Woman who is reading about how investing works.

How investing works

When you invest, you’re giving your money the chance to work for you and your future goals. It’s more complicated than direct depositing your paycheck into a savings account, but every saver can become an investor.

What is investing?

Investing is a way to potentially increase the amount of money you have. The goal is to buy financial products, also called investments, and hopefully sell them at a higher price than what you initially paid. Investments are things like stocks, bonds, mutual funds and annuities. You buy these products through an investment account, like a 401(k), IRA, or brokerage account.

The differences between saving and investing are:

  • You typically save money in a traditional bank account or by simply storing it someplace safe. When you invest, you’re purchasing products and keeping your money in a specified investment account.
  • When saving, your opportunity for growth is lower, and might not exist at all. Investing helps you beat inflation—through interest earned—ensuring your money’s purchasing power stays strong.
  • Saving is usually reserved for short- and intermediate-term goals, whereas investing is better suited for long-term goals like retirement.

3 investing strategies

You’re probably thinking, “I’d love to see my money grow. Investing sounds great!” You’re right—and it even comes with a playbook. The 3 strategies below can help you form a solid investment plan.

1. Start investing as soon as you can

The more time your money has to work for you, the more opportunity it’ll have for growth. That’s why it’s important to start investing as early as possible.

 

2. Try to stay invested for as long as you can

When you stay invested and don’t move in and out of the markets, you could earn money on top of the money you’ve already earned. That’s called compounding returns, and it could mean more money for retirement.

3. Spread out your investments to manage risk.

Putting all your money in one investment is risky—you could lose money if that investment falls in value. But if you diversify your money across multiple investments, you can lower the risk of losing money.
 

Start early, stay long

One important investing strategy is to start sooner and stay invested longer, even if you start with a smaller amount than you hope to invest in the future. This allows compounding to flex its muscles. Compounding happens when earnings from either capital gains or interest are reinvested—generating additional earnings over time.

How important is time when it comes to investing? Very. We’ll look at an example of a 25-year-old investor. She makes an initial investment of $10,000 and is able to earn an average return of 6% each year. If keeps her initial investment and all accumulated earnings invested for roughly the next 40 years, by the time she’s 65, she will have grown her money to more than 10 times her original amount.1

But waiting 10 years before starting to invest, which is something a young investor may do earlier in her working life, can have an impact on how much money she will have at retirement. Instead of having over $100,000 in savings by age 65, she would have just $57,000—nearly half as much. If she puts off investing even longer (20 years, for instance), the total value of her investment will be even lower, just over $32,000.1

Even if it’s early on in your career and you only have a small amount to invest, it could be worth it. The power of time has potential to work for itself—the money you do invest (even if it’s only a little) will compound for as long as you keep it invested.2

Graphic depicting the amount of savings a person would have at 65 relative to the age they started saving.

Let’s say you’re starting a career at 25 and all you can invest from your bi-weekly paycheck your first year is $20, or $520 total. You invest this money through your 401(k) plan at work and are able to earn an annual return of 6%.

Maybe next year you can save a little more—one extra dollar every pay period. You follow this pattern every year: increasing your investment by $1 per paycheck, keeping your money invested in the market, and earning 6% return every year.

At age 65, the total amount you’ll have put into your 401(k) account may be over $42,000. But your account would be worth over 3 times that—more than $147,000.

Graphic depicting the amount invested in a 401(k) versus the total worth of the account because the money was invested.

Diversify your investments to reduce risk

You typically can’t invest without coming face-to-face with some risk. However, there are ways to manage risk that can help you meet your long-term goals.

The simplest way is through diversification and asset allocation. When you diversify—spread your money across multiple different types of investments—you can help reduce the risk of losing money. One investment may suffer a loss of value, but those losses can be made up for by gains in others.

It can be difficult to diversify when investing strictly in stocks—especially if you’re not starting out with a lot of capital. This is where asset allocation comes into play. Asset allocation involves dividing your investment portfolio among different asset categories—like stocks, bonds, and cash. A simple way to spread your investments among different asset classes is to invest your money in mutual funds and exchange-traded funds (ETFs),  Both products typically have a large number of stocks and other investments within the fund, making them more diversified than a single stock.

How can you make money through investing?

Here’s a couple strategies for making money by investing:

  • Icon of a checkmark. Selling your investments for more than you paid.
  • Graphic of a check mark. Receiving payments in the form of dividends (stocks) or interest (bonds).

When and how you make money can be dependent on the type of investments you own. There are certain tax rules regarding income on investments, especially if they’re held outside of a tax-advantaged account like an IRA or 401(k). A financial professional can help answer any questions you have regarding investment income and help you choose a path for your goals.

Investing is something you can start doing today, tomorrow or when you feel ready. Most often, it works by using the power of compounding to increase the value of your money over a period of time—this may impact your money’s purchasing power in the future and help you be more financially secure in retirement.

Next steps:

  • Ready to start? Talk to a financial professional today about your options and what may help plan for your retirement goals. Don’t have a financial professional? We’ll help you find one.
  • See what an IRA from Principal has to offer.
  • Already investing through your employer’s retirement account? Log in to review your current selections and all the options available.

1 This is for illustrative purposes only and does not represent actual or implied performance of any investment option. Past performance does not guarantee future results. Market and economic conditions could have material effects on the results portrayed.

2 Performance shown does not reflect any product from Principal®. For illustrative purposes only. Does not represent any investment strategy or reflect the impact of fees, taxes, or expenses. 

Investing involves risk, including possible loss of principal.

Asset allocation and diversification do not ensure a profit or protect against loss.

The subject matter in this communication is educational only and provided with the understanding that Principal® is not rendering legal, accounting, or tax advice. You should consult with appropriate counsel or other advisors on all matters pertaining to legal, tax, or accounting obligations and requirements.

Insurance products and plan administrative services provided through Principal Life Insurance Co. Securities offered through Principal Securities, Inc., 800.547.7754, member SIPC. Principal Life and Principal Securities are members of Principal Financial Group®, Des Moines, IA 50392.