No course on personal finance would be complete without a section included in investing. And investing early is one of the smartest things you can do. Investing not only protects your money for the future, but it also keeps the money you already have safe and secure. Unfortunately, a lot of young people don’t invest. It isn’t that they don’t want to, it’s usually because they don’t know where to start or what options are available. This article should make all the financial jargon around investing a lot easier to understand.
Bonds: a bond is an interest-bearing debt security. Bonds are issued by both companies and government entities for a specific amount of money that is “lent.” Bonds always have a given term. While interest is generally paid out on specific intervals, the bond amount or face value is repaid in total at maturity (the end of the term). Bond duration is generally between 90 days (treasuries) and 10 years.
Stocks: when a corporation decides to go public, it allocates ownership of the company by partitioning the company into shares. A stock is then a unit of ownership. Stock values generally fluctuate with the understood value of a company. Stocks are generally traded through the stock market.
Mutual Funds: a mutual fund is an investment made by pooling funds from a number of investors for the purpose of investing in stocks, bonds, and other assets. Funds are managed by specific money managers who invest the capital while maintaining the investment objectives and structure. Different mutual funds have different general investments. For example, some funds are focused in specific international markets, while others are focused in specific market areas (mining, the financial industry, technology, etc.).
Risk: in most cases an investment will not have the exact same return as expected. The possibility that some of the original investment will actually be lost is the risk associated with an investment. Risk is calculated using the standard deviation of historical or average returns of investment. Different investments carry different amounts of risk. While risk carries the concern of loss, greater risk also means greater possible returns. An individual’s risk tolerance is thus something that needs to be considered both from a financial and personal standpoint.
Diversification: to manage risk, it is generally desirable to diversify. That means you have a variety of investments that do differently in different scenarios. The idea of diversification in based off the wisdom of not placing all of one’s eggs in one basket. By investing in different country’s markets and in companies that might do well in different markets an investor gives themselves a cushion.
Tax-deferred investments: some investments allow users to accumulate tax free until the investor takes the money out at a later date. These types of investments are generally used for retirement saving and are important for two reasons. The first is the idea of compound interest. If the money can grow unhindered by yearly taxes on interest and gains it is a benefit to the investor. The second is the fact that money is taxed at different rates depending on the income tax bracket that an individual falls into. While one is working, they will generally be in a higher tax bracket than would be expected once retired and not working, and therefore income would be taxed at a higher rate if done immediately.
Interested in investing? Unless strictly interested in treasury bonds or placing money in a money market account, you will need to open account with a brokerage firm. If you are interested in having a financial planner, it is important to decide if you would like to do a fee based or commission based account. Also, consider going through your bank or through a referral.