Investing money can be a hassle because it deals with some very complex systems, the stock market being one of them. Like anything or any system that is complex, it can be highly confusing to anyone who doesn’t have experience with it. If you would like to start investing your money and have decided that you will do the research and make investments yourself, you must educate yourself in the basics of investment.
How to Think About Investing
Educate yourself thoroughly
First, start by browsing the Internet and reading about investments. There are a million sites out there with pertinent information that will help you on your way to building an investment portfolio. One great place to start is this investing tutorial by Prudential. It gives you a great general overview of how to start investing, including how to build an investment portfolio. Another site that is chock-full of extremely helpful information (that is laid out in a very accessible way) is CNN Money.
Here are some basics that many of the sites will tell you right away.
The debate of Stocks vs. Bonds
Stocks have had the highest performance rate throughout history. They have consistently beaten out every other all types of investments. So, if you have no clue where to begin investing, putting your money in stocks will probably yield you the best outcome in the long run. Your next best option is bonds, which are much more practical in the short term.
While stocks outperform bonds long term and look much better in your portfolio, they can be very treacherous for your financial health in the short term (think about what happens when the stock market crashes.) However, when you look at the long-term earnings of stocks, you will make more than you will in bonds. Just remember that the only determiner of stock prices is the overall earnings, even though they can fluctuate in the short term because of many factors. Bonds are hurt much more by the short term, especially by rising interest rates, although, these and inflation are also quite detrimental to stocks. If you really don’t want to play the stocks and are even a bit wary of bonds, your best bet is to put your money in U.S. Treasury bonds. Recently, stocks have outperformed bonds (years 2000 to 2002) but haven’t necessarily done so because they were doing particularly well. It is probably best to diversify your portfolio and put money in both stocks and bonds if you are able to do so.
To risk or not to risk?
Making investments is already stressful enough without the thought of having to risk your money in any way. Unfortunately for the weak and heart, it is recommended that you take risks with your investments. This is because investors demand a higher rate of return for taking greater risks. Also, longer-term bonds are far greater risks than short-term bonds because there is more time for things to go wrong before they final pay off. These longer-term bonds do pay off more in the long run for the same reason that they are risky; there is more money in the end if there is time for things to go wrong with the investment but also go back up. With that being said, risking should be done with caution, as should investing in long-term bonds. Because while high risks equal high pay offs, you only get the pay off if the investment doesn’t fail. Failure is a very real option in the stock market, so one must choose their risky investments wisely and accept that it could turn to dust.
Overall, a portfolio that covers many different types of investments is much less risky than one that is concentrated in only a few investment types. This is quite logical; if the motor vehicle industry tanks and you have all of your stocks in General Motors, you are in big trouble. When you are beginning to invest, spread your investments out over many different kinds of investments. Your multiple investments are also more likely to balance themselves out naturally, meaning you lose less money overall.
Realize that the stock market is constantly changing
There are a million different things that influence the stock market and move it to change. This is because no one can possibly predict how the economy is going to respond to any given event, even if they could predict the event (like a hurricane or a war, for example.) It is also hard to gauge the magnitude of problems, which is why everything can seem fine one day and be drastically different the next.
What is most important to focus on is the market’s long-term behavior and use that to make your decisions. This means looking at corporate earnings and interest rates. Corporate earnings are how the stock market grows; as companies’ profits add up over time, the scale tips and prices rise. When interest rates rise, that is when investors usually take money out of stocks and put it into bonds. They do this because the returns are much more attractive when interest rates are increasing.
Before you do anything, realize what you are getting yourself into
This article is an extremely basic overview of some of the nuances of investing money. If you think that you might want to start investing your own money, whether it be in bonds or in the stock market, no one can stress enough the importance of being well informed. Investing is complicated, and since the economy has been hit in recent years, the stock market isn’t very stable and neither are bonds. There is a good chance that you could loose a lot of money in either, so this is not a matter to take lightly. Remember that some people’s entire job is to advise people about their investments or to manage stock funds. If you are not up to do the work that is necessary, think about hiring a financial advisor or investing on a very small scale until you get the hang of things.