If you already contribute to a savings account regularly, congratulations! You’re already exhibiting good sense by preparing for your financial future. However, savings alone will not be enough to prepare for retirement. Even if you placed your money in high-yield savings accounts and certificates of deposit, it still won’t be enough to fund your retirement. It won’t even grow as fast to beat the rate of inflation!
This is why putting your money alone in savings should not be your only retirement strategy. Investing should be part of your overall retirement strategy. However, a lot of individuals find the idea of investing overwhelming. The anxiety is understandable. After all, the business world is a large and complicated place. If you are not knowledgeable about its intricacies, you will have second thoughts about putting your hard-earned money in it.
However, missing out on investments is never an option. Putting your money on savings accounts alone puts you at risk for an ill-funded retirement. This is why it’s imperative that you start educating yourself about the world of investing so you can reap its benefits. That starts with learning the basic investment terminologies.
There are three essential terms that all neophyte investors need to understand: Stocks, bonds and mutual funds. Let’s look at these in more detail.
Shares of ownership in a company are known as stocks. They are bought and sold in platforms known as stock markets like the New York Stocks Exchange and the Nasdaq. Thus, when you buy shares of McDonalds or Facebook, you actually become one of the owners of these publicly-traded firms. As such, you are concerned about the performance of the company where you hold a stake in. If the firm does poorly, your shares dip in value. If it does well, however, you can expect the price of your shares to go up.
The value of stocks generally goes up with time. On the average, stocks return 7 percent to 10 percent a year. With the inflation rate generally pegged anywhere from 3 percent to 5 percent, it’s easy to see why putting your money in stocks is a wise investment decision.
While the returns are indeed promising, it is important to understand that investing in stocks is very risky. In fact, it is the riskiest of the three investment vehicles. If you have ready your history and have been up to date on the news, you know how volatile the stock market can be. Many investors can lose money when they sell losing investments when the stock market tanks. On the opposite end of the spectrum, investors can also make a lot of money when they see their stocks soar up in value when the market is having a good run.
Putting money in the stock market should generally be seen as a long-term investment strategy. At the least, the money you put in stocks should be funds you don’t expect to use in the near future. To maximize on the growth of the market, your stock investments should be for at least ten years. With this view in mind, it should be pretty obvious that the day-to-day fluctuations of the market are inconsequential. As a stock investor, your concern is the market’s long-term performance.
Bonds are issued by governments and companies to investors who buy them. If you take a loan from a bank, for example, you are borrowing money from the lender which you pay back with interest. When you purchase bonds, the opposite happens: You are the one lending money to the firm that issues it. Just like stocks, bonds are sold by these companies to raise money for various purposes.
Bonds are usually long-term investments, typically with terms that last from five to thirty years. Investors earn money from bonds from the interest paid by the companies. At the end of the term, the principal is paid in full. Bonds can be issued by the federal government, state governments and city or municipal governments. Private companies can also issue bonds.
Bonds are more stable investments compared to stocks. As such, investing in them ensures the investors of predictable and fixed income for the entire length of the bond term. Nonetheless, there are still risks involved in bond investing. One of these is the danger of putting your money in junk bonds. Because they offer particularly high yields, investors often get lured to these very volatile bonds issued by firms whose credit ratings are very low. Because the companies where these bonds came from are faced with financial difficulties, there is a very big possibility that they won’t be able to honor the bonds they issued when the term ends.
Bonds that are guaranteed by the state, such as the US federal government, are often the safest to purchase. If you are contemplating on investing in bonds from corporations, be sure to look at the credit ratings issued by third party credit rating agencies like Standard & Poor’s and Moody’s. A triple A (AAA) rating from Standard & Poor’s means that the company is in good financial footing and the bond is an extremely safe investment.
Mutual funds are the ideal investment vehicle of choice for novice investors. Not only are they very affordable, the hard work that comes with researching on potential investments is not anymore in your hands but in a professional who has had years of experience on the market and often holds a postgraduate degree related to finance.
Mutual funds are basically pools of stocks and/or bonds that a professional money manager buys or sells. A mutual fund manager gets together the money of many different investors and uses these to invest in many different assets. Depending on the mutual fund firm’s investment strategy, they can invest only in stocks or solely in bonds. Balanced funds invest in both stocks and bonds. There are also sector funds that pool securities in the technology, energy and financial sectors as well as global funds that invest in firms located outside of the United States. Index funds are mutual funds that attempt to mirror the mix of stocks in benchmarks like the Standard & Poor’s. The performance of the funds depends on how the index it attempts to mirror performs.
What investors need to be wary about when investing in mutual funds are the fees and commissions as well as the reputation of the mutual fund firm. The loads can drain your earnings if you’re not careful. As much as possible, choose no load mutual funds where no fees are required when the mutual fund shares are purchased or sold.
When investing, there are certain principles you need to keep in mind to make the most of your investment.
Asset allocation refers to how you apportion your investments. You can arrange your investments in such a way that you distribute it in stocks, bonds and cash. When you’re younger, you can afford to have more allocated in stocks because you have time recoup your investments in case of losses. When you’re close to retirement, however, it is more prudent to put more of your investments in bonds and cash savings as they are less volatile and can provide you with a stable income stream in retirement.
You’ve heard it said, “Never put all your eggs in one basket.” When investing, see to it that you put your money in different investment vehicles as well as in various industries. This means that you don’t only invest in stocks but in stocks, bonds, savings and real estate. You should not also focus only on stocks in the transportation industry or the airline industry. Spreading it out in various industries better protects you from the fluctuations of the market.
This is what makes mutual funds the ideal investment for those who don’t have a lot of money to invest. Mutual funds or exchange traded funds or ETFs enable small investors to form a well-diversified portfolio using much less cash compared to if they would invest in individuals stocks or bonds. Mutual fund firms can focus on small yet promising companies, medium-sized firms or big companies that are undervalued. They may also invest in short-term, intermediate term or long-term bonds of various corporations. Other mutual funds may also focus their investments in short term government bonds or money market funds.
Before making any investments, doing careful research is necessary. You’ll need to screen the reputation of the companies you plan to invest in to see if they will give you the best returns. Before buying bonds, you also need to check their credit rating so that you’ll know if you will get your money back when the term ends. If you are in the market for mutual funds, you’ll also need to check out how much their commissions are or if they collect loads at ll. If you don’t do due diligence, you might just be putting your money to waste.
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