A new investor should first decide over what time horizon they want to invest. Is the money going to be used in twenty to thirty years for retirement? Is the money earmarked for an emergency fund in case something happens in the next six months? Does this investment represent a downpayment for a house in the intermediate term, maybe three to five years?
Deciding on a time horizon is important because different investment options are more appropriate for longer-term investing. Broadly speaking, the shorter the time horizon, the less risk an investor can afford to take. Is this new to you? Catch up here
For the investors least able to take risk, cash equivalents are a good bet. Cash equivalents include things like money market funds, certificates of deposit, or savings accounts. These are all generally safe investments and some are guaranteed by the government. The trade off, however, is that they do not offer a very high rate of return.
Fixed income investments, also known as bonds, are riskier than cash, but offer somewhat higher returns. Bonds are essentially loans that get paid back to the investor with interest. The maturity of the bond can be any where from a few days to several decades. There are many different issuers of bonds, such as the federal or state governments or private corporations.
A third common investment choice for new investors are equities or stocks, which represent an ownership share in a company. Equities tend to be the most volatile of these three asset classes, hence are best suited for investors with longer time horizons so that there is enough time to recover from down markets. Stocks also offer the highest potential rate of return, since there is theoretically no limit to how high a stock can go.
Choosing investments is a challenging job and will depend on an individual’s goals and risk tolerance. A mix of cash, bonds, and stocks will serve most investors well over time.