For all my readers who are new to investing or just want to learn about investing from scratch, this article is a must for you. Investing is believed to be very complex, especially for those who are new to financial world. I have tried to ensure that you don’t feel overwhelmed while reading this article and also to cover everything so that even a school kid can understand about investing from basics to advanced strategies. Please don’t worry about words like IRAs, or 401(K)s, etc. After reading this articles you can compete with the people who are investment PRO.
What is investing?
Investing means allocating your funds with an intention to generate or create profit, income or wealth. You put your money to work for you, that slowly results in building wealth for you. When we invest, we focus on buying an asset with the hope that its’ value will increase over time, i.e. long-term wealth building. Your investment options may include stocks, bonds, real estate, EFTs, mutual funds, and so on.
Why should you invest?
I understand we all want to build a successful financial future and investing is an essential part of it. It gives us an opportunity to build and grow our wealth, beat the inflation, and achieve our financial goals. I know it’s easier said than done and many people hesitate from investing due to lack of understanding and the fears/rumors about the uncertainties in investment. I will try to explain why you should consider investing and how you can gain financial freedom with it.
Build/ Grow your wealth:
According to me one of the prime reasons to invest is the potential to grow your wealth. When we invest we have an opportunity to earn higher return on our money instead of keeping it in our bank account and making them wealthy. Putting money in bank is considered safe but I think we should also take into consideration the depreciaton in the value our money because of inflation and not to mention the banks offer such low-interest rates that we can almost feel cheated. Investing in stocks, bonds, real estate, ETFs, etc. gives us an edge over returns that we can earn in banks. I believe that higher return is what all of us deserve on our hard earned money.
Protection from Inflation
If you are regular on my site, you know that inflation is increase in the cost of goods and services over time. It is now believed to be an inseparable part of our economy and it also takes away our power to purchase as our money loses its value. Investing can help us beat inflation. Imagine what we can buy with $100 dollars will cost us $110 next year. If we keep $100 in our bank account and earn say 1% on it, we will end up with $101 by next year which is still $9 short of what we want to buy. On the other hand, if we invest our $100 and earn a higher return than bank, says 10-15%, we will end up with $110 or $115 by next year. We will be able to buy what we originally intended to and even better, we can still save some money and beat the inflation.
Achieve Financial Goals/Freedom
We all have financial goals and investing acts as a catalyst. It helps us achieve our financial goals faster. We can save for a house, or a vacation, our retirement, etc. If start investing wisely and aim at earning higher returns, we not only accumulate wealth faster but also achieve our financial goals faster.
Diversify our Portfolio
We know there are a variety of assets we can invest in. We can identify which one suit us best, however, if we learn a strategy called “Diversifying our portfolio” we can protect ourselves from risks that may come with investing. Imagine this, we buy an Electric car from a company that looks very promising as its share price increased by 40% in last 5 years and suddenly all the countries of the world decide to ban the batteries used in these cars and the share price goes down from $950 to $9. I would lose all my invested money! However, if I invest say 10% in Electronic Car Company, another 20% in technology companies, 40% in pharmaceutical companies, 20% in agriculture sector and remaining in start ups. It’s called diversifying my portfolio. Now, worst case scenario is, if that Electric car Company’s share price crashes, it will hit only 10% of my portfolio and I may still be able to make up for that loss in say Pharmacy sector or Agriculture sector. This way we can spread our risk and reduce the loss of any one investment losing its value.
Types of Investments (Assets):
As a preparation before investing, we should know about the types of assets we can Invest in.
There are different types of investments we can choose from, and each type has its own pros and cons, each comes with some benefits and risks. Below are some of the most common types of investments:
Stocks
Stock also known as Share or Equity of ownership in a company. Buying a stock means we are buying a part of the ownership in a company. If we buy 1 share out of 100,000 shares, then we become 1/100,000th owner of the company. Just like a partner in a business we get to share the profits and losses of the company (only a 1/100,000th though). If a company performs well, the value of the stock will go up. In return we will receive dividends. However, if it doesn’t do well then the value of the stock may go down as well. So, investing in stock has its benefits and losses. Remember Stocks have a long-term growth potential.
Bonds
They are like a debt security. Bonds are kind of a loan that we give to a company. Buying a bond means lending our money to the issuer and we will get interest for a certain period of time. At the end of the term we will get our principal money back. In this type of investment there is a guarantee that we will get regular payments and will also get our principal money back. Usually people who don’t want to take too much risk, opt for this kind of investment as they are less risky than stocks but the down side is that they offer a much lower return than stock and may not have a long-term growth potential.
Mutual Funds
This is a type of investment where our money is pooled in with other investors like us and this pool of money is managed by professional fund managers who invest our money in a variety of stocks, bonds, and other securities. We read about diversifying our portfolio above, and in mutual funds diversifying is an in-built feature and that reduces risk too, as the fund managers spread out the risk.
When we buy a unit of a mutual fund we typically buy a share in that fund. The return on our investment (ROI) depends upon how good or bad the mutual fund performs, i.e. if the performance of a mutual fund in which we have invested fluctuates it impacts our returns.
The benefit of mutual funds is that even with a relatively small investment we can get access to a diversified portfolio of that professionally managed fund. However, investing in a mutual fund comes with a fee that can impact our returns.
It’s a good investment for someone who is looking for a diversified portfolio of investment and we also have to be careful that the fee should not be so high that it eats away all our returns. So, we need to choose wisely and strike a balance between returns and risk tolerance.
ETFs (Exchange-Traded Frunds)
Investing in an ETF allows us to buy and sell a basket of stocks, in a way they are a lot similar to a Mutual fund as they also offer access to a diversified portfolio of investment. However, they are traded like individual stocks. The main benefit accordingly to me is that they can be traded on an exchange like a stock. We can buy and sell them throughout the trading day. It has an edge over mutual funds as we can trade mutual funds only towards the end of the trading day.
ETFs usually have a lower fee than mutual funds as they don’t require a similar level of management of our money. ETFs are suitable for the investors who are looking for a cost-effective way to access diversify their portfolio of investments.
Real Estate
We all have a decent idea about what is real estate. It refers to land, residential buildings, houses, commercial buildings, farms, etc. Buying a real estate means buying rights associated with a property like right to use, sell, rent/lease it, etc. It can be a great long-term investment. It gives us an opportunity to earn rental income, also if over a period of time when the value of a property appreciates it’s equity value increases. It is considered to be one of the best investment option, however, to invest in real estate we need a significantly higher up-front cost and there is an ongoing maintenance cost too.
Commodities
Commodities are essentially raw materials or primary agricultural products that are traded on exchanges worldwide. It’s easy to understand commodities if we know the types of commodities. They are mainly divided into four broad categories:
- Agricultural commodities – like grains, livestocks, cotton, coffee, sugar, etc.
- Energy commodities – Crude oil, natural gas and heating oil.
- Metal Commodities – precious metals like Gold, Silver, other base metals like copper and zinc.
- Miscellaneous commodities – timber, rubber and other industrial metals.
Investing in commodities is an excellent way of diversifying our investment portfolio. Usually investors like to diversify their portfolio by keeping stocks, bonds, ETF, mutual funds, etc. That is a traditional way for diversifying. However, investing in commodities is beyond this traditional way. We know that inflation impact the prices of commodities. I have seen that it’s a nice way to hedge inflation, i.e. commodities perform really well when inflation is going up. Investing in commodities offers a potential for higher return than other types of investments.
The downside of investing in Commodities is that investing in commodities can be highly volatile, i.e. we can see a price fluctuation based on the demand and supply factors. In traditional investments we get interest or dividends but commodities don’t pay any of that.
Cryptocurrencies
We have read so much about cryptos and seen so many debates about them on various social media platforms that most of us have some decent idea about what exactly are crypto currencies.
For those who are completely new to this topic, Cryptocurrencies often referred as Cryptos are digital or virtual tokens that use cryptography to secure and verify transactions and to control the creation of new units. The first crypto currency was BITCOIN and it was created in year 2009 by anonymous person or group using the pseudonym Satoshi Nakamoto. Since then thousands of different cryptocurrencies are developed with different features and applications.
I personally like that it is not governed by any government or financial institution, so technically they are Cryptocurrencies are Decentralized. So no government can interfere or manipulate them and that provides greater financial autonomy. Also, as no banks or intermediaries are required for its transactions the transfers are really fast.
I don’t know if I should call it a benefit or not, but all cryptocurrency transactions are anonymous, i.e. users can make the transactions without revealing their identities. This sometimes sound scary too!
I also feel that because its not governed by any financial institution lack of regulations can be perceived to have high risk factor. Also, I feel cryptocurrencies are vulnerable to cyber attacks, hacks and thefts.
Biggest drawback of cryptocurrencies in present time is that it is not yet widely accepted as a means of payment, but there is an emotion in the market that soon it will become widely accepted. I guess only time will be the judge for cryptocurrenceis.
How to get started with investing?
By now you know about investing, why you should invest and different types of invements/assets. Congratulations!! You are now ready to understand how to start investing.
There are some steps every investor should follow before they start to invest. Let’s go through them one by one. Later you will also know some Investment strategies for beginners.
Set financial or investment goals
It’s very simple and is no secret- to achieve a goal we need to set a goal. We’d e lost if we don’t have goal(s). It’s like you have started to drive without knowing or deciding where to go. We need a clear purpose, plan and direction especially when money is involved whether its spending, saving or investing.
We need to access where we are right now and where we want to go. If we can set a measurable goal it becomes easy to achieve it. For example:
- Paying off credit card debt in say 2 years.
- Accumulating enough to make a down payment for a house.
- Making a systematic investment of $500 per month in mutual funds.
- Having enough money for retirement.
- Creating a portfolio that can generate regular income.
Above are only few examples. Setting up goals with timelines can do wonders. I have done that and seen the benefits, I have read biographies of many successful people and noticed knowingly or unknowingly everybody had goals and worked towards achieving them and they were able to achieve them. If we are diligent we can achieve 100%, it all depends upon taking actions to achieve our goals.
So, setup goals, assess current financial situation and make an action plan to achieve the goals. That is our first step. Once this is done, we need to determine our risk tolerance level.
Determine Risk Tolerance Level
This is an important prep step for investing and understanding our risk tolerance level. It can help us make a better investment decision and achieve our financial goals faster.
**Please remember there is no one-size-fits-all approach. We all are different and we all have different risk tolerance.
As an investor we should know how much we are willing to risk when making an investment decision. We need to find that level of risk we can take and to find that we can consider the following:
- Tolerance quiz – There are many quizzes with questions related to investment goals, financial situation, investment experience & so on. I have filled similar quizzes when I opened my first brokerage account. Most of the online brokers ask these questions before opening a brokerage account.
- Investment goals – all of us can different goals, we need to define them ourselves. For example – we can save for a down payment for a house, or for retirement, I mean we can take more risk to achieve higher returns or we can be conservative with our investment.
- Financial situation – Again it can be different for everyone. For example – if we have a stable income and also a good emergency fund then we may be a little more comfortable to take risk than someone who is living paycheck to paycheck.
- Age – This is one straight forward, usually younger investors have more time and can have a long investment horizon and can take higher risk for higher returns. Investors who are comparatively older have shorter investment horizon and tends to be more conservative with investments.
- Investment experience – If we are brand new to investment then we may be more cautious and try to have a lower risk tolerance. However, more experienced investor may have a higher risk tolerance.
Understanding our risk tolerance can help us become pro at investing and help us take an informed investment decision.
Choose an Investment Broker
We cannot invest without a brokerage account. We cannot buy or sell a stock if we don’t have a brokerage account. It is important to choose a broker wisely, as it is crucial for your investment success.
An investment broker is a person or a firm that facilitates buying and selling of securities on our behalf. There are different types of Brokers, different Brokerage accounts; they have different features and different fees. There are some documents required to open a Brokerage account and some other formalities.
***Click here to know about the Investment brokers and Basics about Brokerage Account.
Keep in mind the following when choosing an investment broker:
- Do a thorough research before finalizing a broker, read views on google or other trusted websites.
- Choose a broker according to your investment needs.
- Compare the fees of different brokers, as fees can vary widely among brokers.
- Read about their after sales support and educational resources they share with account holders.
- Technology platforms – Many brokers offer mobile apps or online platforms to manage securities or trade securities. Try to see if these platforms are user friendly.
Choosing a broker, followed by:
- Opening a brokerage account.
- Funding/ depositing money in a brokerage account.
- Start investing (or trading).
Investment Strategies for Beginners
- Dollar-cost averaging
- Buy and hold strategy
- Diversification
Advance investment strategies
- Value investing
- Growth investing
- Income investing
I hope this article was helpful. Stay tuned for more information on investment strategies for beginners.
3 thoughts on “The Basics of Investing: What Every Beginner Should Know 2023”