Investing: A Basic Overview
By Kevin Dufficy
Different Ways to Invest
There are many different ways to invest, and many different types of things to invest in. Some people choose stocks, bonds, or mutual funds, while others primarily invest real estate. A smart investor knows that portfolio diversification is key, and that caution and research are always the best approaches toward any type of investment, as well as advice from an expert financial planner. This article outlines some basic tips and guidelines to help you make smart investment decisions, but is in no way intended to substitute for advice from a financial professional.
Investment Basics: Risk and Reward
Risk and reward are important things to consider when investing. Investment risk means that you have the ability to tolerate losses while waiting for gains. There are many ways to invest in the stock market, and there are also many level of risk, from low-risk savings accounts to high risk stock futures. The amount of risk that you are able to take on will vary from person to person, but in general, the longer that you have to recover from an investment loss, the higher the risk you are able to afford. Higher-risk investments may lead to higher rewards in the future, but you may feel more comfortable with a lower risk, more solid type of investment. Regardless of your investment strategy and risk tolerance, the following quick tips can help you:
• Don’t yield to pressure-from stockbrokers, friends, or so-called “insiders.” Trust your own instincts, and make up your own mind based on how much risk your financial portfolio can stand, as well as your future goals.
• Beware of market timing, also known as “buy low and sell high,” since it doesn’t always work, even for seasoned investors. Spreading your risk by diversifying your portfolio will generally help keep you (and your investment dollars) safer.
• Do your research. Finance experts may disagree on whether its possible to ‘beat the market,” but those who say that you can beat the market recommend extensive research to uncover information about stocks that are under-and overvalued. Still others say that market movements are random, and stocks are always priced correctly. Whatever the case may be, research the companies and assets that you are interested in investing is essential to making smart financial decisions.
Once you’ve made the decision to invest your money, there are two important decisions you need to make: how much to invest and where to invest it. It’s important to understand your options as well as the risks associated with each of them.
There are three main types of investments:
• Cash –Equivalent
You can invest in any or all three investment types directly or indirectly by buying mutual funds. You may also want to consider an individual retirement account (IRA) or annuity, both of which can offer tax-deferred investment savings. Real Estate investment, while mentioned as a type of investment above, is its own subject and will be dealt with in future articles.
When you invest in stocks, you’re buying a share of ownership in a corporation and become a shareholder. Companies sell shares of stock to raise money for start-up or growth.
There are two types of stock: common stock and preferred stock.
With common stock, shareholders have a percentage of ownership. For example, if you own one share of common stock in a company that has 100 shares, you own 1 percent of the company. Common stock shareholders also have the right to vote on issues affecting the company.
Preferred stock usually does not offer voting rights, but shareholders are generally entitled to dividends (the company’s profits distributed in cash). Preferred stockholders typically receive dividends at specified times and in predetermined amounts; common stockholders may or may not receive dividends based on company profits.
When you buy bonds, you loan money to the government or to a company. Bonds are issued for a set period of time during which interest payments are made to the bondholder. The amount of these payments depends on the interest rate established by the issuer of the bond (the government or company) when the bond is issued. This is called a coupon rate. Coupon rates can be fixed or variable. At the end of the set period of time (called the maturity date), the bond issuer is required to repay the par or face value of the bond (the original loan amount).
Bonds are considered a more stable investment compared to stocks because they usually provide a steady flow of income. But because they’re more stable, their long-term return probably will be less than that of stocks. Bonds, however, can sometimes outperform a stock’s rate of return, depending on the particular stock.
Cash equivalent investments, like passbook savings accounts, money market funds or certificates of deposit (CDs), protect your original investment and let you have access to your money.
These types of investments generally deliver a more stable rate of return. On the other hand, the rate of return (after taxes are paid) is often so low that it doesn’t keep pace with inflation. A passbook savings account, money market fund or CD may give you quick access to your cash and may provide more short-term security. However, they’re not designed for long-term investment goals like retirement.
Here are some types of cash-equivalent investment types:
• Money Market: A fund usually invested in Treasury bills, CDs and commercial paper from large established institutions. They are typically safe, liquid investments.
• Certificate of Deposit: A fixed period, interest-bearing investment with a bank or savings & loan. An FDIC-insured CD is a low-risk investment.
• Passbook Savings: A bank account that generally provides a low, guaranteed, fixed rate of return.
• Mutual Funds: A mix of investments that may include stocks, bonds and cash-equivalents. The fund is managed by a professional money manager and has a stated objective or investment style.
Investment Basics: Further Information
Your certified financial planner is the best person to provide you with the risks, and benefits of all types of investments. Be sure to consult with them before making any type of important investment decisions.
About Kevin Dufficy
Kevin Dufficy is a seasoned financial expert having written articles and blogs on a wide range of financial, investment and retirement planning topics. He has an MBA from UC Berkeley, and a degree from H.E.C., the leading French business school in Paris, France. To follow Kevin"s profile, click here.