Everyone KNOWS they ought to be investing, but few of us do it as we should.
Why not? Mostly fear. Fear of loss, fear of the unknown. This series of articles is intended for people who are absolute beginners at investing, people who might like to start investing, but don’t think they know enough about it.
We’ll start from the very beginning.
I won’t give you too much at once, and I won’t let it get too complex. I’ll tell you about it as though I were telling my mother, or perhaps an interested fifteen-year-old. I’ll assume you’re reasonably intelligent, and hopefully, we’ll have some fun as well.
Deal? Okay, good. Let’s get started.
What IS Investing, Anyway?
The best way of thinking about investing is that someone is paying you to rent your money.
All kinds of businesses (and individuals!) need money. Even the U.S. government rents money from us citizens.
Basically, they are borrowing your money, and when they give it back to you, they pay you a rental fee, which we call interest.
When you invest your money, you are loaning a person or a business your money, so your chances of getting your money back when you want it, and how much interest you’re going to earn, depends pretty much on the reliability of whoever you lend it to.
Some people, companies, and governments are extremely reliable, and some are not. You have to pretty much decide on your own how much you trust whoever you’re investing with.
Investing Law #1
David’s Investing Law #1 is
Higher Reward Usually Means Higher Risk
Higher Risk Usually Means Higher Reward
There are a number of highly academic definitions of risk, but it’s really just what it sounds like – the chance that you’ll lose the money you loan.
Investment advisors will tell you to look at such things as company management, longevity, price-to-earnings ratio, and all that, but mostly common sense will do.
What Is “Rate Of Return” on Investments?
The way you measure the success of your investment is how much money you make from it. Your “return” is your “reward.”
The rate of return is generally given in a percentage that you would earn, if you kept that investment for an entire year. This is called your “annualized” return. It is the best way to compare the performance of various investments.
For example, if you invested $100 for a year, and at the end of the year you had $112, then you would have a 12% rate of return. If you invested $100 for six months, and at the end of that time you had $112, that would still be a 24% (annualized) rate of return.
Well, maybe. Sometimes investments are shown as total return over a period. In the above example, turning $100 into $112 in six months (or any period) would be a straight 12% increase. This is important to know because many investments give you a “Performance over time” measure, such as
|Symbol||1 Week||4 Weeks||12 Weeks||6 Months||1 Year|
Looking at this (not a real) investment, you can see it’s done rather well over the last year, but in the last month, particularly in the last week, it has not done so well. In fact, the annualized return for the last week would be -124.8%. That means if that rate of return continued for an entire year, all your money would be gone before the year was out. On the other hand, the annualized return for the last four weeks would be a very good 31.2%.
Of course, no security performs consistently over an entire year. That’s what keeps it all interesting.
We’ll take a closer look at what all these numbers might mean in a later part in the series, but for now, you can see there is some interesting information we can find out about investments.
Types Of Investments
There are an almost infinite number of investment types, but among the most popular are the following, along with some comments about the risk and return available for each.
Type of Investment
|Savings Account||This is one of the safest (read – least risky), and as David’s Investing Law #1 says, one of the lowest returns. You can generally count on getting something less than the bank’s “prime rate.” As I write this (mid 2006), savings accounts are earning around 3% interest. If you use a savings account, be sure it is insured by the FDIC.|
|Certificate Of Deposit (CD)||These are also quite safe, depending on where you purchase them. CDs from banks or reputable investment advisors are probably totally safe. CDs come in various lengths of time, usually from 3 months up to 10 years. The shorter CDs have smaller rates of return, longer CDs have higher returns. As of 2015, you can expect about 0.8 to 1.5%return on a 5-year CD.|
|U.S. Government Savings Bond||These are about as safe as the U.S. Government. They also have a low rate of return, and it’s difficult to redeem them before their maturity date.|
|Corporate Bonds||These are about as safe as the corporation that issues them. They are for specific periods of time and for specific rates of return. They are legal debts owed by that corporation to the bondholder, so if the company goes belly up, bondholders get paid (out of the settlement) before stockholders. If you are a beginning investor, these might be a bit complex for you.|
|T-Notes||These are treasury notes issued by the U.S. government. They are long term, as in 15 to 30 years, and that’s about as much as I know about them.|
|Stocks||The lifeblood of the U.S. economy, and pretty much any first world economy, is business. Business is conducted by corporations. Corporations usually get their startup and initial operating capital from selling stock, or shares in the company. Once the company sells the stock, people trade it back and forth, and the price fluctuates. Some stocks are risky, some are safe. Some are low yield (return), and some are high yield. We’ll do more on this in a later part.|
|Mutual Funds||Mutual Funds are nothing more than organizations that pool money from lots of people to purchase groups of stocks. A paid fund manager decides which stocks to buy and sell. Mutual funds are generally (but not always) safer than any individual stock, because any given fund will own a number of different stocks, and if any one of them crashes, it doesn’t wipe out the fund. Interestingly, there are more mutual funds today than there are stocks to invest in.|
|ETFs||Exchange-Traded Funds, or ETFs, have over recent years (as of 2015) become more and more popular as a replacement for Mutual Funds. ETFs are baskets of specific securities that work like mutual funds but can be traded like regular stocks. We’ll cover more detail on ETFs in a future article.|
|Commodities||Commodities are the investments with the highest risk by far, but also the highest potential for return. Commodities are really contracts for the future purchase (or sale) of such things as sugar, coffee, unleaded gasoline, precious metals, or cotton. We’ll cover commodities in one of the later parts of this series.|
That’s enough for now. In the next part, we’ll get into some various investing strategies.
Take care, and God Bless,
Note: This article was originally published in July of 2006 on the www.snicko.com website.