Basics of Investing
What is Investing?
According to Forbes, “Investing is the process of buying assets that increase in value over time and provide returns in the form of income payments or capital gains”. When we buy an asset at a lower price and sell it at a higher price, we earn what is called a Capital gain. In addition to selling assets and obtaining capital gains, investing also works when one buys and holds assets that generate income.
Why Invest?
What does one do when one receives a paycheck? One spends a chunk of one’s earned money on paying one’s expenses. The chunk of disposable income that remains after paying the expenses—that is, whatever remains in one’s hands after paying for expenses—is referred to as savings. Savings is that portion of money that sits idly in one’s bank account. Investing, on the other hand, is the act of putting saved money into financial products, which would reap profits over time.
Saving money does not contribute to an increase in wealth; it only leads to the accumulation of wealth. Investments are the way to put money to work and make it grow on its own. Though there are risks associated with investing, making wise and informed decisions can help one grow a fortune through investing.
Where to Invest?
An “asset class” includes investments with similar characteristics that are also usually governed by the same set of financial regulations. Investments can be made in the following asset classes:
- Equities (Stocks)
- Fixed-income investments (Bonds)
- Commodities (Oil, Gold, and so on)
- Alternative Investments (Real Estate, Forex, and so on)
There are also other investment options, like Mutual funds and Exchange-traded funds, that buy different combinations of the above assets. Furthermore, investing in cryptocurrencies has gained popularity in recent years.
Some brief information about the above assets:
- Stocks: When one buys stocks, one purchases a share or ownership in a company. Offering shares helps the company raise capital. In return, the company shares its success (or failure) with its shareholders. Stocks have the potential to provide high returns, but they can be volatile.
- Bonds: These are debt securities issued by governments or corporate organizations. They pay interest and return the principal amount at maturity. There is lower risk involved in bonds, but the returns are also lower compared to stocks.
- Commodities: Investing in commodities implies holding quantities of oil and gold. The prices of these commodities fluctuate based on market demand. This investment option is used by more experienced investors and is not commonly used by beginners.
- Real Estate: Investing in real estate includes buying a home or a piece of land or purchasing shares of a Real Estate Investment Trust (REIT). Real estate can generate rental income and appreciate in value if the neighbourhood becomes more desirable, if the house is newly renovated, and so on.
- Mutual Funds: Mutual funds pool money from investors and invest it in a diversified portfolio of investment options. Following are three basic types of mutual funds:
- Equity Funds: Equity funds invest the money pooled from various investors into stocks of different companies. The gains or losses in these funds depend solely on how the shares of those companies perform. The risk associated with equity funds is higher, but they have the potential to generate significant returns.
- Debt Funds: Debt funds invest in fixed-income securities like bonds. These are a great option for investors who are looking for regular income with minimal risks.
- Hybrid Funds: Hybrid funds, or balanced funds, are an optimum mix of bonds and stocks.
- Exchange-Traded Funds (ETFs): ETFs are similar to mutual funds. ETFs invest in stock exchanges. They provide diversification and liquidity.
How do I Invest?
Define your financial goals: This could include education, buying a home, retirement planning, or simply increasing wealth.
Identify the time horizon: The time horizon is the time for which you want to keep money invested. Based on your financial goals, you should identify how much time you should require to achieve those goals and then choose investment options accordingly.
Assess your risk tolerance. Investment options that offer higher returns always involve higher risk. Investment options that involve lower risk provide lower returns. Depending on how much risk you can tolerate or how much risk you are willing to take, various investment options should be considered.
Diversify your portfolio: Make your portfolio an optimum combination of various types of investments. This will help minimise risk and maximise returns.
When should I start investing?
Today? Why not! Many investors have emphasised the importance of starting to invest money early. Starting early can help one realise the power of compound growth. In compounding, one’s returns generate returns, which leads to exponential growth.
Starting early also allows one to take more risks, which can potentially reap greater rewards. Starting early can help one comfortably achieve one’s financial goals; it provides high financial security and the ability to face unexpected financial challenges.
