1. Investing for beginners
First of all, what is the definition of investing? We could define it as the act of committing a certain amount of money or capital to a specific endeavor (a project, business, real estate, stock, etc.) with the expectation of obtaining an additional income or even profit if possible. Investing can also, and it does include our time, will and energy to study a specific subject, prospective company or something else.
It is important to say that investing is the key to building wealth, material or spiritual. Also, it is important to say that investing in and of itself in not enough. You have to invest wisely if you want to accumulate a certain amount of wealth.
So, first of all, you should know your goals. Why would someone invest? Maybe he is saving for retirement, college for his kids, a brand new TV in the living room or maybe a brand new Ferrari.
Here is a little math. Say you have $1,000 and you put it into the stock market. If you money returned 10% a year, one grand would be worth exactly $17,449.40 after 30 years. Well, we put the inflation aside for now. Not too shabby, right?
This simple calculation shows how some smart investments can you make a richer man literally without lifting your finger.
2. Potential investors, meet the power of compounding
In the table below I will show you how a single investment of $100 will grow at different rates of return. Usually, five percent is what you should expect from a certificate of deposit (CD) or with a government bond over time. Ten percent is the historical average stock market return, and fifteen percent is what you might get if you decide to learn how to pick your own stocks and build you own portfolio. Twenty percent is here just for the effect, you can forget it as it is nearly impossible to get such good rate of return.
You might ask yourself if you are a beginner in investing why is the difference between a few percentage points of return so massive after long periods of time. What you are seeing here is called compounding. It is when your initial investment of $100 begins to earn money, and then those returns start to earn even more money.
The formula for this is initial investment*(1+(interest rate in decimals))^time (usually in years).
In the end, you can have a very nice return with just $100. Money is sometimes beautiful.
3. Some things to consider before investing
Before you say that you are ready to invest in oil, oil wells or stocks, hold your horses, there are some things you should avoid. These are some common mistakes that people make when starting their investment journey.
- 1. Doing absolutely nothing – nobody can guarantee that the market will go up or down, those who say that they can predict it are usually frauds and they want to make money off the lack of your knowledge. But I can guarantee you one thing, doing nothing at all will not provide for a comfortable life.
- 2. Playing it scary – Investing is NOT for everyone, even if you think you beat the unbeatable, you should not put all of your money into something that could go very wrong the very next day.
- 3. Playing it safe – Say you are young and you want to have a portfolio your own, excellent choice! Now, what should you pick? You should build a portfolio that consists mostly of stocks because you have more than enough time to reap the rewards of long-term gains. Now, what if you are older? You may want to transit into bonds later on as they are considered safer.
- 4. Question everything – You might hear somewhere that investing can be considered as an art of asking and answering the right questions when you should buy or sell something. In the real world, there are a lot of fancy names such as CEOs, CFOs, CPAs, COOs and all other acronyms that we use to classify professionals in their industries. Sometimes people forget that they are just people and people have a tendency to lie and make mistakes.To question authority, you have to educate yourself, especially of the subject of financials.
- 5. Put your financials in order first – If you want to become a successful investor one day, you have to make sure your personal finances are in order first. Investing just for the thrill is bad, but investing when you have high-interest debt is much worse. If you are drowning in overdue bills credit card payment that you can not meet, you should take care of them first as they can eat your soul.
- 6. Starting late – Starting late is almost as same as doing nothing. Just take a look at the compounding table above. The conclusion is, the earlier you start, the better off you are. Easy.
- 7. Going in and out of the market – You should believe that the best approach to investing is the long-term one. Pick your investments wisely and reap them over the long period of time. Going in and out in the market is bad, not only for your heart but for you wallet too as the fees are usually enormous and you’ll miss out the market potential that only long-term investors enjoy.
If you’ve read so far and I am sure you did you only witnessed the art of compounding and some general things you should consider before investing.
4. What can I invest into?
I’ve already mentioned that there are lots of ways to invest your money. Of course, you don’t have to invest only your money, you can invest your time, will or energy (as I am investing my knowledge and my time).
So let us get started with bonds.
4. 1. Bonds
Bond is commonly used to refer to any securities that are founded on debt. So, let’s say you have purchased a bond, it means you are lending out your money to a company or government. In return, they agree to give you a certain amount of interest and eventually pay you back. They are considered and grouped under the category of fixed-income securities.
Bonds are attractive because they are relatively safe. Of course, when investing, no investment is risk-free as there if always some amount of risk, but if you are buying bonds from a stable government, your investment is most likely safe. Once again, since the risk of owning a bond is relatively low, so is the reward or the interest rate in this case which means they will yield a lower return.
4. 2. Stocks
If you purchase a stock or equities as your financial advisor might put it, you become a part-owner of the business. For example, if you buy single stock of Microsoft, Apple or Facebook you become a part owner of the said company. This entitles you to a vote at the shareholders’ meeting and allows you to receive any profits that the company allocated to its owners. These profits are called dividends.
We talked about bonds and we said they are mostly risk-free and provide a steady stream of income, but stocks, on the other hand, are volatile. It means they fluctuate on a daily basis. When you buy a stock from a certain company, you are not guaranteed anything, not even dividends as many stocks don’t even pay dividends. The only to earn money on stocks, in this case, is to buy them low and sell them high.
If you would compare stocks to bonds, stocks offer a relatively high potential rate of return, but there is a price for this higher rate of return; you must acknowledge the risk of owning a stock as you could lose all of your investment.
4.3. Mutual Funds
A mutual fund is a collection of stocks and bonds. When you buy a mutual fund, it means you are pooling your money with a number of other investors around the world, which enables you as the part of the group to pay a professional portfolio manager to select specific securities for the best possible rate of return.
So, what is the advantage of a mutual fund you ask? Well, theoretically, you should get a better return by giving your money to a professional investor than you would if you were to choose investments yourself. And, of course, the reality is a whole different story, there are some aspects in mutual funds that you should be aware before choosing them, but we won’t discuss them yet.
4.4. Alternative investments
There are lots of alternative investments such as Options, FOREX, Futures, Gold, Real Estate, Diamonds, etc.
You have learned about the two basic securities; equity and debt, better known as stocks and bonds. While most of the investments will fall in one of these two categories, there are some alternative investments which are a bit more complicated.
But hey, good news only here. You should not worry too much about alternative investments at the start of you investing career as they are generally high-risk/high-reward securities. Also, it is important to say that they are much more speculative than our most basic securities like stocks and bonds. Of course, they could be very profitable, but they require a certain amount of specialized knowledge.
5. Now what?
I’ve introduced to you many topics which you as a potential future investor should know. Let’s recap some of the topics.
• Investing means that money should work for you.
• Reinvesting your money allows you to take advantage of compounding.
• There are numerous investments vehicles and they all have unique characteristics.
• There are lots of different strategies that can be used in investing.
• Each investor in different and they all have their own view.
A combination of these points makes some fundamental knowledge with which any investor should be comfortable. However, all these theoretical concepts are worth nothing unless you can put them into practice.
I’d like to finish this text and say that there are many alternatives out there. I strongly encourage you to explore them and see what works for you. Of course, don’t just blindly put all of your money somewhere. You have to think, study, ask the right questions about potential investments. All in all, keep in mind that the more you learn, you more you will know. Somewhere along this road, you will transit from investor beginner to investor master.