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Investing can seem like a very risky, complex and fast-moving process. With endless combinations of investment vehicles to choose from, it can be difficult to take your first step as an investor—especially with the knowledge that all investments carry the risk of losing some or all of your money. So why bother?
Well, there are many compelling reasons to make investing a part of your overall financial plan. Investing can help preserve your wealth by overcoming the effects of inflation, help you save for long-term goals (such as retirement or your children’s education) and it can even generate income. So how can you get past all the negatives associated with investing and make it work for you? A helpful first step is to realize that, as a young investor, you have time on your side.
The truth is that serious investing requires a lot of time. There’s an entire education behind active trading. If you were to invest into the stock market without any prior research, you might as well be playing the lottery. Educating yourself about the stock market is no simple task and it requires ongoing research. It’s not only about understanding the way economies and global marketplaces work—it’s also about staying up to date on what’s happening in our world. Environment, technology, politics and culture all have the ability to influence economic forces. Beyond understanding those interactions, a smart investor also keeps very close tabs on the industries and companies they invest in by monitoring things like performance, governance, public opinion and industry trends. Now, imagine all that data changing and updating daily; suddenly, it’s clear why it can—and should—take so much time to make educated investment decisions.
When we acknowledge that preparation takes an incredible amount of time, it minimizes the role that luck plays in investing. Suddenly it’s less about taking a gamble and more about making calculated and educated decisions, which is a good thing—it means that investing is something you can practice, explore and ultimately improve on, over time.
It can be tricky trying to separate this myth from the truth, because risk and loss are both very real outcomes of investing. No investment is ever guaranteed, meaning your invested money is never absolutely safe. Some investment types may be safer than others, but the risk of losing your money is ever-present.
After making smart, thoroughly researched investment choices, your next best protection against risk and volatility is the amount of time you have for your investment to mature. The narrower your investment time frame, the more vulnerable you are to sudden and often unpredictable changes in the market. By contrast, if your investment is long term (think decades), day-to-day changes suddenly hold less influence. Plus, there is time to recover from market declines; the same cannot always be said for short-term investments.
Investment Vehicles First-time investor? Do your homework before investing your hard-earned cash. Unless you can predict the future, investing is a risky business. Know your goals, your needs and your tolerance for risk before you put your money at stake. Step 1: Understand the risks of different types of investments From safest to riskiest 1. Savings accounts, CDs, money market accounts 2. Mutual funds with short- or intermediate-term bonds 3. A blend of mutual funds with stocks and bonds 4. Mutual funds with diversified stocks 5. Individual stocks Stocks and bonds are the two main vehicles that you are likely to invest in Bond • A bond is a debt security—the issuer owes the holders a debt, and is obliged to repay the principal and interest • More stable • Lower potential gain • Risk of issuer not paying you back Stock • Stock is capital raised by a corporation through the issuance and distribution of shares through financial markets • Less stable • Higher potential gain • Risk of company failure If trading individual stocks and bonds feels too risky to you, investing in mutual funds is another option to consider. • A mutual fund is a collection of stocks or bonds • Your money is pooled with the money of other investors into a fund that is invested in anywhere from a few dozen to hundreds of different securities • Managed by an expert fund manager who reports to a board of directors • Provides you with professional money management as well as instant diversification Step 2: Establish your goal timeline The time horizons of your goals will have an impact on where you put your money. With a shorter time span, a more conservative investment vehicle is typically in order. With a longer horizon, your investment has time to weather more risk. • 3 years: New car fund – savings account or a mutual fund with short-term bonds • 15 years: Kids college – balanced mutual funds • 30 years: Retirement – stock-focused mutual funds Step 3: Start early in life, start small and keep going When you are starting to invest, it is best to start small and take risks only with money that you are prepared to lose—you’ll have two main choices for actually investing your money. Advisor • Utilizing the services of a financial advisor at your bank, credit union or specialized investment firm is the traditional way to invest in stocks, bonds and mutual funds • Purchases and trades are facilitated through your advisor • Broker commissions and maintenance fees can be expensive • Educated professionals are guiding you • Less time on your part • Less stressful, as you are relying on a proven coach • Even though you are relying on expert advice, there are no guarantees Do it yourself • Direct investing, do-it-yourself investing, self-directed investing—no matter how you describe it, investing on your own is a real option today, thanks to technology • Trades are conducted by you through an online discount brokerage • Typically lower fees and more transparency; you are closer to the process • Learning and research are totally up to you • Can be time-consuming • Your emotions can get the best of you • Your personal decisions and mistakes can be costly Avoid these first-time investor mistakes • Diving in head first The basics of investing are quite simple in theory—buy low and sell high. However, don’t be fooled by this overly simplistic view of the financial markets. It is important to study up before jumping in. • Playing penny stocks At first glance, penny stocks seem like a great idea—with as little as $100, you can get a lot more shares in a penny stock than in a blue chip stock that might cost $50 a share. Unfortunately, what penny stocks offer in potential profitability has to be measured against the volatility that they face. • Going all-in with one investment Investing 100% of your money in a specific market, whether it’s the stock market, commodity futures, foreign exchange or even bonds, is not a good move. It is better to diversify • your risk by putting your dollars into a variety of investment vehicles. • Investing all of your cash reserves Studies have shown that cash put into the market in bulk, rather than incrementally, has a better overall return; however, this doesn’t mean you should invest all of the money you have. You should always have cash available for emergencies and other opportunities. • Chasing news Investing based on news is a terrible move for first-time investors. Trying to guess what will be the next revolutionary product or basing a decision on a rumor of earth-shattering earnings is not a recipe for success. Rather than following rumors, the ideal first investments are in companies you understand and have personal experience with. Investing can be risky: Not all investments are guaranteed—some investments carry the risk of losing money, even when made through a financial advisor or financial institution. Sources: AARP, The New York Times, Investopedia, Morningstar