Investment Terms for Beginners:
If you are just venturing to learn more about investing you may feel overwhelmed by the amount of information that is out there and just how complicated some of the information can be. To be able to get started as a new investor it is important to understand a handful of terms and concepts.
Stocks and Bonds
For most, stocks and bonds will be the first building blocks you choose for your investment portfolio. Before you purchase any you will want to understand exactly what they are.
- Stocks: If you purchase a share of stock, you are buying a share of a company’s earnings. You become a part-owner or stockholder in that company. What does this mean for you? You have a vested interest in the wellbeing of the company. If your company does well, your stock value will increase. However, if the company does poorly, your stock value will decrease.
How do you make a profit? Some companies issue dividends to their stockholders. This happens when the company makes much more than expected. Since you are a part owner in that company, you get to reap the benefits by getting to partake in the dividends. You can also make a profit by having an investment advisor keep track of the market for you and sell your stocks when they have raised in value. You will get to keep the difference in the value as gains or appreciation. It is important to note that doing this can have considerable tax ramifications. Be sure to talk to you tax advisor about these possibilities before you start.
- Bonds: By purchasing a bond, you are essentially lending money to a government or company. This means that you become a creditor to the entity that you purchased the bond from, as opposed to an owner. Many people like to purchase bonds because they consider them to be safer than stocks. This is the case because bondholders are considered creditors, and as such they are more likely to be reimbursed for their loan if the entity were to go under.
How do you make a profit? If you choose to purchase a bond you profit from the interest that the company is required to pay you back for your loan. So you will get back your original investment, plus any interest earned.
Risk and Return
One concept that is very important for investors to understand is that of risk and return. Every investment is going to propose some level of return, but it will also offer some level of risk. Typically, investments that offer huge returns, are extremely risky. Whereas investments that offer up more modest returns have much lower levels of risk. However, there is never any guarantee on how any investment will perform.
Every person has a different level of risk tolerance, this means how much risk they are willing to take on their investments. Your level of risk tolerance will relate to your own preferences and how close you are to retirement. If you are not sure what type of risk tolerance you have, speak will a qualified financial planner who can help you calculate your tolerance level.
One term that you will come across often in the investment world is “diversified portfolio”. What does this mean? This term refers to how many different types of investments that you own. It is the best practice to have several different types of investments so that if one type does not perform according to plan, another type will perform and make up the difference. Having a diversified portfolio is a way of helping you to protect your money.
The Power of Compounding Interest
As a new investor, it is important to understand the power that just allowing your money to accumulate interest can have. How does it work? After a period given by the investment company, you will receive interest on your investment. If you do not sell your investment or withdrawal any money from it, the original money you invested, along with the interest you earned previously, will earn additional interest. This will continue to occur for as long as you keep your investment in place. It is called the snowball effect because you will gradually see you money increase and increase.
These are just a few of the terms that you need to be familiar with as a new investor. You can find other educational information in some of our other blogs. You can also learn more by scheduling time to meet with a qualified investment planner who can answer all of your questions and thoroughly explain all aspects of investing to you.