Investing is an effective way of building wealth in the long run but for emerging investors the investment world is tedious In a way or the other where to start is the biggest challenge. There are some basics of investing that must be adhered to in order to succeed in any chosen investment.
This manual outlines the process of embarking on the start of your investment journey, starting with basic concepts and definitions focusing on the importance of the ‘start first’ and ‘think long term’ principles.
1. What is investing?
In a nutshell, investment refers to the deployment of money in different assets with an anticipation of appreciation in their value in future giving rise to returns. With investing, one’s goal is to seek income by placing funds in appreciating assets, not merely looking at preservation of equity as it is with savings.
Some common types of investments include:
- Stocks: Ownership shares in a company.
- Bonds: Loans you give to companies or governments in exchange for periodic interest payments.
- Mutual Funds and ETFs: Pools of money from multiple investors, which are managed to invest in a variety of assets.
- Real Estate: Property investment that can generate rental income or appreciation in value over time.
- Commodities: Tangible assets like gold, oil, or agricultural products.
2. Why Should You Invest?
Investing is of utmost importance when it comes to wealth building. Without making investments, one can simply lock their money in a savings account but most likely its strength will be diminished because of inflation. Investing however, has the capability of increasing one’s money faster than inflation and hence increasing the value of one’s money.
Key benefits of investing include:
- Wealth accumulation: Investments can grow your money, providing you with financial security in the long term.
- Beating inflation: Inflation decreases the purchasing power of your money over time. Investing in assets that grow faster than inflation helps protect your wealth.
- Building retirement savings: Investing in retirement accounts (like 401(k)s or IRAs) allows you to build a nest egg for your golden years.
- Passive income: Some investments, like dividend-paying stocks or rental properties, can provide regular income without the need for active involvement.
3. The Importance of Starting Early
Time is an invaluable resource in investing. The sooner you start making investments, the longer you leave them to grow on the back of compound interest. To put it simply, you begin earning money on the money you have already made from your investments, which in itself, makes money.
For example, let’s assume you invested $1,000 at an interest of 7% annually, after a year, you will have $1070. In the next year, the 7% interest will now be applicable to the new amount of $1070 and not the initial amount of $1000. Such small percentage increases lead to large sums of money in the long run.
Starting early also means that you can cycle through any market highs and lows. This is not to say prices of stocks will not be moving up and down anytime soon, however looking at history and the development of the stock market, it has always gone up. If you started investing earlier, you can easily sit through the short-term fluctuations and reap the benefits in the long run.
4. Understanding Risk and Return
By deciding to invest, you’re assuming some level of risk to earn a possible return. In general, higher risk investments are likely to yield higher returns. As a beginner in investing though, it is crucial that you appreciate the tradeoff between risk and return and seek to find out the risk level you are willing to undertake.
- Stocks: In the past, investing in stocks have yielded more relative returns compared to investing in bonds or savings accounts despite their greater risk but greater risk exists. The value of a stock can change greatly due to prevailing market conditions, the performance of the company, and even international issues. If you are prepared to handle the variability, however, stocks will likely offer you a great return on investment over time.
- Bonds: In regards to stocks, bonds are relatively lower risk but also provide lower returns. It is basically a loan made to a company or government with the expectation of paying interest until the bond matures, when the principal is returned. Due to the regular payments that they offer plus the lower risk, bonds seem to be an attractive option to those looking to invest more conservatively.
- Mutual Funds and ETFs: These are a handful of assets such as stocks, bonds, and other farms that can help you ensure that your investment portfolio is well diversified. It helps in equations which do take time a lot of risk that are involved in such equations.
Knowing how much risk you are willing to undertake is very crucial in developing an investment strategy which is suitable to you in all circumstances. Investors who are relatively younger and whose time horizon is long, can afford to take on greater risk, but this is not the case for someone closer to retirement age.
5. Diversification: Don’t Put All Your Eggs in One Basket
A fundamental principle of investing is the idea of diversification. This is when capital is allocated to various types of investments in order to mitigate the risk. This means that if one investment goes bad, you will not suffer major losses because your other investments are likely to do well and partially or completely recover the losses incurred.
Diversification can be achieved in several ways:
- Across asset classes: Invest in a mix of stocks, bonds, real estate, and other assets.
- Within asset classes: For example, instead of buying stock in just one company, invest in multiple companies across different industries.
- Geographically: Consider investing in international markets to spread risk across different economic environments.
Diversifying your portfolio ensures that you aren’t overly exposed to the poor performance of any one investment, which helps smooth out returns over time.
6. Setting Financial Goals
Acknowledging Investopedia’s definition of investments as a long-term promise, it is also important to acknowledge that before committing to investments, one must first have set goals. Set goals can be such as putting away money for a down payment to a house, acquiring a nest egg for retirement, or aiming for passive returns on the capital invested.
For example:
- Short-term goals: If you’re saving for a goal you want to reach in the next few years (like a vacation or car), you might opt for low-risk investments like bonds or high-yield savings accounts to avoid the risk of losing money in the stock market.
- Long-term goals: For goals like retirement, which may be decades away, you can afford to take more risk by investing in stocks or mutual funds, knowing you have time to ride out market volatility.
If well planned, managed, and coordinated, investments managed in timelines and risk profiles should have the growth potential to remain on course ambitious for the future.
7. Investment Accounts: Where to Put Your Money
Once you’ve decided to start investing, you’ll need to choose the right type of investment account. Here are a few common options:
- Brokerage accounts: These accounts allow you to buy and sell stocks, bonds, mutual funds, and other assets. They’re flexible and don’t have contribution limits, but you’ll pay taxes on any earnings.
- Retirement accounts (401(k), IRA): Retirement accounts like 401(k)s and IRAs offer tax advantages for long-term savings. With a 401(k), you may also receive matching contributions from your employer, which is essentially free money. IRAs offer flexibility in investment options, and both types of accounts allow your investments to grow tax-deferred.
- Robo-advisors: For new investors who want a hands-off approach, robo-advisors provide automated investment services based on your goals and risk tolerance. They create a diversified portfolio for you and adjust it over time as needed.
8. Staying the Course: Long-Term Discipline
The hardest aspect of a new investor’s journey is often maintaining discipline including during times of market stress. One point that should be well understood is the fact that investing is about the long run and the market will have its share of slumps and spikes. Selling in a panic state can crystallise the losses for the investor and deny them the potential benefits of the eventual upside.
This, in turn, allows investors to stick to their investments without making any rash moves. This is achieved by concentrating on the bigger picture or long term goals, spreading ones investments across different sectors and not allowing emotions to drive investment decisions. Such an occasional review of one’s anticipation of drawing up funds and changing some positions as the needs arise is desirable to avoid excessive and emotionally motivated trades.
Final Thoughts
Investing has the potential to be a great way to accumulate wealth, but it demands basic knowledge, a strategic approach, and lots of determination. The cornerstone of successful investing includes starting early, maintaining a diverse portfolio, and being goal-oriented.
However, the key aspect to keep in mind as a beginner is that investing is not a sprint, it is a marathon. Therefore do not rush into it and learn as much as you can, get help when in doubt, and just be patient. Time and consistent effort on your part will bolster your ability to build a great financial base in the future.