Investing refers to the process of buying assets that are likely to increase in value over time. It is considered a crucial financial strategy that allows individuals to grow their wealth and achieve their long-term financial goals. Whether you are looking to save for retirement, buy a house, fund education, or simply looking to increase wealth, investing provides an opportunity to make money work for you.
How does investing work
Investing simply revolves around the activity of purchasing an asset at a low price and then selling it at a higher price. This return on an investment is called a capital gain. When an investment gains in value, it is known as appreciation.
In addition to potential profits gained from appreciation and capital gains, investment typically works when people buy and hold assets that potentially generate an income. Here, the goal of investing is to purchase assets that potentially generate cash flow over time and hold onto these investments without selling them.
What are the basic types of investments?
Currently, there are four main basic asset classes that people can invest in. These include bonds, stocks, real estate, and commodities. We have listed them and explained them below.
Public companies sell stocks to help raise money to fund their operations and activities. Buying stocks gives investors partial ownership of a particular company. It also lets them participate in its gains and losses. Some stocks also pay dividends to shareholders, which are small regular payments made when the company makes a profit.
However, because there are no guaranteed returns, with individual companies potentially going out of business, stocks come with a greater amount of risk compared to other investments.
Commodities include those made up of energy products, agricultural products, metals, and more. These assets typically include raw materials used for manufacturing, and their prices will often fluctuate based on market demand. For instance, if severe weather conditions impact the supply of wheat, the price of wheat may end up increasing due to scarcity.
That said, most people do not actually hold physical commodities when they invest in them. Instead, investors usually buy commodities from options and futures contracts.
When companies are looking to raise capital, they have the option of borrowing funds from investors. This is done by issuing debt, called bonds. So, when an investor is investing in bonds, they are loaning money to the issuer for a fixed period of time. In return, the issuer will pay investors a fixed rate of return in addition to the money that was initially loaned.
Because of a bond’s guaranteed, fixed rate of return, they are also known as fixed-income investments and are typically less risky than stocks. However, it is important to remember that not all bonds are considered safe investments. Some bonds are issued by companies with poor credit ratings, meaning they are more likely to default on their payments.
Individuals can invest in real estate by buying a home, piece of land, or building. Real estate investments usually vary in risk level. They are subject to a wide range of factors, such as public school ratings, economic cycles, local government stability, and more. People looking to invest in real estate without having to manage or own real estate directly can consider buying shares of a real estate investment trust (REIT). They are companies that use real estate to general potential income for investors. Often, they pay higher dividends than other financial assets.
How to start investing
Start as early as possible
Investing at an early age is one of the best ways to potentially gain solid returns from investments. This is due to compound earnings, which means any returns on investments will start earning their own return. Compounding, therefore, allows one’s account balance to gradually snowball over time. Investing
Decide how much to invest
Investors need to decide how much to invest. How much they are looking at depends on their financial situation, investment goals, and when they need to reach said goals. One common investment goal is retirement. Generally speaking, investors typically want to aim to invest around 10% to 15% of their total income each year for retirement. For other investment goals such as buying a home, education, or travel, consider the amount needed and the time horizon. Then, investors should work backwards to break that amount down into weekly or monthly investments.
Assess risk tolerance
Investors must make sure to understand their risk tolerance levels. This refers to their willingness and ability to bear investment losses. A person’s risk tolerance level will influence their asset allocation and investment choices, as well as the strategy they choose.
Create an emergency fund
Before investing, it is also highly advised that investors build an emergency fund with three to six months’ worth of living expenses. This fund will provide financial security during unexpected events or emergencies.
Set a budget for investing
Investors should determine how much money they can afford to invest regularly without compromising their daily living expenses or emergency fund.
Open an investment account
Choose a suitable investment account, such as a brokerage account like Saxo, a retirement account (IRA or 401K), or a tax-efficient account. Consider their fees, commissions, and account features before choosing a provider.
Decide on asset allocation
Traders should create a diversified investment portfolio, so they do not put all their eggs in one basket. This should be based on their risk tolerance and financial goals. More specifically, asset allocation involves dividing investments among various asset classes to spread risk.
Monitor and adjust
Investors need to stay informed about their investments and monitor their performance. People need to be prepared to make adjustments based on changes in their financial goals or market conditions.
Avoid emotional investing
There is no doubt that emotions can influence investment choices and decisions. As such, it is essential that investors stay disciplined and avoid making impulsive moves based on short-term market fluctuations.
Overall, it is important to remember that investing does come with risks, and past performance is not indicative of future results. As such, investors need to be patient, stay focused on their financial goals, and make well-informed decisions based on their risk tolerance and investment horizon.