Investing is actually a fairly simple concept to understand. Basically, when you invest, you’re putting your money to work and it’s probably a different way of making money that most people are used to. But just because you were taught differently growing up, doesn’t mean that you can’t learn the fundamentals to investing. Here are the basic ideas behind investing so that you can start making money on your own.
Ways to Invest
There are many different ways to go about investing. With so many options, you could essentially choose the one which works best for you and makes you the return you are happy with based on your comfort with risk. You might like a really high return rate, but if you aren’t also willing to lose that money then you might be happier with something safer. A few common types of investments include:
- Stocks
- Bonds
- Mutual Funds
- Real Estate
- Business Ventures
The options are almost endless. And what you may also appreciate is that you don’t need to go with just one of these options. You could choose to invest your money in all of them. This is called “diversification” and it ensures that all of your eggs aren’t in one basket.
Plus, you don’t need to be a rocket scientist to do it. All that you need is some basic knowledge so that you can get started. With that being said, let’s take a look at some misconceptions about what investing is.
What Investing “Isn’t”
To put simply, investing isn’t gambling. Gambling is when you put your money at risk without being reliably certain of the outcome. You’re essentially “hoping” to make money with a gamble. Investing is completely different. When you invest your money, you are using your critical thinking skills to weigh the pros and cons of your investment and then determine whether or not it is a safe bet. By doing some smart thinking, you are making your chances of growing your money go up considerably.
What is Compounding?
“Compounding Interest” is a concept that Albert Einstein considered to be the greatest discovery in mathematics of all time. And most investors would agree with this statement. As you are about to see, compounding is very powerful. It can turn a small amount of money into a larger amount of money in a relatively small amount of time. It essentially allows your money to work for itself.
For compounding to really work, you’ll need two things: time and the re-investment of earnings. The more time you allow your investments to grow, the more and more money you’re going to make. And the process is going to quickly accelerate the longer you keep your money in any particular investment.
The Compounding Example
To demonstrate the power behind compounding interest, let’s take a moment to go over a simple example: let’s pretend that you have $10,000 and you’re earning 6% per year in interest. At the end of the year, you’ll have $10,600. Okay, simple enough. Now, let’s compound that amount and see what you would have after another year at 6% interest: $11,236.00. In two years, you managed to grow your investment by $1,200 by simply allowing it to sit there.
This wouldn’t have happened if you wouldn’t have re-invested the $600 that you had earned in the first year. For compounding to truly work, you need to re-invest your earnings with the original investment. While the process may start slow at first, it can quickly grow into a wildfire. After a few to several years, the compounding interest earned on a particular investment can become massive.
Making $600 on 10,000 sounds good, but when you let it sit in there and really multiply by several years it get’s going really fast. At 6% your money would double about every 12 years, but at 8% it would double every 9. This is why people are so interested in the rate of return.
Bonds
Bonds are a relatively popular investments that every investor should have in their portfolio. Often referred to as “securities”, bonds are loans to the government. In return, the government promises to pay you back a certain amount of money in a pre-specified amount of time. One reason why bonds are so popular is because they are generally safe bets to make. This is especially true if you’re purchasing bonds from a government which is stable and has a profitable future ahead of it.
The stability and safety associated with bonds makes them very low risk. You won’t be making as much money with bonds as you would with other investments. Since they offer a low amount of risk, they also offer a small potential payout. In order to really diversify your portfolio or reduce risk, bonds are something that you should definitely look into as an investor.
Stocks
Stocks are the complete opposite of bonds. When you invest in stocks, you are typically becoming a part of that company. You’re a shareholder and you are entitled to a certain amount of profit that the company makes (if they offer dividends). The thing to realize about stocks is that you are never guaranteed anything. A lot of stocks don’t pay dividends so there is a possibility that you could not make extra money from dividends, which would mean you only make money when you buy or sell them.
There is an upside to stock trading: the potential to make a lot of money. Since stocks are so volatile, the potential for making money is huge. This isn’t an investment where you would want to place all of your money without good research. As we mentioned earlier, it is best to diversify your investments. Having more money in stocks is better for higher risk, higher reward investors and for those who plan to keep their money in the stocks for a very long time.
Mutual Funds
Another popular investment is mutual funds. Basically, these are a mix of bonds and stocks. Whenever you purchase mutual funds, you are pooling your money together with other investors which essentially puts you in a group. The group is run by a team of professional investors who will place your money in the best possible position for it to grow.
What a lot of people really like about mutual funds is that they come with a strategy in mind. For example, some mutual fund companies will focus on bonds while others will focus on stocks. Some even take stocks in other countries. Your mutual fund company will usually do a good job at keeping you up to date with what they’re investing in and why. These are my preferred investments for myself for retirement funds. These offer the higher reward like stocks, but helps minimize the risk.
These are just the investing options I prefer. There are always CD’s and other options from banks as well. I’ll also spend some time going over the real estate investing later on.