What are investments all about?
When you make an investment, you are giving your money to a company or enterprise, hoping that it will be successful and pay you back with even more money.
No one can guarantee that you’ll make money from investments you make. But if you get the facts about saving and investing and follow through with an intelligent plan, you should be able to gain financial security over the years and enjoy the benefits of managing your money.
Anyone can do it, no one is born knowing how to save or to invest. Every successful investor starts with the basics. A few people may stumble into financial security—a wealthy relative may die, or a business may take off. But for most people, the only way to attain financial security is to save and invest over a long period of time.
What is the difference between saving and investing?
Your “savings” are usually put into the safest places, or products, that allow you access to your money at any time. Savings products include savings accounts, checking accounts, and certificates of deposit. Some deposits in these products may be insured by the Federal Deposit Insurance Corporation or the National Credit Union Administration. But there’s a tradeoff for security and ready availability. Your money is paid a low wage as it works for you.
After paying off credit cards or other high interest debt, most smart investors put enough money in a savings product to cover an emergency, like sudden unemployment. Some make sure they have up to six months of their income in savings so that they know it will absolutely be there for them when they need it.
But how “safe” is a savings account if you leave all of your money there for a long time, and the interest it earns doesn’t keep up with inflation? What if you save a dollar when it can buy a loaf of bread? But years later when you withdraw that dollar plus the interest you earned on it, it can only buy half a loaf? This is why many people put some of their money in savings, but look to investing so they can earn more over long periods of time, say three years or longer.
When you “invest,” you have a greater chance of losing your money than when you “save.” The money you invest in securities, mutual funds, and other similar investments typically is not federally insured. You could lose your “principal”—the amount you’ve invested. But you also have the opportunity to earn more money. All investments involve taking on risk. It’s important that you go into any investment in stocks, bonds or mutual funds with a full understanding that you could lose some or all of your money in any one investment. While over the long term the stock market has historically provided around 10% annual returns (closer to 6% or 7% “real” returns when you subtract for the effects of inflation), the long term does sometimes take a rather long, long time to play out. It is often said that the greater the risk, the greater the potential reward in investing, but taking on unnecessary risk is often avoidable. Investors best protect themselves against risk by spreading their money among various investments, hoping that if one investment loses money, the other investments will more than make up for those losses. This strategy, called “diversification,” can be neatly summed up as, “Don’t put all your eggs in one basket.” Investors also protect themselves from the risk of investing all their money at the wrong time by following a consistent pattern of adding new money to their investments over long periods of time.
Once you’ve saved money for investing, consider carefully all your options and think about what diversification strategy makes sense for you.
A vast array of investment products exists—including stocks and stock mutual funds, corporate and municipal bonds, bond mutual funds, certificates of deposit, money market funds, and U.S. Treasury securities.
Diversification can’t guarantee that your investments won’t suffer if the market drops. But it can improve the chances that you won’t lose money, or that if you do, it won’t be as much as if you weren’t diversified.
WHY SOME INVESTMENTS MAKE MONEY AND OTHERS DON’T
You can potentially make money in an investment in a company if:
- The company performs better than its competitors.
- Other investors recognize it’s a good company, so that when it comes time to sell your investment, others want to buy it.
- The company makes profits, meaning they make enough money to pay you interest for your bond, or maybe dividends on your stock.
You can lose money if:
- Consumers don’t want to buy the company’s products or services.
- The company’s officers mismanage the business, they spend too much money, and their expenses are larger than their profits
- Other investors that you would need to sell to think the company’s stock is too expensive given its performance and future outlook
- The people running the company are ensnared in fraud.
- For whatever reason, you have to sell your investment when the market is down.
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