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 1. Individuals
 2. Build your knowledge
 3. How does investing work?

4 min read February 03, 2022
How does investing work?

For long-term dreams like saving for college and retirement, understanding how
investment works can help you create a plan to meet your goals.



Putting money aside as you’re able is a great way to cushion against the
unexpected and make progress toward bigger financial goals such as retirement.
How most people do that takes two forms: saving or investing.

You probably get how saving works. But how does investing work and how can you
select your investments?


WHAT IS SAVING VS. WHAT IS INVESTING

Saving is usually reserved for short- and intermediate-term goals—an emergency
fund for car repairs, for example.

How investing works is you put your money in an account or fund with the goal of
making a profit. Investing comes with the potential of greater rewards (which
can include more risk) over time. That’s why some people use investments to
reach long-term goals such as retirement.

  Savings account Investment account Where money goes An account in a financial
institution, such as a bank. Financial products such as stocks, bonds, mutual
funds, and annuities, the value of which is held in an account. How money grows
Steadily but slowly. The higher the interest rate, generally the higher required
minimum balance. Account value shifts as investments such as stocks gain or lose
value. The potential for growth is higher, but not guaranteed. You may also sell
investments for gain (or loss) or receive dividends with stocks or interest with
bonds. Risk and flexibility Low risk, some flexibility, little variability.
Generally insured up to $250,000 per institution. Many have fees and transfer
limits. Interest earned is typically taxable. Generally fairly flexible to
purchase or add to; may be penalties for early withdrawal on retirement
accounts. No growth is guaranteed, so there’s more risk. Some are tax
advantaged.


HOW INVESTING WORKS IN INVESTMENT ACCOUNTS

The term investment account refers to how the money you use to purchase stocks,
bonds, mutual funds, or some combination, is held. There are three different
types of investment accounts:


1. RETIREMENT INVESTMENT ACCOUNT

There are two main types:

 * A 401(k), which is provided through your workplace and often supplemented by
   employer contributions.
 * An individual retirement account, or IRA, set up by you as an individual to
   put money aside for retirement.

For both, you choose, based on predetermined limits, how much to deposit. If you
have a 401(k), funds are deferred from your paycheck. With both, you may decide
how you want to allocate your investments (see below). Learn about the tax
advantages to both 401(k)s and IRAs.


2. EDUCATION INVESTMENT ACCOUNT

Savings and earnings in these, such as a 529, are used to pay for qualified
educational expenses. You can choose the allocation in funds that contain
products such as stocks and bonds, and there are tax advantages as well.


3. BROKERAGE INVESTMENT ACCOUNT

You as an individual transfer funds to a brokerage firm; you choose individual
investments, such as stocks. Your money has no guarantee against loss and there
are no tax advantages, but there may be more flexibility for withdrawal than a
retirement investment account.


HOW TO SELECT INVESTMENTS IN YOUR INVESTMENT ACCOUNT

When you start saving in an investment account and select your investments, you
don’t buy stock in just one company. You’re investing in a fund that in turn is
invested in a range of companies. There are hundreds of different types of these
funds, and the choices can be overwhelming. That’s why most people with
investment accounts select investments based on age or risk tolerance. For both,
it’s important to understand the role of risk and diversification in your
investment selections.


INVESTMENT ACCOUNT RISK

Investment funds are generally classified based on risk, from conservative to
aggressive. The riskier the investment, the more potential for growth or loss.
If you have more time before you need your investments, you may be able to
withstand more risk. The closer you are to retirement, the less able you may be
to tolerate risk.


INVESTMENT ACCOUNT DIVERSIFICATION

Each investment fund includes a diverse array of companies; if one company does
poorly in a year, another might do well, which offers balance in loss and
growth. Funds might also allocate their assets (i.e., your money) in diverse
ways, putting a certain percentage in stocks, another in bonds, and the rest in
cash. Both are an example of diversification, which can help to spread out the
risk.


THE INVESTING RULE OF THUMB

Invest as soon as you can, for as long as you can. The more time your money
works for you, the more opportunity it’ll have for growth (otherwise known as
the magic of compound interest). Here’s an example:

Age of opening investment account Initial investment Average return Account
value at age 651 25 $10,000 6% $102,857 35 $10,000 6% $57,435 45 $10,000 6%
$32,071


NEXT STEPS

 * What does your mix of retirement investments look like? Log in to your
   Principal account to review. First time logging in? Create an account.

Investing 101


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. 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, other financial
professionals 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 Company®. 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.

2003696-012022

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