Investing Basics: Terms And Insights That Every Beginner Investor Must Know
- Investing is the practice of buying financial instruments with the goal of profiting from them.
- Investing is not the same thing as trading, as investing focuses on long-term growth while trading is all about seeking out opportunities for short-term profits.
- Investing can help you reach your long-term financial goals, such as a comfortable retirement or homeownership, due to how your investing profits can compound over time.
- While investing can be risky and requires you to be financially secure before starting, it offers great opportunities for growing your capital in the long run.
- The four most common investment types are bonds, real estate, stocks and Exchange Traded Funds, which can combine a variety of assets.
- In order for your investment portfolio to be secure and stable, it should be diversified and include different types of assets in different proportions.
69% of American adults aged 18-23 consider investing to be scary or intimidating.
It’s not difficult to see why — you must have considerable knowledge to navigate the ever-changing world of finance, let alone profit from it.
Fortunately, it’s never too late to start learning about investing and how it can help you reach your financial goals.
We’ve created this blog post to cover all the investing basics that every beginning investor should know.
In this post, we will explore:
- The fundamental rules and investing basics to know before getting started
- The different investment types and how to leverage them
- The five key steps to starting your investment journey
Investing Basics: Getting Started
You may hear stories, here and there, of people who buy the right stocks at the right time and profit overnight. While you would surely love to experience such luck, the truth is, it’s highly unlikely.
This is not to discourage you from trying your hand at the stock market, but to make a simple principle clear: Investing is not a gamble, but rather, a thoughtful, strategic plan that includes tangible goals and realistic expectations.
In other words, if you’re looking for a get-rich-quick scheme, you might have to look elsewhere.
But if you’re looking to reach your goals by leveraging the potential of the financial markets, let’s jump right into exploring the investing basics you should know!
3 Key Facts In Investing Basics
If you’re reading this, you’ve made it past the intro — which means you have an investor mindset, the most important prerequisite for a successful investing strategy.
However, there are a few other investing basics you should know before proceeding with your investing journey.
#1: Investing And Trading Are Not The Same
First and foremost, let’s define what investing means.
The truth is, it’s not so complicated: Investing is the practice of committing your capital to an organization, endeavor or resource with the goal of earning a financial return.
In other words, you put your money in a place where it will make you more money — such as in stocks, bonds, real estate and other instruments.
Trading also involves buying stocks with the goal of getting a financial return, but it’s not the same thing as investing.
The aim of trading is to gain a financial return within a short timeframe.
For example, buying and selling a stock for profit within a single day is commonly known as day trading.
Those stories about people buying the right stock at the right time, seeing its price skyrocket and making a fortune after closing their position? That usually happens in trading.
At the same time, trading can be very risky and requires considerable resources — both in terms of capital and time commitment.
Investing involves a long-term, strategic commitment to growing your capital over time, regardless of micro trends and market volatility.
Trading, on the other hand, focuses on those macro trends and volatility to identify short-term opportunities for gaining profit.
#2: Your Finances Need To Be In Check Before You Invest
Even though investing is now more accessible than ever, many people are still deterred from trying their hands at the stock market.
There is a widely circulated misconception that you must possess considerable capital to invest in order to gain a worthwhile profit.
This is only partially true. For example, the average annual return of S&P 500 stocks over the past decade was around 13.6%. So if you invest $1,000 in a portfolio of S&P 500 stocks, you can expect to make a profit of $136 within a year.
While that might not seem like a life-changing fortune, remember: Investing is a marathon, not a sprint. There is nothing wrong with dipping your toe into the water before diving in.
Starting with a small investment — even $1,000 — will allow you to get a better feel of the market and set realistic goals and expectations while building your portfolio.
Of course, if you have $1,000 to your name, investing it all wouldn’t be a financially sound decision.
In other words, you should be in a stable financial situation before embarking on an investing journey.
A stable financial situation means not only a stable income but also savings that can help you maintain your lifestyle for 3 or 6 months without any additional income and an absence of debt.
The absence of debt is, arguably, the most important factor — for purely economic reasons.
For instance, let’s say you have a credit card with some debt on it. The average Annual Percentage Rate (APR) for credit cards in the US ranges between 15.56% and 22.87%, which is much higher than the average annual returns of S&P 500 stocks we mentioned above.
In other words, even if you make a very smart investment, its profits will most probably lag behind the compounding interest of your loan.
As such, be sure to take care of any outstanding loans and debts you might have before diving into investing.
#3: Investing Can Be Risky
Finally, we must address the elephant in the room: Investing can be risky.
No matter how sophisticated and informed your investing strategy is, there is still a possibility that you will lose money on it — especially in a short-term perspective.
This is precisely why you should have savings and take care of your debt before venturing into investing.
The risk factor is an important variable in investing because it usually correlates with your potential profits. Usually, the riskier your investments are, the more profitable they can be.
Similarly, less risky investments are usually less profitable. For instance, building a low-risk portfolio of government bonds and stocks of old, established companies, would be a low-risk investment.
Alternatively, investing in up-and-coming startups that have a rich potential for growth would be a high-risk investment, because they have an equally rich potential for failure.
Unlike investing, trading prioritizes short-term opportunities for profit by closely following market fluctuations.
What Are The Different Investment Types?
While the term ‘investing’ usually refers to investing in the stock market, there are several types of instruments you can invest in. Understanding the difference is an important part of investing basics.
Let’s take a look.
Bonds are debt instruments that represent a loan with interest, given by the bondholder to the bond issuer upon purchase.
A bond functions as an IOU, documenting the terms and conditions of the loan that the holder effectively gives to the issuer.
Although bonds can be issued by companies, they are typically used by governments to raise funds for projects or expenses. The variety of such government bonds that you’re probably most familiar with are the bonds issued by the US Treasury, also known as T-bonds.
The key characteristics of bonds are:
- Principal: Also known as the nominal or the face value, it is the amount of money that the bond will be worth upon its maturity (more on that in a moment). The principal of a bond is determined by the issuer. For example, T-bonds have a minimum value of $100.
- Maturity: Just like all loans, bonds have a specific date when the issuer must repay the bond value to the holder. This date when is known as the maturity date. Just like the principal, the bond issuer is free to assign any maturity period to the bond. T-bonds, for instance, have long maturity periods of between 10 and 30 years.
- Coupon rate: The coupon rate is the bond’s annual interest rate, paid to the holder in specific intervals. The coupon rate is calculated as a percentage of the bond’s face value, while the dates at which the interest payments are made are known as the coupon dates.
Since bonds are usually issued and backed by governments, they are among the most stable and safe investments you can make.
As a bondholder, you will receive pre-determined interest payments on a pre-determined schedule and you will get your full investment back once the bond matures.
Alternatively, you can also profit from selling the bond to another investor at a higher price.
However, as we’ve already learned, lower risk equates to lower profitability — and US Treasury bonds are the best example of that.
For the past 10 years, the yield of 10-year T-bonds has stayed under 4%, which is considerably lower than the average return of stocks over the same period.
As such, bonds are a safe and accessible way to diversify your investment portfolio — but don’t expect impressive profits from them.
#2: Real Estate
Real estate as an investment instrument is more self-explanatory than other investment types.
Real estate investing revolves around purchasing real estate with the expectation that it will go up in value. Technically, if you own a house, a condo or a plot of land, you can consider yourself a real estate investor.
In its more traditional sense, however, real estate investing involves commercial property — such as apartment buildings, storage units and small stores.
The main principle is easy — buy the property and profit from renting it out or selling it after it goes up in value.
Other types of real estate investing include:
- Real Estate Investment Groups (REIGs): Real estate investment groups allow you to invest in commercial real estate alongside other investors, usually through a single company that controls the group. REIGs are similar to mutual funds, but for real estate — you simply put the money in and let the managing company do the hard work. However, just like mutual funds, REIGs require you to pay some sort of fee to the managing company and may be subject to poor management.
- Real Estate Investment Trusts (REITs): Real estate investment trusts are exchange-traded organizations that invest in income properties. REITs are more similar to mutual funds in their nature than REIGs. And while the two terms might sound similar, the investment methodology behind them is quite different. Unlike REITs, which are more akin to private investor clubs, REIGs function more like corporations. They are usually run by a board of directors and pay dividends to their shareholders. In fact, it’s the dividends that truly differentiate them from other forms of real estate investing. REITs are required by law to pay at least 90% of their taxable income as dividends. As such, they are a perfect instrument for investors who are looking for stable profits.
- Crowdfunded real estate investing: Another real estate investing method that has emerged recently is crowdfunded real estate investment. It is usually done via online platforms that are similar to REIGs in their operation but are less formal and offer lower barriers to entry. These platforms allow individual investors to pool their capital for real estate investing. Some platforms allow you to participate with as little as $1,000, making them a great solution for beginner investors.
Real estate investing is the most straightforward investing method that can yield great returns. However, real estate is expensive and you must have considerable resources in order to invest in it.
Nevertheless, you can still diversify your portfolio as a beginner investor by participating in crowdfunded real estate investing or in REITs.
Finally, we arrive at the financial instrument that most people think about when someone mentions investing — stocks.
Also referred to as equity, stocks represent the ownership of a company. A single unit of stock is known as a share. The more shares of a company you have, the bigger your stake in that company’s ownership is.
Depending on the company, stock ownership entitles you to a portion of the company’s profits. After the company pays off its debt and expenses, it can choose to distribute a part of its remaining profits to the shareholders as dividends.
The investors or entities who own the majority of the company’s stock (more than 50%) also get decision-making power within the company, which is known as the controlling interest.
Alternatively, companies can choose to restrict the number of their shareholders, only selling their stock in private deals. Such companies are referred to as private.
Stocks are the most popular financial instrument for most investors for three key reasons:
- High potential for long-term profitability: There are plenty of stories about how stocks of now-prominent companies grew astronomically over the years. For instance, when Amazon went public in 1997, it listed its stock on NASDAQ for everyone to buy, with a share price of $18. The company’s value has grown astronomically since then. In April 2021, the share price exceeded $3,350 — a growth of around 18,000%! We’ve already established that investing is all about long-term profitability — and this is one of the best examples.
- Flexibility: Unlike bonds and their maturity periods or real estate, which can be a hassle to manage, stocks offer great flexibility for you as an investor. You can choose to sell them at any point if you feel like you’re satisfied with their profitability or need cash for an emergency expense.
- The ability to express personal values and interests through investing: Investing does not have to be only about profitability and your long-term financial goals. Your investment portfolio can also represent your personal values. For example, if you are passionate about environmental sustainability, you can choose to invest in companies that prioritize sustainability. The sub-category of investing that focuses on supporting conscious and sustainable companies is known as Socially Responsible Investing (SRI) or Environmental, Social and Governance (ESG) investing.
Apart from buying individual shares of specific companies, you can also invest in mutual funds or Exchange Traded Funds (ETFs).
ETFs usually include multiple stocks of different companies. As such, buying a stake in an ETF allows you to invest in several companies at once.
The contents of an Exchange Traded Fund are commonly referred to as the fund’s holdings and vary from one ETF to another. Some funds are solely comprised of tech companies, while others can include various types of securities in addition to stocks: bonds, commodities such as gold or crude oil and even currencies.
Most ETFs function as index funds in the sense that their holdings are organized according to the composition of popular stock market indexes, such as S&P 500.
Just like those indexes, ETFs don’t have an inherent value — rather, it is derived from the value of their contents.
Many investors prefer to invest in ETFs rather than in individual stocks, as ETFs tend to be less risky and more diversified.
Since ETFs have pre-determined contents, they don’t require you to have such an intricate knowledge of the market and the financial performance of specific companies.
In other words, you can simply leave the fund managers to do all the heavy lifting for you while enjoying the fruits of your investments — in exchange for a certain fee, of course.
Depending on your objectives, your portfolio should include a mixture of low-risk, low-return and high-risk, high-return assets.
5 Steps To Starting Your Investing Journey
Now that we’ve covered the essential investing basics that you need to know, let’s talk about how you can put this knowledge to use and start investing.
The truth is, it’s not as difficult as it may seem — if you follow these steps.
Step #1: Define Your Investing Approach
Before choosing stocks and calculating your potential profits, you need to first define your investing approach. Do you plan on spending a lot of time evaluating the performance of stocks for your portfolio? Or do you plan to simply follow your gut?
Is a company’s growth rate more important to you than its values? Or do you plan to invest only in companies that match your beliefs?
There are no right or wrong answers to these questions but, defining your investing approach will help you choose the opportunities that are right for you.
Step #2: Set Your Investing Goals
For your investing strategy to be complete, it must have tangible, specific goals.
Investing for the sake of investing might be fun, but chances are that you might not stay committed to it in the long run. In other words, you should consider investing to be a means to an end, not an end in itself — that would be trading.
Are you investing to retire early and live comfortably, to buy a house in 10 years or to get a PhD degree without taking on any debt?
Determine how much money your investment would need to make in order for you to achieve your goals. Your investing strategy and portfolio will primarily depend on what it will take to reach your objectives.
Step #3: Create A Draft Of Your Investment Portfolio
Now that you’ve determined your investing goals, you should create a draft of your investment portfolio.
To do that, you don’t have to look up specific securities to invest in just yet — you can simply approximate their ratio within your portfolio.
For example, a safety net-type portfolio that will help you create an emergency fund for unplanned expenses will need to be more conservative — 70% bonds, mostly short-term US Treasury bonds and 30% stocks, for instance.
But if you’re looking to save up for a comfortable retirement, your portfolio will need to offer higher profitability — a ratio of 90% stocks with an emphasis on US corporations and 10% bonds could be a good place to start.
Step #4: Find An Investing Partner Or Tool
The most essential tool that you will need to purchase in stocks, bonds or ETFs is an investment account. The easiest way to open an investment account is through an online investment platform.
Most online investment platforms allow you to open an account in just a few minutes. Once your account is set up, you can put your money in and start investing in whatever instruments you wish.
However, for a beginner investor, an online investment advisory platform can be a better way to go.
They, too, allow you to open a brokerage account, and as a bonus, you also get to coordinate your investment strategy with an experienced investment advisor.
Step #5: Perform A Cost-Benefit Analysis
Before partnering up with an investment advisory firm or opening your account on an online investment platform, be sure to consider the fees and conditions of your prospective investment platforms.
For instance, the downside of many investing platforms is that they set specific investment minimums you must comply with.
As the name suggests, an investment minimum is the minimum sum of money you must invest with the platform to become its client.
Transaction, management and withdrawal fees are other key factors that could impact your end profits — especially if you’re investing at a modest scale.
To determine which tool or platform is best for you, round up a few candidates and compare them side-by-side in terms of the costs and benefits each platform offers.
This way, you will be able to find an investment partner that suits your goals and capabilities best.
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Investing Basics: Takeaways
Investing might seem intimidating at first glance, but it really doesn’t have to be.
As long as you have a solid grasp of the most essential investing basics and know your goals and capabilities, you can embark on your investing journey.
The easiest and safest way to invest is to partner up with a reliable investment advisor and let them do all the hard work while you sit back and enjoy the fruits of your investment strategy.
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