Risk and Return

In general, in investing there is a correlation between risk and return. Over the long term, being willing to take more risk generally results in a higher overall return.

Further reading: Risk-Return Tradeoff

Asset classes

The three primary asset classes are stocks, bonds, and cash. Within stocks and bonds, there are a variety of sub-classes. Within the stock asset class, you can have US vs. international, large-cap vs. mid-cap vs. and small-cap, growth vs. income, etc. Within the bond asset class, you can have various time horizons, risk ratings, and organization types. There are also more minor asset classes (alternative investments), which include commodities, real estate, etc.

Further reading: Stocks – Part II: The Market Always Goes Up

Asset Allocation

Your asset allocation is the percentage of your investments that are in each asset class or sub-class. You can create an asset allocation that reflects your desired balance between risk and reward. A higher-risk, higher-reward asset allocation would be heavier toward stock investments, while a lower-risk, lower-reward asset allocation would be heavier toward bonds and cash. Your asset allocation will reflect your personal risk tolerance as well as your timeline on your investment. Traditionally, an individual with a consistent risk tolerance will move her retirement investments from more aggressive to more conservative investments as she draws closer to starting to withdraw the money.

Further reading: 9 Common Investment Mistakes and How to Avoid Them

Active vs. Passive Investing

Active investing usually involves a lot of activity, such as picking individual investments and trying to buy low and sell high. Passive investing, conversely, applies a buy and hold strategy in which the investments are held long-term. A subset of passive investing is index investing, in which the investor holds a representative sampling of a subset of investments, such as the S&P 500.

Further listening: Planet Money Episode 688 Brilliant vs. Boring; Passive Index Investing is Boring. And it’s Spectacular., Stocks – Part III: Most People Lose Money in the Market