Investing – A Guide for Beginners
- 1 Investing – A Guide for Beginners
- 2 What are Investments?
- 3 Should You Invest?
- 4 The Four Main Types of Investment: The Asset Classes
- 5 What Is “Growth v. Value”?
- 6 Common Pitfalls to Bear in Mind
- 7 Amount of Risk
- 8 Financial Advice
- 9 Diversifying Your Portfolio
Investments are an attractive option for many people seeking to increase their income, build their savings, or put money back for retirement. On the surface, investments are relatively simple: They are anything which you purchase or contribute money to with the expectation of a profitable return.
There are a number of ways that new investors can build a portfolio. This term refers to a person’s collective investments. Most investment professionals will tell you that diversifying or spreading out your investments is a smart move for ensuring that your portfolio will perform well. This is because a single investment has a greater chance of performing poorly. However, having a variety of investments increases your chances of holding something that will increase in value over time.
Before making any investments, however, it is key that you have a general understanding of what they are and how they work. By going into investments blindly, you have only yourself to help — or to harm. This article aims to share a broad understanding of the kinds of investments available to the public and which ones are generally used for specific purposes. However, if you find a type of investment that interests you, make sure to look into it in more depth to gain a good understanding of how it works and what you can do to best ensure you make a profit.
What are Investments?
As discussed, the concept of investments is fairly straightforward. People make investments in the hope that they will see returns, which refers to profit on the original cost put into the investment. Returns are not always cash money; they can take a variety of forms depending on the kind of investment you make. An investment in a rental property will give a return of cash money in the form of rent. On the other hand, shares will yield dividends, savings and bonds will give income from interest, and commodities will pay in the increase of their value from the time you bought them. These are known as capital gains.
Should You Invest?
Most financial advisers will tell you that you should hold off on investing if you have less than six months’ living expenses in cash savings. This is because although investments are important as a part of your overall financial future (especially long term), they are not a replacement for financial security in the present. Six months is purely a benchmark; the more you have saved for a proverbial rainy day, the better off you will be. If you do not currently have six months’ income or more put away, it may be wise to make that a priority before looking into any investments.
On the other hand, if you do have sufficient savings in place and want to take a chance at growing your money more quickly, you should consider making some investments. What kind of investments you pursue is totally up to you.
How comfortable are you with taking risks with your money? What do you want out of investments? Are you looking to build or supplement retirement income, or are you more focused on increasing your income over the next five to ten years?
These are good questions to ask yourself since they will be instrumental in determining what kind of investments are right for you.
The Four Main Types of Investment: The Asset Classes
There are four types of investments people generally look to when considering investing their money. These are known as the asset classes of investments since they are grouped together. The investments in a grouping are generally regulated by the same laws, are structured similarly, and work largely the same way in reaction to the market. Each asset class has several subcategory classes; for example, the asset class of property investments can be divided into commercial, residential, and so on. The four asset classes are:
- Cash Investments
- Investment Shares
- Property and Real Estate Investments
Cash investments are precisely what they seem: investments of cash money put into a bank or other financial institution. Savings accounts are a common type of cash investment.
Investment shares or equities are what most people think of when they hear the term “stocks.” These refer to the purchasing of one or more stakes in a company with the expectation that the company will be profitable in the future, entitling you to a share of those profits. Essentially, owning a share means that you own a portion of the company. Shares can be held in domestic or foreign companies, in brand-new businesses or established industry leaders.
Bonds are loans to either the government or a business with the expectation of being repaid with interest. These are technically known as fixed interest securities precisely because, as their name implies, the interest rate is fixed when you give the loan. Essentially, a business or government entity is put in your debt to whatever amount you loan it, and it agrees to pay you back in full with the agreed-upon interest your money has earned.
Property & Real Estate
Property and real estate investments are purchases or contributions to the purchase of properties, whether these be land or commercial or residential buildings, with the expectation of making money from either the future productivity or the value of the property (or, in some cases, both).
In addition to the four asset classes, there are other less common types of investments. These include things like specific commodities that might have value or whose value might increase in the future, such as gold and other precious metals or natural gas and oil. Collectables, such as antiques, are another less common kind of investment. Many people also make investments in foreign currencies and what are called contracts for difference, which refers to the act of betting on whether shares will increase in value. You may also consider investing in an instant access cash account, which will allow you to withdraw cash at your leisure.
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What Is “Growth v. Value”?
Growth and value are factors you will have to consider if you decide to invest in stocks. A growth stock is one that is initially high in price but carries potentially massive returns. These involve paying a lot of money into the stock upfront with the expectation that the profits will be worthwhile down the road. On the other hand, a value stock is one that is low in price because there is no real expectation that the company’s value is going to rapidly increase. These stocks are lower risk than growth stocks and often have high dividends in exchange for investments, as companies are expected to grow steadily over time.
Some stocks are a mix of value and growth. Value stocks can provide a regular income, whereas growth stocks are more useful for price appreciation, that is, the increase in the value of an asset over time. Again, it is important to remember that no stock is free of risk. It is quite possible that a growth stock can depreciate, or lose value, over time, as well.
Common Pitfalls to Bear in Mind
While investing may seem self-explanatory on the surface, there can be a variety of terms and conditions that apply to any investment. This is especially true if you decide to use any kind of investment service to advise you or even invest on your behalf. For example, almost all investment service providers charge fees for their assistance in managing your portfolio. It is important to have a clear understanding of the charges applicable to your investments before you make them, so you know exactly what to expect. Fees can make what seems like an attractive return into something that might not be worthwhile in the long run.
The most important points to remember are that no investment is without risk and no investment can truly guarantee a profitable return. Nobody likes to put their hard-earned money at risk, but this is an essential part of the investing process, and you should be prepared for that if you decide to take part.
Amount of Risk
Some investments carry a high amount of risk, while some are much lower. Bonds, for example, are a much more stable form of investment than company shares since they have a fixed interest rate. However, because of the greatly mitigated risk, bonds do not have nearly as high a rate of return as other forms of investment. Savings can possibly lose buying power as time goes on, meaning that they lose real value if interest rates do not keep pace with inflation rates. Conversely, falling inflation rates can affect the interest that you might expect to earn on index-linked investments. Company shares can potentially outpace inflation, but there is no guarantee that prices will be higher than what you initially paid at the point you decide to sell them. Generally, the riskier the investment, the more you can expect in returns should the investment turn out to be profitable. The catch is that the more risk you take, the more you leave yourself open to potential losses, resulting in little to no return at all.
In addition to all this, in almost all investments, you and you alone are solely responsible for your actions. What this means is that the burden is on you to make sure you know what you are getting into and the various ways an investment can potentially pan out. If your investment performs poorly, there is rarely any kind of recourse for recovering your money. You may be faced with cutting your losses and abandoning the investment or losing the money you put into it altogether.
While you can get solid financial advice from experts and there are laws regulating various kinds of investments, nothing guarantees that you will have profitable returns. This is why there is no replacement for your own knowledge of your investments and their associated risks, even if you are using an investment service to help you plan your decisions.
All of this means that there is one essential piece of advice that no investor can ignore: Once you have done your due diligence and settled on an investment that you believe is right for you, do not touch it ahead of schedule. Selling in a panic when stock prices drop is a classic example of this pitfall. Because investing is a long-term prospect, it does not matter what a particular investment’s performance looks like at a single point in time. Rather, focus on what you believe an investment will do over the course of the time you plan to own it.
Keeping this big-picture mindset is incredibly important when you hit bumps along the road, whether those be unexpected low stock prices, months where a property brings in no rental income, or periods when interest rates fail to keep pace with inflation. The most productive thing you can do in planning an investment is just that: plan. By looking ahead rather than only at the place an investment currently stands, you can set yourself up for much better chances of success.
Diversifying Your Portfolio
The reality of risk is precisely why diversifying your portfolio is such a vital aspect of investment. As the saying goes, do not keep your eggs in one basket. Having a variety of investment types increases the chances that you will see returns, while having only one or a few investments in your portfolio ups your risk of seeing significant losses if your investments perform poorly. Take the time to look over your investment options with your personal goals in mind, examine the conditions and possible outcomes carefully, and discuss your plans with a qualified investment adviser before you make your final decision.
Investment carries inherent risk, and it is by no means a sure-fire way to increase your income and make solid returns. However, for those who invest prudently and monitor their investments with care, it can be a smart financial move with a lucrative future yield.