Increase your financial IQ | Vanguard

Joseph B. Hash

Knowing the basics can help you pick the right account, funds, and investing strategy. Learning foundational terms makes complex concepts far easier to understand. Building financial knowledge will support better decision-making for your personal goals. Learning financial terms probably isn’t at the top of your weekend plans. Maybe you’re interested, […]

  • Knowing the basics can help you pick the right account, funds, and investing strategy.
  • Learning foundational terms makes complex concepts far easier to understand.
  • Building financial knowledge will support better decision-making for your personal goals.

Learning financial terms probably isn’t at the top of your weekend plans. Maybe you’re interested, but too busy. For some, it just sounds boring. So why bother?

Because knowing these terms can help you save more money for the future.

A recent study showed that a majority of Americans struggled to define key finance terms. But those who knew more about investing tended to have more financial success.*

To help you become a more confident investor, we’ve gathered the answers to some common questions—and why they matter to you.

How do I start investing?

Getting educated is a great first step! When you’re ready to dive in, you could open an individual account, join your employer’s 401(k) plan, or sign up with a robo-advisor. These are just a few of your options; you can even invest in more than one account type.

Why it matters: Investing myths prevent many people from getting started. The truth is, you don’t need a lot of time, money, or knowledge to begin. First, consider why you’re saving. Are you planning for retirement, emergencies, or college expenses? Once you’ve narrowed down your goals, you’ll be able to choose the type of account that’s best for you. And the process to open an account is simple.

Should I choose a traditional IRA or a Roth IRA?

The biggest difference between the two types of IRAs relates to taxes. With traditional IRAs, you contribute tax-free now and pay taxes on withdrawals later; with Roth IRAs, you pay taxes on contributions now and get tax-free withdrawals later.

Why it matters: Your personal situation will determine which is best for you—do you want to pay taxes now or in retirement? Compare the two before you open an account.

How do I pick the right investments?

Stocks, bonds, and cash each have a job in your portfolio. Some have higher potential returns and more risk, while others are less risky but offer lower prospects for growth. Together, they can create balance. This handy list gives a brief overview of investment types, or you can take a deep dive on a variety of products.

Why it matters: How much you allocate between investment types (referred to as “asset allocation”) is one of the key components in investing.

What’s the appeal of a mutual fund?

Mutual funds are popular because they have lower costs and contain a blend of stocks, bonds, or other types of assets. Their structure helps answer another common question, “Which stocks should I pick?”

Why it matters: Mutual funds—including target-date funds—are an easy way to build your portfolio. They offer a solution if you don’t have the time or confidence to pick individual investments. But even confident investors love mutual funds because of the benefits they offer.

Don’t feel ready to go it alone? Vanguard Digital Advisor® can take the guesswork out of investing.

What’s an index?

Think of an index like an investing poll—it’s essentially a collection of investments that represent how the market is doing. For example, the S&P 500 Index shows how 500 of the largest companies listed on U.S. stock exchanges are performing.

Why it matters: Understanding this term can help set a foundation for other concepts, including choosing the right funds for your portfolio.

Passive and active investing—what’s the difference?

Young female looking at laptop next to a plant.

Active investing involves buying and selling different investments to try to “beat the market.” Passive investing is a strategy where you invest in a variety of assets in an effort to keep pace with market returns. Remember the S&P 500 Index? You can own an index fund that tracks the S&P 500 rather than picking the individual stocks yourself.

Why it matters: Active and passive investing choices often complement each other in terms of cost and returns, but it’s not as simple as splitting them 50/50. See how they compare, and decide if you need both.

What is compounding?

Compounding is earnings on earnings—and it’s one of the best reasons to invest. It happens when an asset’s earnings are reinvested to generate additional profits. So the more you put into investing, the more opportunities you have to create a nest egg. See an example.

Why it matters: High costs, early withdrawals, and too much risk can all eat away at your savings. A strong investing strategy that takes advantage of compounding allows your money to increase in value.

How do I make money investing?

There are no guarantees, and plenty of risks, but we believe setting goals, keeping costs low, and sticking to your plan is a great strategy to keep you on track for the long term. Investing with a company who puts you first doesn’t hurt either.

Why it matters: Because every investor deserves a chance for success.

French may be the language of love, but finance is the language of your future. Now is a great time to become more financially literate. The more you know, the better choices you can make to fund your dreams—whether they include a new house, a secure retirement, or just financial independence. Because isn’t financial freedom the biggest dream of all?

*Source: Advisor Magazine, “Most Americans Fail Financial Fluency ‘I.Q. Test’.”

“Increase your financial IQ”, 3 out of 5 based on 96 ratings.

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