In the Money: Investing Made Simple
It is important to understand general principles of investing because it is one way to get your money to grow! When I say investing I am speaking on stocks, bonds and mutual funds. So let’s jump right into what those mean and how they have the potential to make your money grow.
Let’s start off by briefly defining some terms:
Stock: when a company sells shares of itself to people those shares are called stock. You buy a piece of the company. The technical term for this is called equity. Shares of stock can be bought or sold five days a week on the stock exchange.
Mutual Funds: is like a basket that holds dozens or hundreds of individual stocks. When you purchase a mutual fund you are owning a small fraction of each one of the holdings in that basket.
Exchange-Traded Funds (ETFs): a fund that tracks the market index but trades like a stock. You can buy and sell during the trading day based on the current market price.
Bonds: represent debt obligations. If a company or government issues a bond , the money they receive in return is a loan and must be repaid over time.
Diversification:
One of the most important investing rules for anyone is to make sure you are diversifying your money! Diversifying is when you have a broad range of holdings (stocks, bonds, mutual funds or ETFs). These should include large and small companies as well as foreign, new and old companies. When you own a wide range of investments you minimize the risk that any single one will cause a great loss. Most financial advisors recommend taking on a more aggressive approach when you are younger, but then settling into a conservative investment strategy when you are older. However, it’s ultimately your personal decision for how much risk you are willing to take on.
What is Dollar-Cost Averaging?
When you have money deducted from your paycheck every two weeks and deposited into your 401K or IRA the amount you invest most likely does not change. However, the price of the fund does, when the fund share price is lower, your dollars buy more shares and when the fund price is higher, your dollars buy less shares. If you do this steadily the idea is that you will buy more shares at a lower cost over time than if you put all your money into the market at one time.
How Investing can make your money grow:
Let’s take $5,000 and offer you two investing options:
A. Your $5,000 rises 80 percent in the first year and then falls 50 percent in the second year.
B. Your $5,000 rises 5 percent in the first year and then rises another 5 percent in the second year.
What is your choice?
A is the popular answer, because after an 80 percent gain a 50 percent loss is still going to leave you 30 percent. Nah! The correct choice is B.
Now, let’s do some math to clear this up. If your $5,000 rises 80 percent you will have $9,000 after one year. Then, if the $9,000 loses 50 percent, your account will fall to $4,500. You started off with $5,000 but now you are underwater by $500. If your $5,000 instead gains 5 percent in each of those two years, your original $5,000 would be worth $5,512.50. That is a gain of $512.50. This approach is more profitable and that should be the goal. This is also known as compounding, compounding is happening when your money grows each year and when the amount it grows by also grows.
You do not need to invest in risky stocks to be successful!
6 Tips on where you can start:
Invest what you can afford: invest as much as you can while reducing the chance you will need to use the money to cover your basic expenses. Having an emergency fund with enough money in it to ensure that you leave your investments alone when an emergency strikes should be the goal.
Retirement accounts: There are several retirement options - 401k, 403b, IRA and Roth IRA - if your employer provides retirement options you can start there.
Employee matching: if your employer matches your 401k contributions, a full (or even partial) match contribute to the fund! If you do not contribute and they provide matching contributions it is like leaving money on the table. Plus the employers matching contribution is like automatically getting a return on your investment.
Do your own research: if you do not understand a business you either figure out how it works or do not invest in it. Is the business profitable? Are they innovators? So buy what you understand and can believe in, you can start with companies or brands you already buy.
Find an investment company: there are several investment companies (e.g. Vanguard, BlackRock and etc.) and robo-advisors (e.g. Betterment, WealthFront and etc.) out there now. As in point number four do your own research in order to find one that works for you and your financial goals.
Contribute consistency: let dollar-cost averaging work in your favor!
Disclaimer: this is intended for informational purposes only and should not be construed as personalized investment, legal or financial advice. Please consult your investment, legal and financial professional(s) regarding your unique situation.