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Disclaimer: This blog is for educational purposes only and does not provide financial advice. Please consult with a licensed financial advisor before making any investment decisions. The opinions expressed in this blog are solely those of the author and should not be considered professional financial advice.
Investing is fundamental to building wealth because investing your hard-earned dollars enables them to grow over time. Investing simply means buying an asset with the hope that the asset will increase in value over time (Napoletano & Curry, 2022).
This can be a great way to achieve your financial goals, whether buying a car, starting a business, or saving for retirement. With that said, investing can also be confusing, daunting, and even scary – after all, there is a small chance you could lose your money. Don’t worry, in this blog, we will cover the basics of investing and transform the term from something scary and complex into an understandable and exciting concept.
What is Investing?
As previously explained, when you invest, you are buying something with the hope of making money in the future. The asset you buy could be anything that can increase in value over time (Picardo, 2022). We will break down four common types of investments later in the article.
Investing is key to building wealth because it offers a higher return on your money than simply saving. This higher return is achieved by taking risks with your money. With a saving account, you are storing your money in a safe, liquid account with little to no risk of losing any money (Hayes, 2023). With investing, you buy an asset that you think will become more valuable, but there is a chance the asset will lose value (Hayes, 2023).
It's important to understand the different types of investments available and how they work so that you can make informed decisions about investing your money.
Understanding Different Types of Investments:
One of the most confusing aspects of investing is all the different types of investments you can make. Each type of investment has unique risks and rewards, so it’s important to understand them before deciding where to invest your money. While the list of different investments could technically be endless, we will focus on four common investments:
Stocks: The stock market perplexes many people. However, at a basic level, when you buy a stock, you essentially buy a sliver of ownership in a company (Napoletano & Curry, 2022). If the company you bought into does well (meaning it makes a profit), then the value of the stock will typically rise. Some companies will pay their stockholders dividends, which are small payments of the company’s profits (Napoletano & Curry, 2022). Stocks can be risky because companies might go out of business – then your stock would be worth $0.
Bonds: Like stocks, you can buy a company’s bonds. When you buy bonds, instead of buying ownership in the company, you essentially loan your money to the company at a fixed rate and for a fixed period (Napoletano & Curry, 2022). Because a bond investor is getting a fixed rate of return, bonds are less risky than stocks. However, not all bonds are safe. If you buy a bond from a company with a poor credit rating, they still might go out of business and not be able to pay you back (Napoletano & Curry, 2022). Legally, bondholders must get paid before stockholders get any dividends.
Mutual Funds and ETFs: Mutual Funds and Exchange Traded Funds (ETFs) have risen in popularity over the previous 20 years. These investments allow you to invest in hundreds of companies simultaneously (Napoletano & Curry, 2022). They do this by pooling all the money invested inside the fund and then picking individual stocks or bonds to allocate the cash to. The main difference between mutual funds and ETFs is that Mutual Funds are not “traded” on a stock exchange, whereas an ETF is “traded” just like a normal stock or bond (Picardo, 2022).
Real Estate: Most people think of their home as an investment. However, real estate investors take this concept further by owning rental properties. Real estate can appreciate (homes today are more expensive than homes were 30 years ago), but real estate can also provide cash flow. People looking to buy real estate without worrying about the details can buy shares of a Real Estate Investment Trust or REIT (Picardo, 2022).
Risks of Investing:
The possibility of losing money indicates investing inherently comes with risk. That is why it’s important to understand your personal risk tolerance before investing. Risk tolerance determines the amount of money you will lose before it becomes too much (CFI Team, 2023).
Even the safest investments carry some level of risk. As we discussed, certain investments, such as stocks vs. bonds, carry more risk than others. Your timeline, goals, age, and portfolio size are key factors in determining risk tolerance (CFI Team, 2023). You can create an investment portfolio that aligns with your risk tolerance only after you determine your risk tolerance.
How to Start Investing:
We’ve talked about what investing is and what risks come with it. But how do you begin investing? Here are a few steps to help you get started:
Learn about the different types of investments: This article is a good beginner's guide to investing. But before you start buying stocks left and right, learn the details behind the type of investment you will make, whether it be stocks, bonds, ETFs, etc.
Determine your risk tolerance: This can’t be stressed enough. You need to know how much risk you’re willing to take because this directly impacts the type of investment you will make.
Choose your investments: After researching and determining your tolerance, you can choose specific investments to add to your portfolio. Be sure to diversify across different types of assets and industries to minimize your risk (Hayes, 2023).
Monitor your investments: After making your investments, reviewing your results and ensuring they’re performing as expected is important.
Stay disciplined: Investing requires patience and discipline. When the market turns downward, as it always will eventually, it’s important to stick to your plan. Emotional biases often cause investors to make bad decisions and result in losses.
Common Investing Strategies:
Just as there are endless investments, there are many investment strategies. Here are a few common ones:
Buy and Hold: This strategy aims to buy investments that will perform well over many years (Benson & Lam-Balfour, 2023). This approach is less stressful than trying to time the market and can effectively achieve long-term goals.
Dollar-cost averaging: Investors employing this strategy spread their asset purchases out over time, buying the same amount at regular intervals, regardless of market conditions (Benson & Lam-Balfour, 2023). By doing this, you can buy more shares when prices are low and fewer when prices are high.
Value Investing: This strategy involves looking for undervalued investments that have the potential to increase in value over time (Benson & Lam-Balfour, 2023). Value investors typically look for companies with strong fundamentals trading at a discount.
Growth Investing: This strategy involves investing in companies expected to grow faster than the overall market. Growth investors typically look for companies with strong earnings growth potential and a competitive advantage in their industry (Benson & Lam-Balfour, 2023).
Index Investing: One of the most passive strategies, this indexing involves investing in a broad market index, such as an S&P 500 ETF (Benson & Lam-Balfour, 2023). By doing this, you can achieve market returns with low fees and minimal effort.
Mistakes to Avoid:
While investing can be a great way to build wealth over time, it's important to avoid common mistakes that can lead to losses. One of the most common mistakes is trying to time the market (Benson & Lam-Balfour, 2023). Many investors try to buy low and sell high, but this risky strategy rarely pays off. Predicting the market's ups and downs is difficult, and attempting to time it can lead to missed opportunities and losses.
Another mistake is chasing hot stocks. When stock becomes the talk of the town, and everyone seems to be buying it, it can be tempting to jump on the bandwagon. However, investing in a stock solely because it's popular can lead to losses when the hype fades and the stock's value drops.
Diversification is key to reducing risk in investing. Investing in various stocks and asset classes is important to avoid putting all your eggs in one basket. This can help weather market fluctuations and reduce the impact of any stock's performance on your portfolio (Hayes, 2023).
Finally, investing with a plan can be safe. It's important to have a clear goal and strategy before investing. Decide how much you want to invest, what stocks and assets you want to invest in, and how long you plan to hold your investments. With a clear plan in place, you'll be better equipped to make informed decisions and achieve your investment goals.
By avoiding these mistakes and staying disciplined in your investment approach, you can increase your chances of achieving your long-term investment goals. Remember to do your research, stay patient, and seek the guidance of a financial advisor if needed. Investing can be a rewarding experience, but it's important to approach it cautiously and clearly understand the risks involved.
Works Cited:
Benson, A., & Lam-Balfour, T. (2023, January 5). 9 Investment Strategies for New Investors. Nerdwallet. https://www.nerdwallet.com/article/investing/investment-strategies
CFI Team. (2023, March 20). Risk Tolerance: The amount of loss an investor is prepared to handle while making an investment decision. Corporate Finance Institute. https://corporatefinanceinstitute.com/resources/wealth-management/risk-tolerance/
Hayes, A. (2023, Feb 23). Saving vs. Investing: What Teens Should Know. Investopedia. https://www.investopedia.com/articles/investing/022516/saving-vs-investing-understanding- key-differences.asp
Napoletano, E., & Curry, B. (2022, April 4). What Is Investing? How Can You Start Investing? Forbes Advisor. https://www.forbes.com/advisor/investing/what-is-investing/
Picardo, E. (2022, July 22). Investing Explained: Types of Investments and How To Get Started. Investopedia. https://www.investopedia.com/terms/i/investing.asp