Investing 101: What Beginners Need to Know
This week I have a guest post written by Andy Kearns. Andy Kearns is a Content Analyst for LendEDU and works to produce personal finance content to help educate consumers across the globe. When he’s not writing, you can find Andy cheering on the new and improved Lakers, or somewhere on a beach.
Knowing how to invest is one of the most powerful financial tools you can give to yourself. Investing is a broad term, referring to any situation where you’re putting up money in the hopes that you earn a profit from that money.
For example, you can invest in the stock market and hope you earn returns or dividends on that money. You can invest in real estate in different ways, with the same objective. You can also invest in business ventures, and if the business becomes successful, you then earn money on top of the principal you initially committed.
The idea is that you’re putting money to work so that it earns you more money.
Investing is thought of generally as a passive way to earn income, as opposed to going to work every day to earn a paycheck. It’s much more valuable in most cases to invest money, as opposed to leaving it parked somewhere such as a savings account.
Of course, investments indicate risk which is something you must be willing to accept. Some investments are lower risk, and some are higher. Typically, higher-risk investments bring the highest returns, although not always.
Why It’s Good to be Knowledgeable About Investing
One of the biggest differences between successful investors and people who ultimately lose money is often knowledge. Of course, knowledge about investing doesn’t inherently mean you won’t lose your money, but it helps you understand the ins and outs in a way that can guide your decision-making.
Different investment strategies are optimal for different people, which is one reason it’s good to educate yourself. For example, if you’re young and still have many earning years ahead of you before retirement, you may be able to go with a riskier investment strategy. If you’re closer to retirement or in retirement, your strategy will need to be adjusted accordingly and will likely be less risky and more focused on stable earnings.
It’s also important to know about investing so you can ensure you aren’t taken advantage of if you work with a third-party investment manager. Of course, most are ethical, but it’s still good to have a general understanding of what their plan is for your money. With robo-investing, which is very popular for most investors, this isn’t a concern. Still, knowing about investing can allow you to create your own optimal strategy and can guide your decisions in an informed way.
The Difference Between Active and Passive Investing
Two terms are often used in investing, which are active and passive. Active investing means you’re hand-selecting what you invest in and you’re strategic in doing so. With active investing, your strategy may be riskier, and you may be looking more for short-term returns.
Passive investing means you’re putting your money into something, such as a mutual fund or ETF, and you plan to leave it there for the long-term. With funds, you’re buying very small pieces of many different stocks. Then, the funds typically track the overall trajectory of the market. When you’re a passive investor, you don’t make moves based on what’s happening at any given moment, instead, you look at the long-term horizon.
How to Create a Portfolio
An investment portfolio is everything you’re currently invested in. The term “portfolio” most often refers to securities that are diverse and a passive investing strategy. This is different from a situation where you might invest directly in a company, or even become part of its management because of the large stake you have.
Portfolios are typically diversified across different asset classes. This means a portfolio could have a mix of stocks, bonds, ETFs, mutual funds and even certificates of deposit. A portfolio can also include investments with physical elements like real estate, and options or derivatives.
How you build your portfolio depends on how long you plan to invest, your risk tolerance, and your age. If you have a greater tolerance for risk, you may go with things like stocks and real estate. If you’re more risk-averse, you may have more government bonds or mutual funds.
The Importance of Diversification
Finally, diversification is valuable when creating a portfolio. Diversification means you’re putting investments in many different vehicles. This allows you to protect yourself, at least somewhat, against risk because you’re not relying too heavily on any one investment. Diversification is also important for meeting your long-term goals.