The concept of investing is something we start hearing about at an early age. But what does investing mean? Most people understand it at a surface level: saving money now so you can access it in the future. The reality is that investing is more complex—especially when you consider compound interest, different investment vehicles and different styles of investing. To truly understand investing, you need to do more than scratch the surface. 

Whether you’re a fresh-out-of-school 20-something opening your first 401(k) or a worker with decades of savings in an index fund, investing is important. Knowledge is power when it comes to capitalizing on your investments. Here’s what you need to know about investing, in a nutshell. 

The Definition of Investing

Investing and saving are two different things. There’s often a lot of confusion around these two terms, and it’s important to make the distinction between them. While investing involves saving, there’s a fundamental difference between them. Saving refers to principal; investing refers to gains on principal. Simply put: investing is about making money with your money. 

Consider a simple example. If Brad puts $1,000 in his bank account each month, he’s saving. That bank account only has a 0.10% interest rate, and inflation ranges between 1-3% during any given year. That means Brad is actually losing money by saving it! Conversely, if he were to invest it at a rate of 8% per year, he’s making money year over year. In fact, if his investment compounds annually, he’s going to make a lot of money over time! Check out our investment calculator to see what compound interest looks like in action. 

When you invest, you’re letting someone else borrow your money to make money, and you’re earning interest that makes you money. It’s part of the cycle of economics. To save is to stagnate due to inflation; to invest is to profit through appreciation. 

Types of Investments

There’s a wide array of investment vehicles out there that can lead to wealth accumulation. Here are some of the most popular:

• Stocks. These are equity investments that represent your interest in a company’s growth and success. As the company grows and makes money, so do you—be it through share price, dividend payments, or other means. 
• Bonds. These are debt equities that represent a promissory note. The issuer agrees to pay you back your principal investment with a fixed rate of interest over a fixed term. This debt helps issuers finance new growth opportunities. 
• Funds. Index funds, mutual funds and exchange-traded funds (ETFs) are all managed investments. You’re pooling your money with other investors and letting an expert leverage larger sums and expertise to generate ROI.
• REITs. Real estate investing without actually owning the real estate. REITs return 90% of their income to shareholders, which means strong compounding power through dividend reinvestment—or a passive revenue stream.
• Derivatives. Options and other derivatives allow investors to make money without holding assets. They’re a riskier form of investment with big upside for those who understand market tendencies and catalysts. 
• Commodities. Everything from gold and silver to livestock and crops have intrinsic value. Investors in commodities capitalize on these values without owning the commodities themselves. 
• Property. From rental houses to multifamily properties and commercial real estate, there’s wealth-generating power in property. Collecting rent passively, fix-and-flip sales, buy-and-hold appreciation and more are all forms of investing. 
• Private equity. If you own a stake in a local business or fund a startup with an infusion of capital, you own private equity. This stake entitles you to a portion of the revenue or value of the asset.

Within each of these investment vehicles are numerous choices investors can make to obtain wealth. Consider investigating them further as you diversify your portfolio.

Passive vs. Active Investing

There are two approaches to investing: active and passive. Active investors prefer to be hands-on, making adjustments to their portfolio by reallocating their investments. This takes work, and a working knowledge of different investment strategies. It also requires a strong knowledge of tax and accounting, to ensure you’re making sound investment choices.

Passive investing is a “set it and forget it” style of investing. These investors prefer to contribute money regularly and let automated systems do the work for them. It might mean buying index funds that track the market or letting a dividend portfolio compound automatically. In any case, passive investors don’t change their investing habits or thesis. They’re in it for the long haul, and will stay the course.  

Investing vs. Speculating

It’s important to note the difference between investing and speculating. Speculating is a short-term mindset: “the stock will go up next week, so I’ll buy today and sell when it rises.” Investing is traditionally a long-term mindset: “the stock price will go up and down, but will generally go up over time.”

Speculators open themselves to more risk by trying to time the market. Investors benefit from time, since they’re relying on compounding and macro growth. There’s a reason the stoic investor Warren Buffet famously says, “Time in the market beats market timing every time.”

Smart Investing Adds Up

Putting money in a savings account for 45 years isn’t an investment. Investments involve making your money work for you! Whether it’s compound interest earned through the stock market or rental income from an investment property, investments add up over time.

And these investment can help you build wealth. Sign up for the Liberty Through Wealth e-letter below to get started on your journey to financial independence.

Once you understand the fundamental concept of investing, you’ll be able to make smarter decisions about how to invest your money. Stocks vs. property. Passive vs. active. Growth vs. dividend. Each person will make different choices depending on their level of risk and comfort with certain investments. What matters most is your understanding of the basic principle behind them. 

Always ask yourself, “what does investing mean?” before making investment decisions. It’ll drive you to save your money in a way that compounds your wealth.