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Investing may seem intimidating, but it's a crucial tool for building wealth, achieving financial security and reaching your financial goals. Whether you're a beginner or an experienced investor, understanding the basics of investing is essential for long-term financial success.

From the power of compounding to the different types of investment accounts, here's what a beginner needs to know about investing and why it's an important aspect of financial planning.

Why investing is important

Investing is a powerful tool for wealth creation, financial security and maintaining your purchasing power in the face of inflation. As an investor, you allocate funds to different assets, anticipating future returns in the form of income or capital appreciation. Investing allows you to grow your wealth over the long term, offering financial cushioning for future needs like retirement or education.

Investing also serves as a shield against inflation, preserving your purchasing power in the long run even as the dollar becomes worth less over time. The Federal Reserve targets a long-term inflation rate of 2 percent, so if your money doesn't earn at least that return, your purchasing power will erode.

The power of compounding is another key advantage of investing and can lead to significant wealth over a long enough time horizon. Your returns can compound over time, leading to exponential growth of your investment.

Where to invest: Key accounts you should know

Deciding where to invest your money involves choosing the right type of account for your needs. Different accounts offer various features, tax advantages and rules. Here are some key types you should be familiar with.

Brokerage account

A brokerage account is an investment account that allows you to buy and sell a wide range of investments, such as stocks, bonds and exchange-traded funds (ETFs). To open a brokerage account, you need to register with a brokerage firm, which acts as an intermediary between you and the securities you wish to buy. There are different types of brokerage accounts, but most people will likely open an individual or joint account.

Brokerage accounts don't have any contribution limits or withdrawal penalties, making them a flexible option for investing. They also don't offer any tax advantages, meaning returns from your investments, such as capital gains and dividends, are subject to taxes.

The best online brokers allow you to trade stocks and ETFs without paying commissions, and they offer thousands of no-transaction-fee mutual funds. You can also get access to investment research through your broker to help you identify new investment ideas.

Retirement accounts

Retirement accounts, like Individual Retirement Accounts (IRAs) and 401(k) plans, are designed to help individuals save for retirement. These accounts offer various tax advantages. For instance, traditional IRAs and 401(k)s provide tax deductions on contributions, and the investments grow tax-deferred until retirement.

On the other hand, Roth IRAs and Roth 401(k)s involve contributions with after-tax dollars, but withdrawals in retirement are tax-free. By using these accounts, you can reduce your current or future tax burden and grow your retirement savings more efficiently.

Retirement accounts also come with annual contribution limits. Here's how much you can contribute in 2024.

IRA and Roth IRA: $7,000 (those age 50 and older can contribute an additional $1,000).

401(k) and 403(b) plans: $23,000 (those age 50 and older can contribute an additional $7,500).

There are various rules for retirement accounts regarding areas such as tax deductions and income limits. Be sure to understand the specific rules before making any contributions.

It may be useful to work with a financial advisor to develop a personalized plan. Bankrate's financial advisor matching tool can help you find an advisor in your area.

What to invest in: Stocks, bonds, funds and more

Once you've set up your investment account, the next step is to decide what to invest in. The right choice depends on your financial goals, risk tolerance and investment horizon. Here's a brief overview of some common types of investments and their characteristics.

Stocks

Stocks, also known as equities, represent an ownership stake in a company. When you purchase a stock, you're buying a piece of the company and become a shareholder. Stocks can provide high returns through price appreciation and dividends but come with higher risk due to market volatility.

Investing in stocks offers the potential for growth and income, making them an attractive option for investors with a higher risk tolerance and a long-term investment horizon.

Bonds

Bonds are essentially loans that investors make to issuers, which could be governments, municipalities, or corporations. In return, the issuer promises to pay interest at a predetermined rate and to return the principal amount at maturity.

Bonds are generally considered less risky than stocks, making them a suitable option for conservative investors seeking steady income and preservation of capital. Allocations to bonds and bond funds typically increase as investors approach retirement.

Mutual funds

Mutual funds are investment vehicles that pool money from multiple investors to buy a diversified portfolio of assets like stocks, bonds, or other securities. They are managed by professional money managers and offer investors exposure to a variety of asset classes and sectors with a single purchase. Mutual funds offer diversification and professional management, but they come with management fees and are priced only once per day at the end of the trading day.

ETFs

Exchange-traded funds (ETFs) are similar to mutual funds but trade like stocks on exchanges. ETFs often track a specific index, such as the S&P 500, and offer a way to invest in an entire segment of the market with a single purchase.

These index funds, which can also exist in mutual fund form, are a great choice for any investor because of the diversification benefits, low costs and history of outperforming actively managed funds.

Investors can also use ETFs to invest in more narrow segments of the market, such as small-cap or large-cap stocks, or even particular industries such as technology or energy.

ETFs are priced throughout the trading day, which offers flexibility for investors, and typically have lower expenses than actively managed funds. ETFs offer diversification and flexibility, and are suitable for both long-term investors and active traders.

Alternatives

Alternative investments refer to assets that do not fit into traditional investment categories like stocks or bonds. They include real estate, commodities, hedge funds, private equity, and more.

These investments can provide diversification benefits as they often have low correlation with traditional asset classes. However, they can be more complex, less liquid and riskier than traditional investments, making them more suitable for experienced or high-net-worth investors.

Knowing yourself as an investor

Knowing yourself as an investor involves understanding your investment goals and risk tolerance. These factors are crucial in shaping your investment strategy and making informed investment decisions.

Goals

Your investment goals are the financial objectives you want to achieve through investing. These goals could be short-term (like saving for a vacation), medium-term (like saving for a down payment on a house), or long-term (like saving for retirement).

Your goals will influence your investment strategy. For example, if you have a short-term goal, you might prefer safer, more liquid investments such as a money market fund, while long-term goals may allow for more risk-taking in pursuit of higher potential growth.

Understanding your investment goals can help you select the right investments and maintain focus on your financial journey.

Risk tolerance

Risk tolerance refers to your ability and willingness to withstand losses in your investment portfolio. It is determined by various factors, including your financial position, investment horizon, investment knowledge, and personality traits.

Understanding your risk tolerance is crucial in investing because it helps guide your investment decisions and ensures you're comfortable with the level of risk in your portfolio. For instance, if you have a high risk tolerance, you might be comfortable investing a larger portion of your portfolio in stocks, while a lower risk tolerance might lead you to invest more in bonds or other lower-risk investments.

By aligning your investment strategy with your risk tolerance, you can ensure that you're comfortable with your investment decisions and can better handle market volatility.

Bottom line

Investing is a valuable tool for achieving your financial goals and increasing your wealth over time. By understanding the different types of investment accounts and investment options, you can make informed decisions on where to invest your money.

Knowing the characteristics and risks of different investments -- such as stocks, bonds, mutual funds, ETFs and alternatives -- can help you create a diversified portfolio that aligns with your goals and risk tolerance.

Take the time to identify your goals and understand your tolerance for risk, and use this knowledge to make strategic investment decisions that can lead to long-term financial success.

Editorial Disclaimer: All investors are advised to conduct their own independent research into investment strategies before making an investment decision. In addition, investors are advised that past investment product performance is no guarantee of future price appreciation.