Beginner’s Guide to Finance – Investing

The world of investing can seem daunting at first.  With so many different parts, and so many nuances as to how it all works, people can quickly get overwhelmed.  Unfortunately, that means many people fail to fully develop their financial plan because they do not take the time to realize that investments are a necessity for those who have long term goals.  Storing cash for emergencies is important; investing for larger goals, such as retirement, is also important.  By taking some risk, the investor can substantially increase the reward (rate of return) on their money.

When most people think of investing, they immediately think of the stock market.  In order to really understand investing, we should know basically how the market works.  When a company wants to raise money, usually in order to expand, they issue stock.  This stock is then sold on the corresponding market.  Similarly, when a company wants to borrow money, they issue bonds.  These bonds are like small loans that the investor gives to the company with the promise that the company will pay them interest, and repay the loan at the end of the term.  The actual processes of the stock and bond market are much more complex (I recommend Kenneth Morris’ book for a great overview), because of this a good number of people believe that to be an investor you need to know all about stocks and bonds, and how to analyze those stocks in order to buy at just the right time, and sell at just the right time.  Most people will never do this.

Instead, the vast majority will invest in mutual funds.  In order to reduce some of the risk an investor would take by putting their money into just one company, a mutual fund will invest in many different companies.  Each share that the mutual fund issues is made up of hundreds of shares of the underlying companies that the fund invests in.  This means that if one company fails, the investor does not lose all his or her money, but rather just a small portion.  These funds usually follow an investment style, so some mutual funds will be domestic investments, others will be foreign investments, some will have only bonds, and others a blend of stocks and bonds.  The downside is that the funds charge an annual expense and some charge an up-front sales charges in order to cover management and transaction fees.

The largest need many people have is retirement.  So for most people, their first investments will be into their retirement fund.  Retirement planning is important.  And the sooner someone can start to put away money for retirement, the longer it will grow, and the more they will have to use during their golden years.  It is estimated that the average worker only spends 1 hour per year getting their financial planning in order.  You can do better than most people without much effort.

For those who want to earn more than the paltry returns banks are providing, they need to start investing.  The first step is to learn about risk vs. reward, then take an investor profile questionnaire.  From there they can start to choose some funds that fit their risk profile by researching them on Morningstar.com.  Setting up an account to do all the work yourself is easy, finding a trusted advisor is often even easier.  And advisor can help educate you, and guide you through investing so you use logic, not emption.  By doing your homework first you will insure that the advisor does not take advantage of you.

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