What are the Investment Basics?
The basics of investing in stocks can be confusing to a beginner. Yes, there's a wealth of knowledge available on investing. But no, not all of it is necessary to know to invest well. I've intentionally left off many concepts and investment terms because they can be distracting to the things that really matter. On this page, you'll find the most important investing basics for a beginner.
Before we begin discussing investing for beginners, it’s important for me to say that I'm talking about investing and not speculating. Speculation is not a long-term winner for most people. Yes, some people get lucky and end up winning big with speculation. However, those same people typically end up losing those big winnings eventually because they had to take big risks to get the big win and they continue to take those big risks to try to win more. In the end speculation is just like gambling.
I'm not saying that speculation is wrong. Speculating is OK if you recognize that’s what you're doing. However, many people speculate and call it investing. Make sure that when you think you're investing you're not actually speculating. If you answer yes to any of the following questions, then you're speculating:
- Are you acting on a "hot tip?"
- Are you acting upon a guess as to how events in the short-term or long-term future will turn out?
- Are you putting money in because you think the market has "bottomed out?"
- Are you taking money out because you think the market will fall soon?
- Are you acting on some article, book, blog post, or overheard conversation about the future of some industry?
- Has someone sold you on an "investment" that promises quick and easy returns that seem too good to be true? If it were such a money maker, why are they selling it to you?
- Are you investing based upon a formula somebody gave you?
- Are you investing based upon how a stock chart looks?
Again, it's OK to speculate. Just make sure that you know you're speculating. In fact, some amount of speculation may be necessary for you to get it out of your system. Speculate with a small amount of what you plan on investing or, better yet, don't use real money. I did a little speculating when I first started investing. The engineer in me said, "this is just another system I can break down and figure out. I'll make millions and retire to a tropical island in no time!" I learned my lesson and have now gone back to the investment basics. I didn't lose all my speculation money. I just did worse than the no effort solution and lost money as a result.
A really great example of people speculating when they thought they were investing was around the summer of 2008 when oil prices went higher and higher. To many people they seemed like they would go to the moon! I saw ads for "investing in oil." Those ads were fraudulent because had you followed their advice you would have been speculating. Generally, if the X in "investing in X" is very specific, then its speculation. We all know how "investing" in oil turned out for those people. A good example from today would be "investing in gold." Lots of people are investing in gold with companies like U.S. Money Reserve, but it's merely speculation as to how well the gold market will do.
As an investing beginner just trying to nail down investment basics, I suggest you stay away from speculating. Unfortunately, speculating is fun and entertaining while real, prudent investing is boring. The prudent method of investing won't let you brag to your friends how you picked a stock that doubled in a week, but you also won't have to feel shame for the stock that tanked by 90%. This is a critical part of stock investing basics.
Most people think of the Stock Market exclusively when thinking about investing. The stock market is a big part of the best way to invest money and the best investments. However, there's more to investing than the stock market. If you want to know basic information about the stock market, head on over to stock market for beginners.
Here, in layman’s terms, are the most important tips on investing for beginners:
- Before you even think of investing, pay off any high interest credit card debt. Credit card debt is a huge drain on anyone's finances. Think of this as tax-free, guaranteed high return on your money. You just can't beat 10-30% guaranteed tax-free returns on your money. The only exception to this rule is first putting money into your 401k up to your company match.
- Check out some great quotes by Warren Buffett to help understand how one of the greatest, if not the greatest, investors of all time thinks about investing.
- Online investing is a convenient, low cost, and really easy way to invest. (Almost too easy!) Go to the linked page to see the best online investing options.
- Many people use an investment club to reduce risk and minimize their weaknesses in investing. You should really consider joining or forming one. It is a realistic option for many. Otherwise, you can just stick to your own investment planning
- Are you afraid of ups and downs? One of the most conservative ways to invest is through treasury bills. They are easy to buy and are fully guaranteed -- you will never wake up one morning to find your money gone or cut in half. Although, your returns may struggle to even beat inflation.
- Don't have a lot of cash to get started investing? Learn how to invest with little money. It is not as difficult as people think.
- Want to know how well an investment performed? You cannot just average your annual returns. That would give you an incorrect answer. Check out my really easy investment calculator. You may also want to check out the more sophisticated retirement calculator. I've even got a simple interest calculator! Understanding ROI will help you with your calculations. There's an ROI Calculator for that too.
The government can take a HUGE bite out of your gains on your investments with taxes. However, there are several ways to go about tax free investing
- Come across a lump sum of money? Check out my response to a reader question on lump sum investment. It's really not that hard, but many people make a mistake in this case.
- Investing in Oil is not what you think it is. Oil can be valuable part of an experienced investor's portfolio.
- Make sure you focus on saving money. The more you save, the more you can invest and benefit from smart investing.
- Why should anyone invest? Why not just park your money under your mattress until you need it? The answer is inflation slowly erodes your buying power. Therefore, you are effectively losing money if you let your cash just sit there doing nothing.
- You may want to consider some alternative investments. If you are interested in going all-out in investing in stocks, they can round out your portfolio if you have a lot of money and are looking to diversify.
- There are many different ways of investing money in the different investment options available to you. Your life situation will determine which method(s) you choose. If you need the money sooner, then you will want to be safer with it. If you aren't looking to pull the money out for a while, then you can be more aggressive.
- It's important to know about bonds. As you'll see in more detail in the investing in bonds section, bonds are an extremely useful counterpart to stocks.
- Index funds (a subset of Mutual Funds -- AKA Investment Funds) are the basis to easy investing. You won't have mastered investment basics until you understand them. An index fund takes a list of investments and puts some money into each of them. For example, Total US Stock Market index fund would put money into each of the US Stock companies for you when you bought the fund. Therefore, you can invest in the entire market with one simple action. You can do this with just about any investment type or sub-type that's out there. I love index funds for many reasons. For more details on index funds click on the link at the beginning of this bullet point.
- One of the best things about investing in an index fund is that it instantly gives you diversification. Diversified investments get you reduced investment risk. When you're invested in 1,000 or more companies, it's much harder to lose a big chunk of it due to a company going out of business than if you had all your investment money in 1 company.
- Asset Allocation is one of the most important factors in determining your investment success. What makes Asset Allocation so important? The answer lies in Asset Correlation. Asset Correlation is a big key to the big picture of, not just Asset Allocation, but all of investing. Let me rephrase for emphasis. Understanding Asset Correlation will greatly help you setup the best portfolio for your needs - whatever they may be. When your assets don't move up and down together, your portfolio is much less risky.
- It's good to know the difference between a money market fund and a money market account. Having a good chunk of money in a money market account (my preference over a fund) is an investment basics key because it helps you not panic if your stock investments suddenly drop. Also, if you suddenly need money for something in your life, you won't have to sell out of your portfolio when it could be at a low point. Most importantly, having money in a money market account will leave you feeling more secure about your investments. This results in better decision making and, therefore, better investment results.
- Don't be fooled by Average Annual Return (AAR) statistics on funds. That number can be extremely misleading - and not just for beginner investors. What you want to look at is Compounded Annual Growth Rate (CAGR).
- A great basic investing habit is the practice of dollar cost averaging. This helps remove or reduce the impact your emotions can have on your decisions. With major Mutual and Index Funds, you can easily automate the dollar cost averaging.
- Make sure you understand family economics if you have a family. The ins and outs of a family are similar to a mini-economy. Understanding basic decision making in this area is useful.
- It is important to know saving money basics, make sure to budget properly (a good tool for this for businesses is budget software by Prophix), practical money saving tips, saving money on electricity, money saving websites, and saving money tips on big items, so that you can maximize your investment funds. After all, if you have no extra money to invest, then there's really no point in knowing how to be a good investor.
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