The Basics of Investing
The word investing conjures in the popular imagination of non-investors the get-rich-quick schemes of Jordan Belfort or Bernie Madoff. However, the overwhelming majority of investments are made by honest, hardworking Americans who take advantage of America's brilliant economic systems formulated by the first Treasury Secretary, Alexander Hamilton. Someone interested in investing need only know the basic concepts of wealth creation along with the types of investments to use their money to make more money.
Investing is the process of using money in several ways to earn a healthy and hopefully stable return. One can imagine an investor as an owner of a gold mine and investment capital as a miner, similar to a mine owner sending a miner into the depths of the Earth to excavate gold for profit. The investor sends his/her money into the world of investments to bring back more money. A miner might hit a vein of gold and reap enormous profits, an investor if he/she follows tried and true financial principals can also win big.
One of the chief investment principals is investing money in ventures with acceptable risks. A risk is anything that decreases the chances of one’s investment making money. For a gold mine owner, a risk could be a cave-in which kills his/her miner and prevents future gold profits. For an investor, a risk might be a market collapse, which wipes out one’s investment capital and any chance for returns. Risks are inherent in investing, but a wise investor understands the risks on every investment and accounts for them. A general rule regarding risks is don’t invest money, which one can’t afford to lose. There are ways to manage risks in investing, and the most important mitigating factor is diversification. Diversification is essentially not putting all of one’s proverbial eggs into one basket lest all the eggs break at once, and one can’t make any breakfast. In a diversified portfolio, an investor places investment capital in multiple industries, so if one venture doesn’t work out, the investor can still earn money on other investments.
Along with risk assessment and diversification, the successful investor sets realistic, long-term goals and sticks to his/her’s plan to reach them. The need for well-developed investment plans cannot be overstated. The investor first must set a goal to strive for before investing any money. It might be to earn money for a child’s college tuition or to go on a vacation. Investment goals take many forms, but only once a clear goal is set does the wise investor weigh the risks and then send his/her money out into the investment world. Generally, the stable high return investments result from long-term diversified financial plans with set goals.
There are many types of investments to choose from, each with its own innate levels of risk and potential for returns. One of the most well-known kinds of investments come in the form of stocks. An individual stock is a small portion of a public or private company. Publicly traded stock can be purchased or sold by anyone on a stock exchange, while private stock is not. Stocks are very volatile investments, meaning the price of a stock can change rapidly depending on the overall market or for a myriad of other factors. As such, stock is considered one of the more high-risk investment options. Buying a handful of stocks of one company is risky because it is not a diversified portfolio. If that one company goes under, the investor stands to lose the entire investment. Bonds are another common investment commodity. A bond is a loan that the investor provides to a party who is most often a government for a fixed interest rate. These can be excellent long term investment options because they are lower risk than stocks with a fixed rate of return.
Another common type of investment is real estate. Real estate investing involves purchasing property such as houses or land to earn a financial return. A landlord renting out an apartment is an example of real estate investing. When performed cautiously, this type of investing can be very profitable, but it is challenging to start in real estate as purchasing property can be costly compared to stock or bond investments. Also, an investment property comes with upkeep costs such as taxes, insurance, and other expenses related to maintaining a property. Real estate investors do stand to make healthy returns if they have a lot of investment capital and a plan which accounts for all foreseeable costs.
Although investors can personally purchase stocks and real estate, the most effective way to invest is through mutual funds. These funds are low risk compared to volatile individual stocks because they are diversified portfolios of many stocks and securities. Mutual funds work by investors pooling their investment capital together and giving a fund manager the job of investing that capital in securities like stocks and bonds. The fund manager oversees the investments making sure they are highly diversified and generating a return. The returns are then given back to the initial pool of investors. The gold mine metaphor helps to exemplify the advantages of mutual funds. Suppose the investor is a mine owner, a miner the investment capital, and gold a return on investment. A mutual fund manager acts as a mine supervisor. The supervisor keeps the miner as safe as possible and knows where to dig for the gold. Likewise, the professional fund manager protects the capital from bad investments and knows how to diversify efficiently to generate a stable return. Just as a mine owner would pay a supervisor for his work, investors pay a commission for the fund manager’s job. In the grand scheme of investing, paying a small commission is acceptable because mutual funds are such a fantastic low-risk option.
Investing is a tool for financially savvy individuals who can afford to take on risks and follow through on their plans. There is no great secret or dark magic involved in making great investments. By following a few simple principals, the average investor can reach financial success benefiting themselves and their families.
Goldman, A. (2020, June 10). Investing 101: Investing Basics For Beginners. Retrieved July 01, 2020, from https://www.wealthsimple.com/en-us/learn/