What is investing?

Introduction

Investing is one of the main ways people can build wealth over the long term, but it can feel overwhelming when you’re just getting started. With thousands of investment options and unfamiliar financial terms, knowing where to begin is not always obvious.

At its core, investing means putting money into assets with the goal of increasing its value or generating income over time. People invest for goals such as retirement, buying a home, financial independence, or maintaining purchasing power as prices rise.

Investing always involves risk. Markets rise and fall, investment values fluctuate, and returns are never guaranteed. Understanding both the potential benefits and the risks is an important part of making informed investment decisions.

In this guide, you’ll learn what investing is, how it works, why people invest, the main types of investments, and several principles that form the foundation of long-term investing.

What is investing?

Investing is the process of putting money into assets with the expectation that they may increase in value or generate income over time. Instead of keeping all of your money in cash or savings, you use part of it to purchase investments with the potential to grow.

Investments can include stocks, exchange-traded funds (ETFs), bonds, real estate, commodities, and other assets. Each asset class has different characteristics and sources of risk.

Unlike saving, investing does not provide guaranteed results. The value of investments can rise or fall depending on factors such as business performance, interest rates, economic conditions, and investor expectations.

Investment returns can come from capital appreciation, dividends, interest, or other forms of income. When returns are reinvested, compounding can allow those returns to generate additional returns over time.

How investing works

The basic process is straightforward. An investor commits money to one or more assets. Those assets can increase or decrease in value over time, and some may also generate income while they are owned.

Stocks may pay dividends, bonds can pay interest, and real estate can generate rental income. Investors may spend that income or reinvest it, depending on their goals and circumstances.

For example, imagine an investment of $1,000 increases by 10% to $1,100. If it then increases another 10%, the second gain is calculated on $1,100 rather than the original $1,000. The investment would be worth $1,210. This illustrates the basic effect of compounding.

Real investment returns are not consistent from year to year. Markets experience gains, losses, and periods of volatility, which is why long-term planning should not depend on receiving the same return every year.

Why do people invest?

People invest for many different reasons, but most involve preparing for future financial needs or increasing purchasing power over time.

Common goals include retirement, buying a home, paying for education, generating investment income, and building long-term wealth. Investing can also provide an opportunity to outpace inflation, although there is no guarantee that a particular investment will do so.

The appropriate approach depends on factors such as the goal, time horizon, and ability to tolerate losses. There is no single investment strategy that is appropriate for every investor.

For a closer look at the reasons people put money into financial markets, read our guide on why people invest.

Common types of investments

Different investments serve different purposes. Some are primarily used for long-term growth, while others may emphasize income, stability, diversification, or a combination of these characteristics.

Risk and reward

Every investment involves some level of risk. Investments with greater return potential can also expose investors to greater uncertainty and larger losses.

Risk should therefore be considered alongside expected return rather than treated as a separate issue. A suitable level of risk depends on factors such as the investor’s time horizon, financial goals, and capacity to absorb losses.

Diversification can reduce excessive dependence on a single company, industry, country, or asset. It cannot eliminate market risk or guarantee against losses.

Our guide to risk and reward in investing explains this relationship in more detail.

The power of compounding

Compounding occurs when investment returns remain invested and can themselves generate future returns.

Time plays an important role because the effect can build across many years. Regular contributions can add to this process by increasing the amount of money invested.

Compounding can also work against an investor when an investment loses value, and actual market returns fluctuate. Examples using constant positive returns are illustrations rather than forecasts.

Learn more about how this process works in our guide to compound interest and investing.

Investing vs saving

Saving and investing serve different purposes. Savings are generally better suited to money that needs to remain accessible and relatively stable, while investing involves accepting greater uncertainty in pursuit of potential long-term returns.

Many financial plans use both. Emergency savings and near-term expenses may require stability and liquidity, while money intended for longer-term goals may have more time to recover from market fluctuations.

See our full comparison of investing vs saving for a more detailed explanation.

Getting started with investing

Before choosing an investment, it helps to define the goal for the money, understand the time horizon, consider risk, and decide how the portfolio will be diversified.

Beginners do not need to understand every investment product before taking their first steps. Building a foundation in risk, diversification, fees, and the assets being purchased is more important than chasing whichever investment has recently performed best.

Our step-by-step guide to starting investing explains the process in more detail.

Key takeaways

• Investing means putting money into assets with the goal of generating income or increasing value over time.
• Returns can come from price appreciation, dividends, interest, and other sources.
• Every investment carries risk, and returns are not guaranteed.
• Diversification can reduce concentration risk but cannot eliminate market losses.
• Compounding can become increasingly meaningful over long periods when returns are reinvested.
• Saving and investing serve different purposes and can both play a role in a financial plan.