Personal Investing: The Missing Manual

Chapter 4. How Investments Work

During your lifetime, you invest in a lot of things: a college education, financial investments, or a long-term relationship. In every case, you expect some kind of payback in return, whether it’s a good paycheck, savings to support you during retirement, or someone to hold your hand at the movies.

You know that life can be a bit of a gamble. The higher you aim, the higher the risk of failure. The same holds true for investments; the ones with the highest returns also come with the greatest risk that you may lose money. Investments with lower average returns tend to be safer, but don’t help your portfolio grow as much. So, when you invest, you perform a balancing act between earning high enough returns to reach your financial goals and limiting the risk you face.

This chapter starts with an introduction to the four main types of investments. You’ll learn how each one works, why they produce the returns they do, and the level of risk each one presents. Because investment returns are so important, you don’t want to give them up needlessly. That’s why this chapter also talks about how the government taxes your investments, and how you can keep those taxes from eating up your returns.

The Big Four: Typical Investments

Although the financial world is as rife with exotic investments as a cafe is with fancy coffees, most people do just fine choosing from four basic types of investments (funds, stocks, bonds, and real estate). In fact, with the right fund, you ...