Introduction to Investing

There’s a point in life when it makes sense to start considering your financial future. The time may come when you land your first big job, move out of your parent’s house, or maybe when you are ready to start a family of your own. The fact is, you can never start investing too early. The available investment options are plentiful and the decision on where to invest is much less important than simply deciding to invest. However, once you put your mind to saving, you must then choose the best investment vehicle for your hard earned cash. The recommendations will vary depending on your situation, age, the amount of money to invest, and perhaps most importantly, your tolerance for risk. Some people may be a little intimidated by the thought of starting to invest. After all there are a lot of specific terms to learn and the options can be simply overwhelming. Let’s break down some of the most common terms and take a look at a few of the investment options available to remove some of the intimidation factor from investing.

How Investment Work

If you are doing research on investing, then you already understand that investing involves committing a resource (money in our case) with the expectation of a profitable return. In simple terms, we give up cash in hopes that we get our cash back plus a little more. The profit we get back is our return on investment (ROI). Typically, the more risk involved in any particular investment, the greater ROI you should expect back. It is not always quite this simple, but investing is often a balancing act between the risk and your potential return.

Importance of Compound Interest

Albert Einstein is often quoted as saying, “Compound interest is the most powerful force in the universe.” Whether or not he actually said those words is up for debate. However, what is not in question is the incredible importance of compounding interest. Compounding interest is basically money making money. For example, let us say you start with a £100 investment at 10% annual interest. After the first year, your account will have earned £10 and your total balance will be £110. In the second year, you will not earn £10; you will earn £11, making your balance £121. You will then earn interest on £121 and so forth.

The more often the compounding interest is calculated, the better. For instance, if you are comparing two savings accounts with the same annual rate of interest, but one compounds monthly and one compounds quarterly, the one that compounds monthly will be a much better investment.

Investment Terms

There are a lot of other terms you will hear mentioned and we will cover a lot more of them in the chapter on Investing Terms and Ratios so here we will just mention a few. Some of them are very important while others are just investment jargon that people might use to impress or even intimidate others. Either way, you should know what they mean, as you will likely begin using them yourself
An asset is something you own of value. When talking about investments it might a stock or bond that you own but it could also be things such as your vehicles or your home. Capital is the money you have available to invest in a particular asset.

Equity is a common term and has several meanings depending on the context. If you own an equity, you own a stock or a share in a company. Companies will also refer to equity or shareholder’s equity, which is the sum of their assets minus the sum of their liabilities. Equity is also used in the real estate market in reference to the difference between what a property is worth and what is owed on the property. In the futures market, the equity is the value of an account if it was sold in its entirety. Finally, if you have a margin account, your equity is the difference between your total account balance minus any margin requirement. As you can see, there are certain terms such as this that can be very complicated. Once you start to understand and use your investment vocabulary however, you will find that it comes quite easy, and in no time, you too will be impressing your friends.

Understanding Investment Risk

As mentioned previously, your risk tolerance will be one of the most important aspects to determine how you should invest your money. While the purpose of all investments is to increase the value of your current money, some investments are inherently more risky than others. In fact, most investments have no guarantee of increased value. For this reason, more risky investments will usually (but not always) offer a higher potential for return on your investment.

Safe Investment

Some investments are considered so safe that they are as good as cash. This includes simple savings and interest-bearing checking accounts, money market accounts and some government-backed investments such as US treasuries or savings certificates through National Savings and Investment in the UK. Since these types of investments involve such little risk, the reward, paid in interest, is often minute. Some of these types of investments will pay as little as a half percent annually.

Moderately Safe Investments

If you want to increase your return then you must be willing to accept an increased level of risk. This is not to say that you cannot get a decent return without great risk. You must simply weigh the amount of risk you are willing to accept against the rate you seek to get back. Bonds are a very good option for those who are willing to take on a little more risk for more return on their investment. A bond is basically a loan in return for repayment of principal plus interest. A bond holder has no ownership rights but is a creditor of the entity that issued the bonds. Bonds may be issued by companies or by governments and the terms may vary quite a bit. You can find more information in Chapter 9 – Bonds.

Riskier Investments for Larger Potential Return

Stocks are covered in Chapter 8. When buying shares of stock, you are buying shares of a company. You are in fact a part-owner of that particular company. Stocks can be very lucrative but also quite risky if you do not know what you are doing. Section 3 – Research and Analysis provides resources on how to research stocks, how to read a stock ticker, the Dow Jones and FTSE Indexes and more.

There are more advanced investment vehicles available. These should really only be undertaken once you have a good understanding and some experience with the more basic investments, such as stocks and bonds. However, a lot of people are interested in day trading, options trading or Forex and these can be very exciting and profitable investments. They can also lead to financial tragedy when misused or not understood, so do not rush into anything without careful consideration, a lot of research, and often, professional advice.

Investing can be extremely rewarding in several different ways. Of course, the monetary reward is the main reason most people invest in the first place. However, the research process can be fun, challenging, enlightening and a great learning experience. Start small, accumulate knowledge along with wealth, and remember the day you decided to invest. It could be the most important day of your life.