Grow Your Money By Investing in Stocks, Bonds, & CDs

Investing involves many options, terms, and strategies. Building a basic understanding of how it works is a great place to start. This article covers the basics of investing and a few ways your money can grow.

Investing in stocks

When you buy stocks, you’re buying a small piece of ownership in the company. For example, if you own one share of Acme Corp stock, you’re an owner of Acme Corp. A very small owner, but an owner nonetheless.

The key to investing in stocks is time. Stocks are traded all day, and prices can vary greatly from minute to minute. That volatility can feel quite risky to some investors, but one way to lessen that up -and-down movement is to invest in several different companies, especially companies in different industries. This is called diversifying your investments.

Diversify stocks with index funds

One way to buy stocks in different companies is to invest in index funds.

An index fund is a type of mutual fund. A mutual fund gathers money from various investors, and the fund invests it on their behalf. Index funds are cheap to run  because they simply follow a market index.

Index funds give you diversification — that spread out, lower-risk mix — without the added cost. Instead of buying shares of 500 individual companies yourself, you can just invest in an index fund that tracks the S&P 500 (an index of 500 large U.S. companies). You can often do this at a fairly affordable cost, since the  index funds tend to charge the lowest fees of any fund.

Other mutual funds focus on specific categories or goals, like gold or real estate. Those funds can cost more because they require more people and expertise.

Held over the long term, investing in stocks can yield some of the biggest annual returns compared to other assets.

How do you report stock investments for taxes?

When it’s time to file your taxes, you’ll report capital gains or losses from your sale of stock on your tax return. How long you hold the stock before selling will determine if it’s a short-term or a long-term capital rate. 

Short-term capital gains come from investments you’ve held for one year or less. Long-term capital gains come from investments you’ve held for longer than one year, and they get a lower tax rate (0%, 15%, or 20% depending on your income).

The capital gains tax calculator can help you plan ahead. It shows whether you have a gain or loss and compares the tax difference between selling short-term vs. long-term, whether you already sold your stock or just considering it. 

Investing in bonds

A bond is basically a loan. When you buy a bond, whether it’s from a company, a municipality, or the United States Treasury, you’re lending that organization money.

Every bond has three key parts: a face value, a term, and a coupon. The face value is the amount you get back after the term expires. The term is how long you agree to lend the money. The coupon is an interest payment you receive while you hold the bond.

For example: A 30-year treasury bond issued by the United States Treasury has a term of 30 years, an interest rate set at auction, and pays out that interest every six months. At maturity, you get paid the face value of the bond.

You can also buy and sell bonds after they’ve already been issued, similar to stocks, on what’s called the secondary market.  The price you pay moves up and down because it’s set by supply and demand. If you buy a bond and hold it until maturity, you know how much you’ll make on your investment as long as the borrower doesn’t default on the bond and can’t pay you what they owe. 

What risks are associated with investing in bonds?

Understanding the risks of bonds can support more informed decisions, especially for a first-time investor.

There are a few risks worth knowing: 

• Interest rates: Bond prices and interest rates move in opposite directions. When rates fall, investors buy existing bonds with the highest interest rates to lock in better rates. This results in rising bond prices. When rates rise, investors sell existing bonds with lower interest rates, which results in falling prices.
• Inflation: If the cost of living or inflation increases dramatically after you buy bonds, you’re locked into a fixed return. That return might not be as valuable when you factor in inflation, and you could even end up losing money on your investment.
• Call risk: When a bond is called (paid off) before maturity, you’ll receive cash for the bond. But you may have trouble reinvesting that cash at the same rate, which can hurt your returns.
• Default risk: Unlike government bonds, corporate bonds aren’t guaranteed by the U.S. government. If a company can’t pay off its debt, you could lose money. 
• Liquidity risk: Corporate bonds can also be riskier investments because they’re harder to resell quickly. That can make it tougher to get your money when you want it, and it can cause prices to swing more. 
• Credit rating risk: A company may also have its interest rates increase as a result of a poor credit rating. When that happens, it becomes harder for the company to repay its debts, which negatively impacts your corporate bonds.

How taxes work for bonds

The type of bond you buy will determine your tax situation.  

Generally, the interest you earn on Treasury bills, notes, and bonds is taxed by the federal government, not by states or cities. Savings bond interest can also be subject to any federal estate, gift, and excise taxes, and any state estate or inheritance tax.

If you use savings bonds to pay for higher education, you may be able to keep from paying federal income tax on your savings bond interest, but there are some rules that apply. 

Interest from municipal bonds is tax-free at the federal, state, and local levels as long as investors reside in the same place or municipality as the issuer. That said, if the municipal bond is purchased in the secondary market and later sold, it may be taxed.

 If there are short-term capital gains, they will be taxed at ordinary income rates. Long-term capital gains are taxed at preferential tax rates that may vary according to income.

Investing in certificates of deposit

A certificate of deposit is a type of deposit account you open with a bank. A CD will have a term and an interest rate. Normally, the longer the term, the higher the interest rate. As long as you don’t close the CD, you’ll get paid that interest rate until the CD matures.

What is the risk level of investing in CDs?

A CD is considered especially low-risk because it’s backed by the bank itself. In the extreme case that the bank collapses, the FDIC should step in and reimburse you for up to $250,000.

If you need access to your funds and want to close the CD, you’ll have to pay an early withdrawal penalty. This penalty is often calculated in days of interest, depending on the bank’s fee structure and the term of your CD.

How are CDs taxed?

Generally speaking, the interest you earn on a CD is taxed at the same rate as the rest of your income. Even if you decide to reinvest the money, you have to pay taxes on the interest you earn from a CD.

Interest earned from CDs with terms longer than one year is also taxed at the regular income tax rate. You have to report and pay taxes on earned CD interest every year you hold it, even if you can’t cash it out yet.

If you cash out a CD early and face an early withdrawal penalty, you can deduct those penalties from the amount of interest you’ll have to report as income.

Which type of investments are right for you?

Every investment carries its own risks. Looking at historical performance is one way to decide how to invest. Comparing the past returns of stocks versus bonds can help you understand what kind of return you might expect.

Diversifying, or spreading your money across different investments, is also key to long-term success. A diverse mix helps limit the damage if one investment performs poorly. The general rule: don’t put all your eggs in one basket.

These are three ways to grow your money, among others. The world of investing is much bigger than stocks, bonds, and CDs, but this is a solid place to start. As you gain experience, you can explore other options and see what works best for you.

How to minimize taxes when investing

Minimizing investment taxes is a key part of maximizing investments. These are just a few strategies you can implement to minimize taxes as an investor:

• Use tax-deferred retirement plans to postpone taxes on investments until you retire and have a lower income and, in turn, a lower income tax rate. Alternatively, you can use after-tax retirement accounts to allow your money to grow tax-free and make tax-free withdrawals in retirement.
• Hold onto stocks for at least one year before selling them to avoid short-term capital gains tax.
• Leave investments in your retirement accounts for as long as possible to allow them to compound interest and continue to grow.

Working with a tax expert is one of the best ways to minimize taxes and keep more money in your pocket or available for future investments.