the handout, don't worry. We'll have the images on the pause screen for you to look at and take your own notes from.

So without further ado, take a moment and review the goals you listed at the start of this class. These goals can be as specific or broad as you'd like. For example, my goals include paying for a wedding, buying a house, and saving for retirement. Think about what's important to you personally and what you consider to be the best use of your money in the coming years.

Let's aim for a minimum of three goals. We won't need to use all of them in this activity, but we want you to be able to see where investing for your goals may be helpful and where it could potentially be hurtful.

Now that you have an idea of what those goals are, think about the time horizon for each of them. When are you hoping to achieve each goal by? Your time horizon as one of the most important factors when considering how to invest your money. And we're going to spend a lot of time talking about why. A lot of people tend to think of investing as only for the very long term, but investing can actually be appropriate for many different time horizons. Think about the things you're saving for. And if you have enough risk tolerance and capacity, consider saving through investing instead of through traditional cash accounts.

Also, the timeline does not need to be definite. The timeline for purchasing that beach house can be flexible, while other goals may have a set deadline-- like your son or daughter heading off to college, or that wedding I mentioned I'm planning.

So taking into consideration when you want to reach the goals you listed earlier, write down what your time horizon is next to each goal. When would you like to achieve that goal by? If it's in the next zero to five years, this is considered short term, 5 to 10 is medium term, and anything over 10 years away is considered long term. We'll pause the screen so you can take a moment to jot this down. Then, keep this information handy. We'll come back to it in just a moment.

You risk losing money if the value of your investment goes down. Riskier, sometimes called aggressive strategies, come with the potential for greater reward but also the risk of a significant decline in value. Less risky are sometimes called conservative strategies, have less potential for growth but better protection against declines. Investing is all about tradeoffs. We'll talk more about this as part of our risk assessment activity at the end of the class.

Remember when I said that your time horizon is one of the most important components of building your investment strategy? That's because different goals and timelines warrant different levels of risk.

For example, if your retirement is 20 plus years away, you're likely to be able to tolerate more risk in your retirement account. The stock market moves up and down, which we generally call market volatility. These short-term market fluctuations can be scary, but ignoring the noise and investing for the long term can really pay off. Simply put, you have time on your side to ride out the market swings. As you age, your retirement draws nearer, and you'll want to take on less risk as this date approaches. For shorter term goals, like that house I hope to buy within three years, being too aggressive could mean the money I'm investing for my down payment won't be able to recover from a market dip.

Investing requires that you consider your goal, time horizon, and the amount of risk that you're comfortable with. The good news is you've already done two out of these three things. The closer to your goal or the less you can afford to lose, the more you may want to focus on preserving your investment rather than taking on risks with the hope of earning more. Preserving may mean a conservative asset allocation or even just leaving it in cash. For example, I won't be investing my wedding fund, because imagine if I lost 20% of the account's value. I would have to cut my guest list or may end up short for some of my contracted vendors, which would have a very real impact on my big day.

So think about your goals and the amount of risk you're willing to take on for each of them. Perhaps you're willing to take on more risk when investing for a trip around the world, but you're less apt to speculate with your child's college fund.

Ultimately, it comes down to what you're comfortable with. Use the risk personas we've outlined on the handout to help identify how much risk you're willing to take on for each of your goals. Are you low risk? High risk? Or somewhere in between? We'll pause the screen now for you to read through the personas and decide which sounds the most like you.

Now that you've identified your risk persona, let's continue to step two of the activity on the handout. This activity is aimed to help you understand what kind of investment strategy is best suited for your goal, tolerance for risk, and time horizon. It's best to complete this activity with one particular goal in mind and then start over for each new goal. This is because your goals may have very different time horizons and, therefore, warrant very different strategies.

Do you have your total? Let's combine your score with your risk persona and see what an example asset allocation might look like.

Use this chart to understand which type of strategy might be appropriate for your goal. There is a corresponding sample asset allocation for each strategy, directly below the chart.

So where did you fall? If you're an A, you're a conservative investor. Your aim is to preserve and protect your money. As such, your opportunity for growth is limited because you're not taking on much risk. This strategy makes sense if your goal is short term or you simply prefer to play it safe. An example of a conservative allocation would be 10% stocks and 90% bonds.

On the flip side, if you're an E, you're an aggressive investor. You're in it to win it-- hoping for big gains, even if it means you may lose some money along the way. This strategy makes sense if your time horizon is long term or you're comfortable taking chances with the money earmarked for this particular goal. An example of an aggressive allocation would be 90% stocks and 10% bonds.

Chances are you're somewhere in the middle. You have an appetite for growth, balanced with a desire to thoughtfully take on risk. Whichever strategy you ultimately employ, remember to keep your own personal comfort level in mind and continually evaluate your goals. Just because you're an aggressive investor at this present moment doesn't mean this will always be the case. Your risk persona is not an official document. It's not set in stone. It's OK to update your asset allocation as your circumstances change.

If you've decided that investing is appropriate for your individual goals, the next step is to think about whether you'd rather pick your own investments or work with a professional. Check out the PDF on our resources page to learn about ways to manage your investments and decide which one works best for you.

Once you get started, let your account do its thing. Don't obsess over whether you chose the best investments of all time, and don't panic and sell at the first sign of market noise. Remember, you're investing for your chosen time horizon.

And finally, revisit your goals periodically as your circumstance changes. Have your goals changed? Or has the time horizon shifted significantly? What about new goals? Taking a fresh look at your goals and accounts from time to time will help you make sure they continue to be invested appropriately. Or if investing isn't right for your goals right now, perhaps it will be in the future as you start to cross some near-term goals off your list.

I hope this class has been useful in helping you learn about the mechanics of investing as well as determining whether investing is right for your financial priorities.

For more information about budgeting for your goals, check out our online spending plans class. Stay in touch by signing up for our newsletter or liking us on Facebook. Thank you for taking the time to complete this class, and good luck investing.

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Any third party resources or websites referenced are not under our control. We cannot guarantee and are not responsible for the accuracy of the resources, websites, or any products or services available through such resources or websites. While we hope the information in these materials are useful, it’s only intended to provide general education. It’s not legal, tax, or investment advice, and may not apply or be useful to your specific financial situation. If you need recommendations geared to your personal financial situation, schedule time with a financial planner.

The S&P 500 is a market-capitalization weighted index that includes the 500 most widely held companies chosen with respect to market size, liquidity, and industry. Ticker symbol is SPX. The Barclays US Aggregate Bond Index is a broad base index, maintained by Bloomberg L.P. since August 24, 2016, and is often used to represent investment grade bonds being traded in United States. Index funds and exchange-traded funds are available that track this bond index. You cannot invest directly in an index, which also does not take into account trading commissions and costs.