If you’re starting out as an investor, you might be feeling overwhelmed. After all, it seems like there’s just so much to know. How can you get enough of a handle on basic investment concepts so that you’re comfortable in making well-informed choices?
Actually, you can get a good grip on the investment process by becoming familiar with a few basic concepts, such as these:
Stocks versus Bonds — When you buy stocks, or stock-based investments, you are buying ownership shares in companies. Generally speaking, it’s a good idea to buy shares of quality companies and to hold these shares for the long term. This strategy may help you eventually overcome short-term price declines, which may affect all stocks. Keep in mind, though, that when buying stocks, there are no guarantees you won’t lose some or all of your investment.
By contrast, when you purchase bonds, you aren’t becoming an “owner” — rather, you are lending money to a company or a governmental unit. Barring default, you can expect to receive regular interest payments for as long as you own your bond, and when it matures, you can expect to get your principal back. However, bond prices do rise and fall, typically moving in the opposite direction of interest rates. So if you wanted to sell a bond before it matures, and interest rates have recently risen, you may have to offer your bond at a price lower than its face value.
For the most part, stocks are purchased for their growth potential (although many stocks do offer income, in the form of dividends), while bonds are bought for the income stream provided by interest payments. Ideally, though, it is important to build a diversified portfolio containing stocks, bonds, certificates of deposit (CDs), government securities and other investments designed to meet your goals and risk tolerances. Diversification is a strategy designed to help reduce the effects of market volatility on your portfolio; keep in mind, however, that diversification, by itself, can’t guarantee a profit or protect against loss.
Risk versus Reward — All investments carry some type of risk: Stocks and bonds can decline in value, while investments such as CDs can lose purchasing power over time. One important thing to keep in mind is that, generally, the greater the potential reward, the higher the risk.
Setting goals — As an investor, you need to set goals for your investment portfolio, such as providing resources for retirement or helping pay for your children’s college educations.
Knowing your own investment personality — Everyone has different investment personalities — some people can accept more risk in the hopes of greater rewards, while others are not comfortable with risk at all. It’s essential that you know your investment personality when you begin investing, and throughout your years as an investor.
Investing is a long-term process —It generally takes decades of patience, perseverance and good decisions for investors to accumulate the substantial financial resources they’ll need for their long-tem goals. By keeping these concepts in mind as your begin your journey through the investment world, you’ll be better prepared for the twists and turns you’ll encounter along the way as you pursue your financial goals.