Investing is a familiar word. As a matter of fact, popular investment marketplaces like the New York Stock Exchange (established in 1792) and the Amsterdam Stock Exchange (dating as far back as 1602) have roots that dig deep into history.
The beginning of a New Year is sure to bring an unequal mix of economic opportunities and uncertainties. However, you can effectively mitigate these uncertainties by fortifying your finances beyond savings with strategic investments. In this article, we'll explain the basics of investing for beginners, different investment types that you can explore, and guide you on how to embark on your investment journey this year.
What is Investing?
Investing is the act of committing your money in order to earn a financial return over time. It is an added layer of financial security underpinned by the expectation of a positive return. However, that is hardly always the case. When investing, you are guaranteed one of two outcomes - a positive or a negative return. Oftentimes, these outcomes are directly proportional to the risk level of your investment. Low-risk investments will yield low or moderate returns, while higher returns are accompanied by high-risk investments. Investing is crucial to a secure financial future and serves many purposes like; curbing the effects of inflation, high-interest rates, and eventually helping you build wealth over time. On the surface, it might seem scary and risky, but with good research and an execution strategy, investing can be highly rewarding.
How To Get Started in Investing
As a beginner, investing requires a cautious process of planning, research and patience. You need to know your risk level, understand clearly your financial capacity and the financial goals you wish to attain. Then you can develop a viable investment strategy based on the options available to you. When investing, most investors often believe in adopting the long-term approach.
Understand your Risk Level and the Type of Investor that You Are
Investing entails risk. It is important to remember that you can end up with less money than what you started with, and knowing your risk level at any point in your investing journey will help you decide the amount you can invest and the options that are available to you. If you are a student or a low-income earner, then it is advisable to limit your exposure to high-risk investments like cryptocurrencies.
Also, consider the type of investor that you are. Are you comfortable with actively managing your investments, trading, and rebalancing them periodically, or do you prefer passive forms of investing? As an investing newbie, making a positive return through actively investing can be difficult and sometimes not the best way to manage your money. On the other hand, passively investing - through the buying and holding of assets for the long term - can benefit you more.
Have a Financial Set Goal
A financial goal is the set target or purpose of your investment. Your goal for investing could be for retirement, a home purchase, an educational pursuit, travel, or even a trust fund for your children. Having an investment goal will help you determine the amount to invest and the time horizon you have. It will also help in breaking down the amount needed into weekly or monthly investments.
As a newbie in investing, your goal for investing can be to cushion the effects of surging inflation and high-interest rates. Your financial goals can also evolve over time to be socially and environmentally conscious. For example, investors may sometimes rebalance their portfolios to support LGBTQ-friendly organizations, humanitarian causes, and environmentally-friendly companies.
Develop an Investment Strategy based on your Financial Goal
An investment strategy analyzes your current financial situation and guides you on the steps to take to achieve your financial goal. If your investment goal is for a long-term plan like retirement, consider investing in a Traditional IRA, Roth IRA, or a 401k account. You can also invest in various stocks (mutual funds or index funds), ETFs (exchange-traded funds), and real estate for the long term. If your investment goal is for a short-term plan like an educational pursuit or migration, you are better off investing in low-risk options such as interest savings accounts. Having an investment strategy is the blueprint to achieving your financial goal. And it is worth mentioning that your investment strategy should also be inflation-proofed.
Create an Investment budget and stick to it
How much money are you willing to invest? It could be $1,000 monthly, $10,000, or any amount depending on your income and financial level. Creating an investment budget that aligns with your goals is crucial because beyond achieving your financial goal, you gain compound returns on your investments and build a consistent habit. For instance, when investing for retirement, a common practice is to budget 10 - 15% of your annual income each year for your retirement.
Set up an Emergency Fund
A solid emergency fund is a strong indicator of financial wellness and is very essential to a good investment strategy. This is because as enticing as investing can appear, you should be able to handle your monthly expenses and still cater for contingencies like emergencies. Your emergency fund could be cash deposited in a savings account or money that is easy to withdraw. Typically, it is advisable to have an emergency fund that caters to 3-6 months of your expenses. This might seem like a stretch, however, the idea here is to ensure that you do not end up withdrawing your investments before maturity or incurring tax deductions and losses on premature investments.
Avoid High-Interest Debts
Debts inherently are not bad and can be used for different purposes, but high-interest debts like credit card debts and bad debts need to be paid off and completely avoided because they can eat into your finances and water down your investments. To further explain how this works: The S&P index fund consecutively produces an average return of 10% yearly. Most bonds also pay an average of 4-5% annually as dividends depending on interest rates and other fixed factors. However, the average credit card interest rate as of December 2023 is 25%, and it can sometimes climb up to 29%. These types of high-interest debts accumulated from credit card and bank loans can put you in a bad situation, eventually, making you lose money over time.
Diversify Your Investments
When creating an investment portfolio, it is important to diversify your investments across different assets and market sectors. These assets could be in the form of mutual funds, ETFs, and other investment choices according to your risk level and goal of investing. The theory behind investment diversification is that holding both equities and bonds will positively impact the risks of return compared to holding just equities, which can be very risky, and bonds, which can be less rewarding. According to Steven Goldberg, a simple way to diversify your portfolio is by holding three index funds—one based on international equities, another on the US market, and lastly, a broad bond index. This way, your portfolio is insulated in case a market sector experiences a downturn. Diversification of investments will also help you when rebalancing your portfolio.
Rebalance your Investment Portfolio
Rebalancing your investments involves making adjustments in your asset allocation to bring it back to your desired target. This is because your original investments will shift based on market ebb and flow and when this happens, you need to take profits from winners that may not be able to sustain their success while adding to investments that have struggled but have good prospects. There is no one-size-fits-all approach to rebalancing but a rule of thumb is to rebalance your general portfolio whenever you notice a 5% overall drift from the initial allocation. When rebalancing, avoid the mistake of reacting to daily market changes and beware of tax implications like capital gains tax.
Invest no matter how small
The principle on investing is similar to little drops that can make a mighty ocean. Rather than focus solely on the amount you are investing, focus on investing itself. If you cannot start with a defined amount, start by micro-investing (investing small amounts of money usually leftover change from purchases at a time) and gradually build to other forms of investing.
Types of Investment Options to Take Advantage of in the New Year
Every investment carries its own risk and while there is a vast number of investment options, the most popular investments for newbies are stocks, bonds, index funds and mutual funds, commodities, collectibles, cryptocurrencies, etc.
A stock is a piece of ownership of a company (private or public) that guarantees you a share in the dividends of the company. While owning a company’s stock will not often equate to making business decisions. As an investor or shareholder, you can partake in the growth and success of the company through it stock appreciation over time or dividend distributions of the net profits. Stocks can either be common or preferred, with the former offering you voting rights and participation, and the latter offering a first claim to dividends.
When you invest in a bond, you are essentially lending money to the issuer (usually a corporation or the government) who then uses your money to fund a project or even service debts. In return, the issuer pays you periodic fixed interests known as coupon payments In most cases, this is usually 4-5% of the capital investment. It is important to note that the return of a bond is inversely proportional to its current price in the market. This means that as the price of the bond goes up, its yield goes down and vice versa. Investing in bonds is a low-risk investment and a good investment option if you are risk-averse.
Index Funds and Mutual Funds
Investing in index funds and mutual funds is investing in a mesh of moderate-to-high-risk equity investments across different companies. They are a reliable type of investment that guarantees an average of 8 to 10% annually. A good example is the Standard and Poor’s (S&P) 500 index which is a combination of stocks from 500 of the largest publicly traded companies in the US stock market. When investing in an index or mutual fund, you can use a robo-advisor or firm to manage your investments.
Another type of investment is investing in tangible commodities like gold, rare earth metals, oil and gas. These types of investments are traded on commodities futures (agreements to purchase on a given date at a specified price) or commodity pools. Investing in valuable commodities helps you hedge against risk and speculations. For example, gold is a valuable commodity in times of economic and political uncertainty. As a matter of fact, during the 2020 COVID pandemic, the price of gold surged to all-time high levels.
Investing in collectibles like art, vintage cars, sports memorabilia, and other rare items in anticipation of a future increased value is another type of investing albeit a more traditional form. This type of investment provides a way for you to own the things you love along with the added advantage of earning from them. However, unlike other forms of investments, investing in collectibles has no intrinsic value hence they are very risky. Their worth is usually subject to the perceptions and tastes of the buyer or general public.
Investing in cryptocurrencies is a way to own digital innovative assets that are convenient to hold, send and sometimes liquidate. Also, when compared to the currencies of many developing countries, cryptocurrencies pose a better store of value than local currencies. However, if you decide to invest in cryptocurrencies, you should be prepared to lose all your money.
Why? - Compared to stocks, bonds and other forms of investments, cryptocurrency is still in its infancy and largely remains unregulated. It is also highly volatile and susceptible to speculations and trends. Once your money enters the crypto ecosystem, it becomes devoid of any protection and in cases where something goes wrong (like a hack or exchange collapse), you are unlikely to access to financial compensation schemes. When investing in cryptocurrencies, always do your research and invest what you are prepared to lose.
The Bottom Line
There is no one-size-fits-all approach to investing and a piece of advice can only take you so far. However, remember the basics; your financial goals, plans, strategies and always research more. It is important to do your research on the investment you want to undertake. Check its tax and liquidity implications if any. Avoid high commissions and service fees. Use roboadvisors where necessary and if you can, get a financial advisor. When choosing one, ensure that he or she is fiduciary (mandated by law to protect your interests and investments). Think long-term and never invest in what you cannot understand. Sometimes the most sensible investment for the great majority of investors is a low-cost index fund and a good-performing bond. In the famous words of Warren Buffet, by periodically investing in an index fund, the know-nothing investor can outperform most investment professionals.
Africhange is an international remittance company that helps you send and receive money across Nigeria, Canada, Ghana, and Australia, including sending USD to over 100 countries and other parts of the world. To know more, please click HERE.