Investments are a way for consumers to earn additional income. People can invest money into financial plans, shares, bonds, property, and more!
Basics of Investment and the Stock Market
Below are some terms that will help you understand how investing works.
Capital Appreciation
Capital appreciation refers to profits from an investment that exceeds the original price of that investment. For example, say you bought a home for $50,000, fixed it up, and resold it for $125,000. In this case, the capital appreciation from that real estate investment would be $75,000. Besides real estate holdings, other common investments that investors seek capital appreciation on include:
- Mutual funds or different types of funds that pool money from various stocks.
- EFTs or other securities that use index tracking (such as the S&P 500 index).
- Material assets such as oil, copper, etc.
- Other types of stocks or equity securities.
Diversification of Investment Accounts
Diversification of your investment accounts means having a mix of investments. For example, it may not be the best investing strategy to have only high-risk or high-cost investments. Instead, try to balance your risk tolerance with some safer investments. Before you invest in a stock, bond, or other security, asses the risk to protect your overall investment portfolio.
Speculation
When it comes to investment decisions, speculation is one that carries a high risk but also a potential for high profits. Speculation involves the trading of stocks that have a high potential for loss in the hopes that market conditions will cause the investment to rise in value. Trading and selling stocks on speculation is extremely risky and should only be done by experienced investors or on investment advice from a respected financial professional.
Volatility
Volatility refers to an investment’s potential to change or alter unexpectedly, usually for the worse. If an investment has high volatility, it may not be a good idea to contribute your hard-earned money towards that investment.
Types of Investment Accounts
Below are some common investment options available for interested consumers.
Individual Stocks
Consumers can purchase individual shares of a company via stocks, also called equity securities. Stock investors have the potential to earn massive profits depending on the success of the company they decide to purchase stocks with. However, if a company fails or begins to lose money, investors may see a significant decline in profits.
Purchasing individual stock funds is best suited for experienced investors who are able to handle potentially high-risk investments. You can purchase individual stocks most easily from an online broker.
Mutual Funds
One of the best ways to diversify your investment portfolio is with mutual funds. The purpose of a mutual fund is to generate money from investors in order to purchase assets like stocks or bonds. Mutual funds may also work to protect an investor’s portfolio since their money is spread across multiple investment types.
Mutual funds work best for consumers who are looking for diversification or are looking to save for a major financial goal or retirement. Something important to note is that mutual funds may come with investment minimums that can range from $500 to thousands of dollars.
Investors can purchase a mutual fund directly from a company or brokerage firm.
High-Yield Savings Accounts
While it’s a great idea to have a basic savings account, a high-yield savings account may be able to take your finances to the next level. High-yield savings accounts, also called cash management accounts, bring consumers the best of both worlds when it comes to savings and checking accounts. This type of investment pays the account holder interest (like a savings account) and may also offer a brokerage account, debit cards, and/or checks (like a checking account).
Since account holders usually have limited access to their high-yield savings accounts (you may only be able to make transactions six times a month), this type of investment is best used for emergency cash purposes. You may open a high-yield savings account at places like a brick-and-mortar bank or online bank.
Certificates of Deposit (CDs)
Certificates of deposit, also called CDs, are insured by the federal government. Consumers usually get CDs when they know they will need money on a particular date/point in time. CDs come with predetermined terms and fixed interest rates. A typical term deposit for a CD is about one to five years, making them a popular investment to pay for big purchases like a home, wedding, etc.
Although CDs come with a preset term, account holders may still be able to access their money early for a fee. To avoid losing out on money, try not to take money out of your CD until it has fully matured. Customers can access CDs with online banks and credit unions.
Money Market Funds vs. Money Market Mutual Fund
It is important to distinguish the difference between money market mutual funds and money market accounts. A money market mutual fund is a type of investment product consumers can use to purchase government, bank, or corporate debt. A money market account is a type of bank deposit account similar to a traditional savings account.
While money market mutual funds are often considered a lower-risk investment, they also do not typically yield very high returns or profits. If a consumer has a brokerage account, they may be able to access market mutual funds with online brokers. Otherwise, they may access this investment type directly from a mutual fund provider or bank.
Government Bonds
Consumers can use government bonds to diversify their investment portfolio. Government bonds are a very low-risk type of investment because they are fully backed by the United States government. While they are a low-risk investment, government bonds can have long terms, often ranging from one to thirty years. During this time, account holders receive steady payments from the government, which is why government bonds are known as fixed-income security.
Since government bonds are such a safe investment, they also usually come with lower returns. So, if you are trying to use your investments to earn enough money to retire, a government bond won’t work well for this financial goal.
People can access government bonds via the following institutions:
- Broker.
- Underwriting investment bank.
- U.S. government.
Corporate Bond Funds
Corporate bonds work similarly to government bonds, but consumers are issuing a loan to a company or corporation instead of directly to the U.S. government. Also, since the money is not going directly to the government, they do not insure the investment. Furthermore, corporate bonds are also much riskier than government bonds because the investor accepts risks like the company losing money or going bankrupt.
Corporate bonds may work well for investors who are financially stable and able to accept a bit of investing risk. If a company is losing profits or close to going out of business, it may issue higher revenue bonds. More successful companies, on the other hand, will usually lower revenue bonds since there is less risk.
If you are interested in a corporate bond, you may access them through investment brokers or directly from companies.
Index Funds
Index funds fall under the umbrella of mutual funds. This particular type of investment can be great for long-term savings because they focus on a specific market index and provide profits that coincide with that index’s performance. Index funds may also come with lower fees since account holders don’t necessarily have to pay a professional to organize the fund’s profits.
Since index funds are so great for saving long-term, they fit best with younger investors who are willing to handle the ups and downs of the stock market.
People can purchase these investment products through a broker or directly from the fund provider.
Exchange-Traded Funds (ETFs)
Exchange-traded funds, also called EFTs, are another fantastic way to diversify an investing portfolio. Similar to mutual funds, EFTs collectively use investor funds in order to purchase a variety of securities. These two investment products differ, however, regarding how they are sold off. EFTs are sold in shares, giving investors the opportunity to buy multiple shares if they please. The most common way to get an EFT is through a brokerage.
Dividend Stocks
Stable companies earning a profit may allow investors to purchase dividend stocks. With this type of investment, companies pay dividends to shareholders on a regular basis. Dividend stocks may be an excellent investment for everyone, from first-time investors to seasoned professionals. Like other stocks and bonds, the most efficient way to purchase dividend stocks is through a financial institution like an online broker.
Alternative Investments and Cryptocurrency
There are also other types of investments that do not fall under the umbrella of stocks or bonds. These alternative investments may include hedge funds or cryptocurrencies. Hedge funds use high-risk methods (like investing with borrowed money) and involve a partnership of multiple investors. Cryptocurrency is virtual currency where users can purchase specific items from retailers who accept this form of funding. One of the most popular cryptocurrencies is Bitcoin.
Real Estate Investments
Usually, real estate investments involve the purchase of a piece of property (whether it be land or land with structures on it) and reselling it later in the hopes of earning a profit. However, it is possible for consumers to make profits with real estate investing without having to purchase or renovate properties on their own.
Real Estate Investment Trusts, also known as REITs, are companies that pay shareholders in regular payments in exchange for their initial investment.
Keep in mind that real estate investing can be risky, so this type of investment is best suited for wealthy individuals who have an excess income they are willing to lose.
Rules To Follow for Successful Investments
Investing can be great for building wealth and increasing your cash flow. But it’s important to keep in mind that some investments come with more risk than others. By following the rules below, you can work towards developing a successful financial plan and making smart investment decisions.
Research Before You Buy
For the protection of your personal finances, it is best to research any type of investment before purchasing. If you don’t want to work with a financial advisor or professional, you can access free resources online or even at your local library.
When doing research on your own, make sure to seek out multiple sources to make sure you are getting unbiased, accurate information.
Don’t Invest More Than You Are Willing to Loose
Investments can cause an extreme influx of cash into a consumer’s bank account, but they also have the potential to wipe out someone’s savings if they are not careful. Before you invest in anything, ask yourself if you would be able to get by if you lost everything you were contributing. If the answer is no, you may want to think again about going through with that investment.
A stable investment is one that carries little risk; however, some consumers may be able to take on higher-risk investments if they have the expendable income to spare.
Have a Personal Spending Plan and Investment Strategy
Never go into an investment blind! Before committing, think about the basics of your investment and how it will affect your finances.
Know the Tax Implications
Many investments are taxed. There are usually two circumstances where tax payments may affect a consumer’s investments. The first is when the investor receives income from their investment. This income may have to be claimed when the consumer does their state or federal taxes. The second situation that may cause taxes to affect a consumer’s investment is when an investment has a significant gain or loss.
Consider Working With a Financial Advisor or Professional
If you are new to investing, it may be in your best interest to work with a financial advisor. A financial advisor can help you develop investment strategies tailored specifically to your budget and financial situation. They may even help you avoid investments that would have ended up being a huge portfolio risk.
References:
Investing Basics: Frequently Asked | Charles Schwab
Introduction to Investing | Investor.gov
Investing Basics: Bonds, Stocks, Mutual Funds and ETFs | Finred USA Learning
Do You Pay Taxes on Investments? What You Need to Know | TurboTax Tax Tips & Videos