We bid you a warm welcome to our Investing 101 class. Are you interested in learning more about what it means to invest? Then you’ve come to the right place because we are going to show you that when it comes to investing, there are is no hocus-pocus, just some good old know-how.
The need to invest, or to put something on the side for later, is probably one of the oldest human drives. Because we don’t know what’s around the corner, we are compelled to save something for rainy days. But investments go way beyond the simple need of conservation. By investing your earnings, you will not only make sure that you have a good nest egg waiting for you once you retire, but you can also enjoy your hobbies without having to think about money all the time.
If you choose to invest your money, rather than spending it all together, you will have more time to enjoy the things that make you happy. How does that work? Well, think about it for a second. What is the most common way to earn money? By working, of course. And should you need more money, you will need to work some more – this is how things work.
Naturally, there’s a limit to how much a person can work. But now the question is: after all that hard work, what happens to the money you’ve earned? If you don’t hold on to them, they will fly out the window.
Putting them under the mattress is one way of making sure that your money doesn’t vanish overnight, but they won’t multiply. So, what’s the solution?
Investing is the most sensible solution to all your money-related problems. Whether you’re thinking about retirement or about kicking it back and enjoying your hobbies, investing is the course you will need to take.
Now, the actual act of investing might seem pretty complex, especially when you hear some lingo like mutual funds, bonds, stocks, index funds or compound interest. But don’t worry stress yourself too much about these things. Keep on reading our comprehensive Investing 101 article, and you will become an investment aficionado in not time.
Investing 101 – How to Compound Interest
So after boring the daylights out of you with our long-tailed Investing 101 introduction, we are now going to show you the easiest method to invest your hard-earned money. Compound investing, or simply compounding, is the core ability of an economic asset to generate profit. Furthermore, this profit can, in turn, be reinvested, in order to generate more profit.
To put it in simpler terms, you are using your profit to generate more profit. How does this work? Here’s an example that may help you grasp the concept of compounding:
Let’s say that Sam is interested of investing his money to have something on the side when he retires. He doesn’t have a salary that high, so he will only invest $10,000. The bank to which Sam entrusts his money offers him a 6% interest rate per year. Over the course of only one year, Sam’s bank account will have $10,600 in it.
But, instead of withdrawing his money, Sam decides to keep them there for another year. So, after the second year has passed, Sam’s account balance will hold $11,236. If Sam decides to keep his money in the bank and reinvest it at the end of each year, by the time he will retire, he’ll look forward to a nice sum of money.
Now, as far as compounding is concerned, there is no magic involved. In fact, it all boils down to a simple mathematical formula which can predict (with uncanny accuracy, we may add) how much your account will grow after a number of years given that the interest rate remains unchanged.
So, if you’re interested in investing your money, rather than spending it, you now have the first tool at your disposal which can help you make more money without having to lift a finger. The great thing about compounding is that you don’t need to do anything in order to see your bank account grow.
Just make an initial investment, and, at the end of each year, reinvest the interest. You can start making some real dough right away, and, as you’ve seen you don’t need to do anything out of the ordinary.
If you want to know the math behind compounding, there is a mathematical formula which can give you a fairly good glimpse of how your bank account will look like:
A = P (1 + r/n)^(n x t)
A – the total amount of money you are going to gain over the years provided that the rate of interest remains unchanged;
P – the amount of cash you’ve borrowed or deposited in the bank;
r – the rate of interest (Note that the rate of interest can be subjected to change, depending on how the market fluctuates);
n – this is the number of times your interest is compounded within the year. Usually, the interest is compounded quarterly.
t– the number of years the amount is either deposited or borrowed.
Seems rather nasty, doesn’t it? We can assure it that the method is as easy as it is foolproof. For the sake of the exercise, let’s try another example:
Jill, another young investor, wants to put some money aside for her retirement. Naturally, Jill will open a savings account at her bank and will inquire about the interest. After a trip to the bank, Jill finds out that the bank offers a steady 6% interest rate and that this interest is compounded quarterly (that’s four times per year). What does this mean in terms of Investing 101?
Let’s assume that Jill wants to make an $10,000 initial investment. So, the value of P is $10,000, the value of r is 6%, and n is 4. This leaves us with the number of years. Jill is still in her 30s and wants to make a long-term deposit and thinks about re-investing her money for a period of 25 years.
So, this is what Jill’s investment calculation will look like:
A = 10,000 (1+0.06/4)^(4 x 25)
After doing the math, Jill finds out that after reinvesting her money for 25 years, her balance will indicate no less than $44,320.46, having earned $34,320.46 just by choosing to reinvest her money rather then spending them on things she doesn’t need.
So, as a beginner investor, this is the easiest way to ensure a steady cash flow, albeit the method is rather passive, meaning that it takes quite a lot of time in order to get something out of your interest. Still, the method is risk-free, and the only factor that varies in this equation is the interest.
Investing 101 – The magic of Bonds, Stocks, and Other Financial Instruments
Did you enjoy our Investing 101 article so far? Well, stick with us a little longer, because we are going to show you, even more, ways to make money without having to toil like a regular Sisyphus.
As we’ve mentioned in the introductory paragraph of our Investing 101 article, compounding is not the only financial instrument that you have at your disposal. In fact, based on the nature of the risk you are willing to take versus the sum you are looking forward to gaining from each transaction, there are several types of financial instruments:
Alternative Financial Instruments: FOREX, Gold, Real Estate, Futures, Options.
For the purpose of our Investing 101 article, we are only going to discuss bonds, stocks, and mutual funds. Other financial instruments such as FOREX or Gold are generally considered high-risk/high-gain operations, and it takes a good grasp of the basics in order to master them.
In general, financial specialists tend to agree that for beginner investors, bonds, stocks, and mutual funds are the best courses of action: they are typically risk-free or low-risk, and they can generate a steady income.
This is probably not the first time you hear the word “bonds.” If you’re a movies aficionado, then it’s more than likely heard about war bonds or those little pieces of paper soldiers would buy in time of war, thinking that they will earn a good sum of money once they’ve been discharged.
Bonds, commonly known as fixed-income securities (this term refers to other financial instruments as well such as stocks or mutual funds), are a financial instrument that implies lending the State or the Government a sum of money. At the end of the year, depending on how many bonds you’ve bought, you will receive some money in the form of interest.
As a security, bonds are commonly regarded as a risk-free instrument, meaning that you can be sure you’ll have a steady income. However, apart from being risk-free, bonds tend to bring a low income compared to other financial tools.
However, should you wish to start investing your money into something secure, bonds are the best place to start. But, again, don’t expect your bank account to start bleeding money at the end of the year.
If you’re interested in buying bonds, then here’s what you need to do:
Decide if this instrument serves your purposes. Take note that this is a long-time investment, so commitment is the key.
Choose your bonds trader. At this point, you can opt between a Full-service broker (a licensed financial company) or a discount brokerage. If you choose the latter option, be careful, as most brokers require a minimal initial deposit. Also, don’t let yourself fooled by “commission free” advertisements. Always ask your broker to disclose all the costs of the transactions.
Buy your bonds of choice.
Enjoy your interest.
The second financial instrument we are going to present in our Investing 101 course, is stocks. Of course, this is probably not the first time you hear about stocks, but let us presume for a moment that you haven’t.
Stock are another type of securities, but, compared to bonds, they are not fixed-income securities, but variable and volatile. When you buy stocks is like buying a small part of a company. This gives you the privilege of participating the annual or biannual shareholders’ meeting, and to commit a vote.
Furthermore, if you choose to invest money in stocks offered by a company, you will also be entitled to a small part of the company’s profit. The more stocks you buy from the company, the higher your profit will be and vice-versa. These profits you earn at the end of the year are called dividends in financial lingo.
Compared to bonds, stocks tend to return a higher profit at the end of the year, but they aren’t low-risk or risk-free. In fact, depending on the stock market’s fluctuation, you may have the misfortune of buying stocks which do not produce any kind of dividends.
Unfortunately, this issue cannot be remedied by direct intervention, meaning that the only way you can obtain profit is to wait for the stocks to return dividends.
All in all, stocks tend to return a much higher profit than bonds, but they are more volatile. This means that if you are committed to buying stocks, you should definitely do your homework well to see what stocks will return profits and which are dead-ends.
The last item on our Investing 101 course are mutual funds. What are mutual funds, you ask? It’s very easy: take some stocks and some bonds, put them together in a common portfolio, and the result is a mutual fund.
But the definition does not stop here. When investing in mutual funds, you are not alone. Basically, a mutual fund is composed of several investors who choose to pool their resources. Furthermore, the main advantage of being part of a mutual fund is that you can pay off a financial pro who can tell you and your partners where to focus your investments.
Compared to stocks or to bonds, mutual funds can generate a higher profit, and are, in general, low-risk operations. Moreover, by letting a professional take charge of your investments, rather than managing them yourself, you will have higher chances of making a noteworthy profit.
And so, we’ve reached the final part of our Investing 101 article. So far, we’ve talked about the philosophy behind investing, and we’ve even shown you some of the easiest ways to make money without having to toil overtime.
As a parting note, we need to add one more remark. Remember that all type of investments, be them based on compounding or financial instruments, are not an over the night money-making vehicles To make a profit, you will need to analyze, compare and seek advice from professionals.