Investing 101 and Terms to Understand

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What is Investing?

When you invest, you purchase something with the expectation of profiting off of it in the future. In the 1990s, some people thought they were making smart “investments” in Beanie Babies and McDonald’s toys. But traditional investments include things like ownership in a business, real estate assets, or lending money to a person or company in exchange for interest payments.

Why Should I Invest?

Merely saving money isn’t enough to build wealth. A bank will keep your money safe. But, each year, inflation makes every dollar you’ve tucked away slightly less valuable. So, a dollar you put in the bank today is worth just a little less tomorrow.

Comparatively, when you invest, your dollars are working to earn you more dollars. And those new dollars work to earn you even more dollars. Which then work to earn you even more. The snowballing force of growth is known as compound growth.

Over the long term, investing allows your assets to grow over and above the rate of inflation. You past savings build on themselves, instead of declining in value as the years pass. This makes it significantly easier to save for long-term goals like retirement.

When Should I Start Investing?

Yesterday. But if you haven’t started yet, today is a great second choice.

In general, you want to start investing as soon as you have a solid financial base in place. This includes having no high-interest debt, an emergency fund in place, and a goal for your investments in mind. Doing so allows you to leave your money invested for the long-term – key for maximum growth – and be confident in your investment choices through the natural ups and downs of the market.

What is a stock?

A stock, also known as a “share,” is a tiny ownership stake in a business. Public companies allow anyone to buy or sell ownership shares of their business on exchanges.

If you own a stock, you are actually a part owner of the company. Go you! While owning a share of Walmart won’t give you the power to fire the slow cashier at your local store, you do have some rights. You can, for instance, vote on members of the Board of Directors.

What is a bond?

A bond is debt of a corporation, municipality, or country.

By purchasing a bond, you are loaning money to one of these entities. For companies, bonds are typically segmented into $1,000 increments that pay interest every six months, with the full value paid back at “maturity,” i.e., the date the debt is due. Government bonds are typically known as “treasuries.”

What is a portfolio?

A portfolio is a collection of all your investments held by a particular broker or investment provider. You may own some individual stocks, bonds, or ETFs. Everything in your account would be your portfolio.

However, your portfolio can also mean all your investments across all account types, as this gives a better picture of your entire exposure.

What does diversification mean?

Just like you wouldn’t invest all your money in your friend’s idea for a pumpkin-spiced toothpaste business, you don’t want to only invest in one stock or bond. Diversification means owning a variety of different investments, so your success or failure isn’t dependent on just one thing.

To be properly diversified, you want to make sure your investments actually have variety. Owning three different clothing companies still means you’re facing all the same risks. An import tax on cotton products, for example, could crush the value of all three companies at once.

What is asset allocation?

There are three main asset classes for most investors: stocks, bonds, and cash. Asset allocation is how you split your investments across those three buckets.

Stocks offer greater long-term returns, but significantly greater swings in value. These swings, sometimes north of 20% up or down in a given year, can be a lot to stomach. Bonds are safer but provide lower returns in exchange for that security.

You determine your asset allocation by considering the length of time until you need your money, your risk tolerance, and goals.

What are ETFs?

ETFs, or exchange-traded funds, allow you to buy small pieces of many investments in one security.

An ETF is a fund that holds numerous stocks, bonds, or commodities. The fund is then divided into shares which are sold to investors in the public market.

ETFs are an attractive investment option because they offer low fees, instant diversification, and have the liquidity of a stock (they are easy to buy and sell fast). Buying a stock or bond ETF gives you access to numerous investments, all held within that ETF.

Stock funds

A stock ETF often tracks an index, such as the S&P 500. When you buy a stock ETF, you are purchasing a full portfolio of tiny pieces of all the stocks in the index, weighted for their size in that index.

For instance, if you purchased an S&P 500 ETF, you are only buying one “thing”. However, that ETF owns stock of all 500 companies in the S&P, meaning you effectively own small pieces of all 500 companies. Your investment would grow, or decline, with the S&P, and you would earn dividends based on your share of the dividend payouts from all 500 companies.

Credit: dollarsprout

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