Ask two people why they invest and you’ll likely get two different answers, yet everyone’s reasons stem from one idea; to end with more than you started. This usually occurs over some period of time. Below are common reasons people invest.
Reasons to Invest
- Retirement: Adds to your ability to quit work and live off the gains later in life.
- Life events: Puts enough money together to pay for a wedding or starting a family.
- Personal development: Save for college and higher education.
- Housing: Bank enough money for a down payment.
- Wealth creation: Make money to increase your net worth.
- Provide for others: Invest to generate funds for charity.
- Avoid inflation: Use low-yield savings accounts to offset inflation.
Create a plan
People often give Treasury bonds as gifts for newborns for college. Such a conservative investment guarantees the money and gain will be there when needed, but this strategy may not be right for someone trying to make enough to quit his job.
Your reason for investing creates the framework for an investment plan and considers the following:
- Goals should be as specific as possible.
- They answer how much and by when.
- An individual’s personality and goals define how much risk to accept.
- With a longer time horizon, you can take more risk now that will average out over time.
- Create a portfolio geared towards lower volatility if the thought of waking up one morning with your portfolio down 5% makes you uneasy,
Income vs expenses
- Financial plans look at inflows (income) and outflows (expenses).
- Expenses include ongoing items like food, housing and loan payments
- What remains after paying all your expenses can be used for investing.
Listen to what Warren Buffett has to say about investing and time horizons:
Types of investments
After you’ve created an investment plan, select your options. Investments fall on a scale that balances risk and return. Riskier stocks should provide bigger gains than safer ones. Stocks should provide better returns than bonds. The type of investments you choose balances these forces.
- Partial ownership of a company.
- You share in the profits and losses along the way.
- Different stocks have different levels of risk.
- When companies go bankrupt, stockholders usually get nothing.
- Stocks can be easily bought and sold.
Government and corporate bonds
- Guarantee of payment from a company or government.
- Failure to pay a bond results in default.
- Bondholders can force the issuer to sell assets to pay them back for their investment.
- Ownership of residential or commercial land or buildings, including primary residences.
- Very illiquid market that can take weeks to months to buy or sell.
- Risk varies depending on the location and market cycle.
Peer to-peer lending
- Lending to individuals or businesses
- May not come with the same rights to force asset sales as bondholders
- Used by individuals to start businesses or lower high-interest payments
- Risk and return is evaluated on an individual deal basis.
Savings accounts and certificates of deposit (CDs)
- Money given to banks or financial institutions provides a small but guaranteed interest rate.
- Conservative investment that people use for emergency funds
- Easy-to-access and very liquid
- CDs may have a penalty for closing them early.
- Both may require a minimum balance.
Education and self-development
- Use savings to pay for school and training.
- You take classes and develop skills with the expectation that it will lead to better jobs in the future.
Learn more about stocks. Check out Benzinga’s article How to Buy Stocks for Beginners.
Reducing your expenses is one of the best ways to invest. People often forget to look at the way they live as an opportunity to make money. Spending $300 to add insulation into your home could provide a better return than the stock market. Paying off your credit card that charges 20% interest will get you a better return than most stocks.