Investing 101
What is investing?
Understanding Investing
Investing is the act of putting money into anything in the hopes of receiving a greater reward in the future. You may invest in your bank savings account, a business, a college education, or various types of assets including real estate, commodities such as gold and silver, bonds, cryptocurrencies, or stocks.
_______ With each investment, you sacrifice spending money in the present so that your money might be put to work in something that will increase in value. _______ For most people, the largest investment they make in their lives will be their college education (investing in themselves and their skills) or their house (investing in real estate). In short, you set aside money now, for greater rewards later. |
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What are Investments - Securities, Stocks, Bonds
When an investor decides to place his/her money into the stock/bond market, there are several different ways in which that capital can be put to use. The general way in which an investor can make a profit off of the market is through what are called securities. Securities is the general term used to describe interest and holdings in a company as well as debt collection from a company. Securities however can be broken up into several niche subcategories with the first being stocks, the most basic asset for investment portfolios which can be bought and sold by the investor. A stock is essentially a share of a company that gives whoever purchases its partial ownership of that company and makes them a shareholder, entitling them to the company’s profits and assets. Investors most likely purchase a company’s stock if they feel that the company will go up in value and if it indeed does, the investor will also make a profit. However, if a company depreciates in value, so too will the investor’s stock. In addition to stocks, investors can also purchase bonds which are units of debt sold by companies or sovereign nations and if they do, they then become creditors. Bonds are traditionally issued by corporations and governments to help collect funds for various projects. If an investor purchases a bond, the way in which they make a profit is through fixed interest payments that are usually determined by the borrower. On the other hand, investors can lose money from bonds if they sell it at a lower price than what they bought it for. In extreme cases, borrowers can even default on their payments. One difference between stocks and bonds is that stocks are mainly sold in one centralized location such as the New York Stock Exchange while bonds are usually dealt over the counter.
Types of Stocks - Blue chip vs Penny stock
When it comes to investing, there are two very different types of stocks every investor should know: blue chip and penny stocks. To begin with, blue chip stocks are the most valuable stocks that any person can buy on the stock market. These stocks mainly belong to the most valuable and profitable companies in Wall Street. In addition, blue chip stocks tend to be among the most traded stocks in the world with some notable blue chip stocks coming from Coca Cola Co, Boeing, and Disney. Investors mainly deal in blue chip stocks due to the reputation of these major companies as well as a strong but slightly flawed belief that blue chip stocks can withstand financial recessions and crashes. On the other hand, penny stocks belong to small companies and cost no more than five dollars a share. As opposed to most blue chip stocks, penny stocks mainly trade over the counter on the OTC rather than on large exchanges. With penny stocks comes a higher risk of taking losses as smaller companies do not have the same capital or experience as larger corporations have. Penny stocks also tend to be more volatile than blue ship stocks which is why penny stocks should be dealt with by high risk investors rather than those looking for security.
Principles of Simple vs Compound Interest
Compound Annual Growth Rate of CAGR is used in almost all financial calculations by investors across the world but what exactly is CAGR? To understand one of the most vital tools for portfolio management, one must understand the principles of simple and compound interest. Simple interest is what is calculated on a loan’s original amount and its formula is P x i x n with the “P” standing for principle (original amount), the “i” standing for the interest rate, and the “n” standing for the time period of the loan. For example, if someone was given a loan for $20,000 with a 5% interest rate over 4 years, the total amount of the interest would be $20,000 x .05 x 4 = $4000. Therefore, the borrower would have to pay back the creditor a total of $24,000. On the other hand, compound interest not only accounts for the simple interest but also the interest that accumulates over time. In other words, compound interest calculates “interest on interest”. While compound interest yields dramatically different numbers than simple interest, it may be beneficial to investors to make profits. The compound interest formula is P[((1+i)/n)^nt -1] with n standing for the number of years compounded and the t standing for the time period of the loan. Now that we’ve covered simple and compound interest, the real world applications of these calculations in terms of investing comes down to CAGR which helps calculate stock, fund, and portfolio growth. CAGR can help give investors a prediction on how much they can potentially make on an investment which is why these calculations are crucial to understanding investing.
Risk Management
With reward comes risk, always. For example, a very low risk, low reward investment is US Treasury bonds. These are loans to the US government, which the government will pay you back with interest. Since the US government is almost guaranteed to pay you back, the gain on your investment will be extremely small. A step up in terms of risk from these treasury bonds would be corporate bonds, which are loans to corporations. These have higher yields (reward) because there is a higher possibility you may not get your money back if a corporation goes bankrupt. To check how much risk you are taking for corporate bonds, check the company rating on Standard and Poors. Triple A (the highest rating) to triple B minus are called investment grade bonds which are what many people trade. Anything below triple B minus is a junk bond. The various credit ratings allow investors with varying appetites for risk to invest comfortably. Finally, stocks are one more way to invest money. Since stocks are valued by the perceived worth of the company, they can vary wildly at times in price. Yet, even with stocks, there are varying degrees of risk that can be taken on. The riskiest stocks are penny stocks, which are worth very little per share and can go bankrupt at any time, causing you to lose your entire investment. On the other hand, there are “blue-chip stocks” which are the most popular stocks to trade simply because the company is reputable and large enough to be considered much safer. No matter what you invest in, just remember to consider the risks y being taken and think about what level of risk you are willing to take.
When the stock market crashes
The market has crashed many times before and it will crash many times in the future. Market crashes are all part of the risk you take when you buy stocks. The important thing to note is that the market will recover, eventually. Unless the company you have shares of is going bankrupt and you must cut your losses quickly, market crashes are just a time to hold on to your shares, not to sell at a loss. If anything, market crashes provide an opportunity to invest since stock prices are heavily discounted. However, that all depends on how much cash you have to invest when the market crashes. The main idea is to, as much as possible, consider whether your environment is ripe for investment and to always be on the lookout for financial opportunity.
How much you should expect from returns
Many investments are very volatile, but there are averages that we can look at to see how much we should expect depending on what we invest in. Currently, the returns on the US 30 year treasury are trading around 1.5% which is relatively low. Contrast that with the stock market where, by historical average, investors can expect yearly returns of 10%, 5-7% by conservative estimates.
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This is a book called "Stock Investing For Dummies" and provides a lot of basic information. If you're new to stock investing, through this book, feel free to explore the various aspects and topics that the market has to offer!
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