Imagine that you’ve simply stashed your money in a safety deposit box, earning no interest. 

Over time, you’d likely find yourself much poorer.

That’s because inflation – the rise in prices of goods and services overall – eats away at the purchasing power of cash. 

In 2023, it would take $1.73 to buy the same goods and services that could have been bought for $1 in 2000. ¹

Here’s where investing comes in. 

The main aim of investing is potentially to grow your money’s purchasing power at least as fast as inflation erodes it. 

Really, though, investing seeks to do better than inflation, such that you may become better off over time. 

Investing can be one way of saving for the future, whether you intend to live off the money one day, pass the money on to others, gift it to good causes or a mix of all three.  

Investment returns are a reward for taking risk. In general, the higher the risk taken, the larger the potential rewards need to be.

Lending to the governments of the wealthiest countries can be considered one of the safest investments of all. After all, the US, Germany and Japan are deemed almost certain to repay you what you lent them. So, such investments generally pay lower returns.

Contrast that with becoming a shareholder in a small, unproven company that could easily fail, or where you have to tie up your money for several years. 

To make up for the riskiness, such investments need to offer high potential returns.

Many new investors make the mistake of simply chasing after the investments that seem to have the highest potential returns. 

Instead, you should consider holding a selection of investments that may work well together and that are suitable for your investment objectives. 

Many people become wealthy from just one source, often by founding a game-changing company.

However, very few people then stay wealthy by keeping all their eggs in one basket.

Instead, most newly wealthy people try and preserve what they’ve made by investing it in a diversified portfolio, thus spreading their risks.

A diversified portfolio is a carefully planned collection of various assets that could include, for example, different countries, asset classes and maturities.

A hypothetical investor starting out with $1 million might choose to put the majority in a broad selection of shares with a substantial minority in bonds from a wide range of countries.

The intention would be to earn long-term returns from both, with the bonds potentially helping to offset losses on the shares when markets are stressed.

Historically, high-quality bonds have often held or even increased their value at times when equities have fallen hard. But it’s important to remember that past performance is not indicative of future returns.

Compound interest is where you earn returns on previously earned returns. 

For example, if you invested $100 in an asset that returned 10% in year one, you’d then have $110. 

If the asset returned 10% in year two, you’d then have $121. 

Not only would you have made 10% on your original $100, but also on the $10 return you made in year one. 

If you left that $100 alone and kept earning 10% annual returns for 10 years, you’d amass $259.

The longer the time period, the more compounding interest may help.

In the stock market, investors who have reinvested the dividends they earned into shares have seen higher compound growth over time than those who did not.

Figure 1 compares the performance of US large cap equities – as measured by the S&P 500 Index – with and without reinvested dividends.

Between 1988 and 2022, $100 would have grown to $3176 with reinvested dividends and $1494 without them. ²

Traditionally, investors have put their money to work in pursuit of financial returns alone.

Many still do take this approach. However, it’s not the exclusive reason for investing nowadays.

There’s a growing recognition that the assets we invest in may simultaneously help seek other goals.

Sustainable investing is about trying to contribute to a healthier planet, a fairer society and more transparent businesses, alongside pursuing financial returns. 

Armed with the key rules outlined above, you can start thinking about whether you’re an active or a passive investor.

Active investing means trying to pick favorable assets from a group in the hope of earning higher returns.

For example, an active investor might buy just 20 stocks from an equity index containing hundreds of stocks, based on their prospects.

Passive investing means not trying to pick the assets but instead buying the entire index.

If it works, active investing can potentially deliver higher returns.

However, it can be more expensive, as active investment managers typically charge higher fees.

Passive investing may deliver returns similar to an index or a broad asset class. And the fees involved tend to be lower.

There is no need to pick one approach over the other, though. Many investors have both active and passive investments in their portfolios. 

One approach may make more sense in some situations while not in others.

There are at least two more things you’ll need to decide. 

The first is when to invest. This could involve committing a large lump sum or a certain amount each month. 

Lump sum investing means you’re putting your cash to work immediately. Generally speaking, the earlier you invest, the better, as it gives compound interest more time to do its stuff. 

Of course, there’s a risk you may invest just before a big sell-off in markets, from which it may take some time to get back to breakeven. 

Drip-feeding money into investments in regular instalments reduces the risk of investing at once just before a sell-off. 

Over the long term, however, the larger potential gains may come from investing all at once, straight away.

The second is how to invest: do you want to do it all yourself, get advice and then pull the trigger yourself or leave it all to someone else? (You can even take all three approaches with different parts of your portfolio.)

Whatever you decide, careful planning and disciplined execution are vital to your prospects.