What is investing? Wikipedia defines investment as the following: “Investment is putting money into something with the hope of making a profit. More specifically, investment is the commitment of money or capital to the purchase of financial instruments or other assets so as to gain profitable returns in the form of interest, income (dividends), or appreciation of the value of the instrument.”
So what does all of that really mean… you know, in English? We all know what money is, it’s the stuff we carry around in our wallets (although never enough of it). So what are financial instruments? Specifically they are:
• Treasury Bills
• Mutual Funds
• Exchange Traded Funds (ETFs)
• Options and other derivatives
‘Investing’ means that you spend your money and in return you receive one or more of the above financial instruments. ‘Profitable returns’ refers to:
• Interest – this is what a company will pay you for the privilege of using your money. Think of a savings account at a bank. You give the bank your money and they use it to lend to other people and businesses. The bank pays you a small amount of interest for the use of your money.
• Income (dividends) – this is a form of profit sharing. When a company makes a profit, they pass some of those profits back to the owners of the company (some they keep to reinvest in the company to help it grow or survive during down times). As a stockholder you are an owner of the business and entitled to a share of the profits that are distributed.
• Appreciation of the instrument – this refers to the increasing value of whatever it is that you bought. For example, if you bought your home for $100,000 ten years ago and today you could sell it for $150,000 you would say that your real estate (real property) had appreciated by 50% or $50,000 in this example.
This all sounds good, but there is more to consider before you plunk down your money and expect to earn a luxury vacation in Cabo San Lucas. Your education is just beginning and the fun is about to start.
You need to understand what your financial goals are and what your position is on risk management. Your goals may include:
• The need to draw an income from your investments
• Saving for a vacation or major purchase
• Planning for your retirement
Whatever the case, you need to determine your financial goals because the answer will determine how you should invest.
Many people believe that the more risk you take with your investments, the more rewards you will receive. This is true to a certain extent, but it is also true that the more risk you take, the more likely you are to lose your entire investment. What we are talking about is called risk management and it is very important to understand. Every person is different when it comes to risk. In general, the older you are and the closer to retirement you are, the less risk you should be willing to take with your investments. This is because the older you are, the less time you have to recover from a big loss.
For a person to succeed in the stock market, he or she needs to commit to learning. Investing on your own can be very liberating and very rewarding, but if done in ignorance it can also be very dangerous to your financial well being. Beginners should scan the business section of the local newspaper and look for names of companies that they recognize. If you’re feeling adventurous try picking up a copy of the Wall Street Journal. Read those articles and get a feel for what is happening with those companies and how they work. Even Warren Buffet, the greatest investor of all time, does not invest in companies that he does not understand.
How about you? Do you have any advice for first time investors? Let us know in the comments below!