Home Finance for beginners

The Foundation of Investing

Why Save and Invest?

Saving and investing are on one side of a continuum that starts today and goes into the distant future. The nature of putting aside money that you could use today is that you are delaying your gratification and living below your means for a future time in which you will have something better. With each dollar you earn, you have the potential to either save it for later or spend it right now, and both ways can be right depending on your priorities.

The saving and spending continuum ultimately comes down to when you want to have something enjoyable. The more you want to spend for today's enjoyment, the less you are going to be able to spend later. A lot of people are living solely for today and may find themselves in serious trouble down the road, because they will not have anything for tomorrow. However, the people who are dedicated to saving today will give up something right now but will be able to gain far more in the future because of their foresight.

There is also another element to your use of cash that comes about when you borrow money. While saving is delaying your gratification and thinking about the future, borrowing money is spending future cash today and then paying it back over a longer term. For many people, this is a cycle that they get into during a moment when they have not thought to save and find it hard to break out of , because it becomes a painful and constant cycle.

Remember that there is no right or wrong about how much to save, how much to spend or how much to borrow. You can make any choices you want, but remember that every choice you make will have some kind of consequence down the road. If you save a lot of your paycheck today and begin to invest it, you will generally end up with more tomorrow than you would if you lived from paycheck to paycheck or borrowed money to pay today's bills. But, in the short term, you would have to sacrifice a few enjoyable things.

Have Realistic Expectations

The purpose of investing is lost on many people because of the natural human tendency to be overly ambitious. For most people, investing is not a rapid producer of extravagant wealth. If you try to see it this way, you will ultimately only end up chasing high returns that will almost always result in disappointment. In some cases, chasing unrealistic returns will actually result in horrible losses. Taking excessive risks for a small chance at big payouts is just gambling, not investing. Keeping your expectations reasonable is a key component of investing for genuine gains.

One of the worst things you can do as a layperson is to attempt to successfully pick individual stocks. While you could have some success at doing this, the overwhelming statistical data says that your net returns will be lower and riskier than those of the broad market. While you may have a dozen solid successes, one or two significant failures can erase most of your earlier gains. When you consider that most professional stock pickers among mutual fund managers are not able to consistently beat the average market returns, you begin to understand how thoroughly the odds are stacked against you.

Even if you have the education and the time to thoroughly review investments for a significant portion of your day, there will always be factors that you could never know. In some cases, these are internal matters within an individual company that no investor could know. It ultimately comes down to management by a simple computer program, and it is often easier to get into and out of this type of fund. In other cases, the factors are external like future competition, customer behavior, war, weather and changes in technology. All in all, stock picking is not a good way to make money.

The main goals of investing are to preserve and slowly grow your wealth. While the term "wealth" is often used subjectively, here "wealth" implies purchasing power and the ability to access your money for what you want in life. If you begin to invest as a young person and do so with consistency, you can build reasonable wealth. You can meet many of your financial goals and live the latter part of your life on your own terms. But, remember that this is a gradual process that will never get you on the cover of a finance magazine or be especially interesting to talk about at cocktail parties. Investing is a long-term method of preserving your money's buying power, not a sure-fire path to fortune and glory.

Essential Concepts

As a general rule, investors have two goals: the growth of their wealth and the reduction of their risk. Growth is the expansion of how much your holdings are worth, while risk is the difference between the best- and worst-case scenarios of your investments. Naturally, most kinds of investments will grow over the long term. However, there can be ways to increase your rate of growth, also known as your rate of return. In the same vein, there are also numerous different ways that you might be able to reduce the level of risk you take on. Keep in mind that no matter what you do to work on either of these aspects, there will always be some limits to the level of growth that your investments can achieve and you will always have some risk of losing what you have invested.

Growing your wealth means increasing the overall value of your portfolio, and there are a few different ways to do this. You can also lower the level of risk you take on. Again, this can be done in many different ways, but the two most powerful are diversification and dollar cost averaging.

Diversification is spreading your bets or putting your eggs in different baskets. It comes from understanding that no investment is guaranteed to be successful and from acting accordingly. Even when you believe that an investment will do well, you may be wrong. This is the best reason to avoid putting all of your eggs into one basket. No matter how good that basket may be, there is still the possibility that it could break open and send your hard-earned money crashing. When you diversify your investments, you spread them into a variety of different asset classes like commodities, real estate, stocks, bonds and cash. When you are properly diversified, a downturn in one market such as a housing correction or a tumble in the stock market will not cripple your wealth overall. Just as you keep some of your wealth in highly liquid and safe cash investments to hedge your bets against downturns, it is also wise to make sure you have investments in other asset classes that may be resistant to the downward trend. It is rare that every market goes down at once, and keeping a diverse mixture of investments can help you avoid taking outsized losses.

Dollar cost averaging is the discipline of investing automatically whether you feel like it or not. A lot of people will tend to invest based on emotions; this is flawed, because your emotions are not proven to predict investment returns. Human nature can trick us to put more money into investments when they are going up and take out money when they are going down. While financial analysts warn investors to stay the course and make decisions based on reason instead of emotion, individual investors often use their feelings to make decisions. When you dollar cost average your investments you can avoid the emotional aspects of investing. To dollar cost average means that on a set schedule you invest a certain amount of money. If the market is down you buy more, and if the market is up you continue to buy. Over the long term, this averages out and removes any dependence on market timing. Since no one can predict the future with any certainty, dollar cost averaging is the best method of securing the steady growth of your wealth.

Good Ideas to Implement

Invest your money based on what you want to do. In far too many cases, the motivation for investing is because something is aggressively marketed to you. While selling and advertising are great ways to alert the general public to excellent potential investments, the fact that these solicitations can influence people into making bad decisions is a downside. Whenever you see an advertisement or hear a salesperson speak about an investment, you have to remember that this person is paid when you invest into this asset. They do not necessarily have your best interests in mind.

You would also do well to remember that fees are bad. Whenever there is a high commission or management fee, you are typically getting inferior service. Regardless of laws, certifications and ostensible integrity, human beings do what they are rewarded for doing. If the salesperson is rewarded for making a sale, then that is going to be his or her ultimate objective. If the investment manager is rewarded for churning the account, buying and selling with reckless abandon, then that is what he or she is going to do. Your best interests and those of the manager and salesperson are almost never in direct alignment, so you need to guard yourself against paying fees that will hurt you in more ways than one.

Another reason why fees are bad is that every fee you pay reduces your ultimate level of profit. When you earn a certain percentage rate of interest, this is your base level of profit. However, when you have to then pay some of this profit out in the form of fees it reduces your overall profit level. The more fees you pay, the less profits you can take for yourself. In some cases, the fees and additional taxes that you pay from your investments can actually erase any of the gains you are ostensibly paying for. You could save yourself some difficulty and just put your money in a savings account if that was all you wanted. Fortunately, plenty of excellent investments are very tax efficient and require minimal fees.

Do Not Believe Hype

There is a magical way you can make humongous returns with extremely little risk. This method is called delusion, and it is surprisingly pervasive in the world of investing. Outside of delusion, the future is unpredictable and carries with it risk. Every time you add an extra variable that can potentially make you a profit, you add more risk. This rule applies to virtually every component of investing.

The problem with higher returns is that they almost always come from higher levels of risk. When you take on risk, you take on the possibility that what you're doing could fail. This chance of failure is never zero, but much of the time it is moderately low.

However, there are people who are either ignorant or trying to swindle you who will say that there are low risk and high return methods of investing out there. These people are not to be believed, because their ignorance can cost you dearly. If you give your money to ignorant, misguided people, regardless of their intentions, you could lose that money.

Treat every claim as a suggestion, and make sure you can prove or disprove every part of that suggestion. Make sure anyone who makes a claim can back it up with solid evidence. You should also keep in mind that markets go down as well as up, and that there may be an ulterior motive to anyone claiming a low- risk way to heavy gains. While risk is part of everything in life, keep in mind that higher risks are likely associated with higher expected gains.

Avoid Shams, Lies and Frauds

There is no benefit to trying to predict the future. For a lot of people, it sounds good to try and "beat the market" or go for a "sure thing." Unfortunately, this is when human nature runs contrary to reason. There is no sure-fire way for an investment to make you rich, and trusting anyone who claims there is will most likely accomplish the exact opposite of building wealth. More wealth is destroyed by scammers and hucksters than by anything else.

One of the best ways to safeguard yourself against scam artists and others who want to take your money is to temper your desire for rapid and incredible gains with common sense. If someone had actually found a "sure thing" that was bound to create massive wealth, why would they be coming to ordinary people to finance it? Would it not be the exclusive purview of the incredibly wealthy to further build their wealth in this way? When you think in terms of reason, you open yourself up to experiencing real gains and avoid the illusions and speculative fervor that costs people a ton of money. 

The Foundation of Investing586The Foundation of Investing