What Are Investments?
An investment is a monetary asset bought with the expectation that it will provide income and/or increase in value in the future, at which time the asset can be sold for a profit. Among the most common investments are stocks, bonds, cash, commodities, precious metals and real estate.
One popular way to purchase investments is to buy mutual funds or exchange traded funds (EFTs). This is an easy and affordable strategy to build a well-diversified investment portfolio. Mutual funds pool money together from many individuals to purchase investments, giving investors exposure to a wider range of securities, which helps decrease risk.
ETFs are similar to mutual funds. The biggest difference is that the market price of ETFs changes throughout the day, while the price (or net asset value) of mutual funds is calculated at the end of the day.
The Power of Compounding
One of the most important things to understand about investing is the power of compound interest over time. With compound interest, you earn money not only on the amount of your initial investment, but also on the money that your investment earns.
An example helps illustrate the power of compound interest. John is 25 years old and wants to start investing money for retirement, so he puts $5,000 a year into an Individual Retirement Account (IRA). By the time he reaches age 65, he will have invested a total of $200,000.
But if John earns an annual return of 7% on his investments, due to the power of compound interest, John will have far more than $200,000 saved for retirement. He’ll actually have more than $1 million dollars.
Choose the Right Asset Allocation
As you begin to think about an investing plan, remember the importance of a concept known as asset allocation. This refers to how your money is divided among different types of investments.
The goal of asset allocation is to build a diverse investment portfolio in order to minimize risk of loss. Asset allocation is built on the theory that different asset classes — such as stocks, bonds and cash equivalents — have a low correlation with each other. In other words, as one type of asset rises in value, another type may fall in value, and vice versa.
There’s no one-size-fits-all approach to asset allocation. The right asset allocation for you will depend on such factors as your investing goals, time horizon and tolerance for risk. If you’re young and investing for retirement, for example, you have a long-term time horizon, which could allow you to assume more risk.
However, if you’re older, you may want to be more conservative with your retirement investments, since your time horizon is shorter and you have less time to recover losses. In this case, you might choose an asset allocation with a higher percentage of less-risky bonds and cash equivalents and a lower percentage of stocks, which tend to be riskier.
Investing Money for Beginners
It’s never too early or too late to start investing money, and you can start investing with only a little money. If you are a beginning investor, find a professional to help you put the principles outlined here to work.
Disclaimer: The content is for informational purposes only, you should not construe any such information or other material as legal, tax, investment, financial, or other advice.