Are you interested in learning how to make more money by investing in them? Today you will learn the best way to how to invest. There isn’t a quick way of doing that but certainly, there is a way of doing it through investing over time,
If you would like to understand the basics of investing and how you can best equip yourself to have the best start in investing read the full article.
I believe that everyone should at least understand and preferably do some investing if they can afford it. At the end of the day, you already know how to maximize the growth potential of your hard-earned money.
What is investing?
Investing is about putting your money to work now in the hope that it can grow over a period of time to provide a source of income in the future.
Basically investing well is an art of creating more money from existing money. I will be explaining the fundamentals of investing that you will need to understand before starting your investment journey. I will be covering why you should invest, understand the risk, and return, when you should start investing, the mindset or the emotions of investing.
Why should you invest?
Inflation is one of the important reason why investing is important. Inflation is when prices of everyday goods and services becoming more and more expensive over time.
Another way of looking at it is our currency or money is designed to devalue over time due to inflation. As a result, reducing your purchasing power.
The annual inflation rate is the percentage of increase in prices of these goods and services in a year. Inflation is why buying a loaf of bread cost less than 60 cents about 30 years ago and now it’s about $3.
As an example, if the annual inflation rate is 3% and you have kept $10,000 in cash or in a bank with minimal saving interest rate, the $10,000 will be devalued by $300 after twelve months. Over ten years your original $10,000 will only be worth less than $7,500 in real terms. This effect applies to almost any bank account.
Your savings are kept in because the inflation rate is much higher than the saving interest rate provided.
Why is there inflation?
Will it ever stop devaluing our money?
No, this is the short answer and this is partly because governments actively maintain and promote inflation. If you do want to understand more about inflation please read the post what is inflation? Learn how inflation works?. That post explains details about inflation.
why investing is important?
The effect of inflation is one of the main reason why investing is important for everyone. If you do not learn and invest your money to allow it to grow faster than the inflation rate slowly but surely the value of your money will be eroded over time.
Therefore for those who want to at least maintain the value of their hard-earned money investing is not optional.
The Risk and Return:
Investment does not guarantee a higher return. Any investment carries the risk of getting back less than the original investment and in general the higher the potential return the higher the level of risk involved, and similarly the lower the risk the lower the expected return.
Understand this risk is important because as discussed earlier with inflation keeping cash or money in the savings account and not taking any risk with investment is not just a theoretical risk but a guaranteed way of losing the value of your money over time.
Therefore rather than deciding whether you want to take on investment risk, you should really be understanding the risk involved in investment and the degree of risk you personally are comfortable in taking on.
Like most things in life like driving a car or cycling in a city, the more knowledgeable and experienced you are on investment, the more comfortable you are going to be managing the risk.
There are many strategies in investing that can minimize your investment risk and maximize your returns such as longer-term investing, diversification with asset allocation.
If you losing sleep knowing that your investment might temporarily fall in value on and off, think hard before you decide to do any investments, as any form of investment is almost certainly going to have some degree of volatility.
As long as you understand that it is just the nature of investment and come to terms with it, you are already developing skills to manage the investment risk.
When do you start investing?
You need to be financially ready. Only invest with your spare cash after accounting for all your necessary expenses. You should have cleared all your high-interest loans such as credit card or personal loans, and have put aside some emergency or contingency funds before you start investing.
What is high interest?
In general, I classify any loan or debt with an interest rate above 7%. This is because most investments are just about able to consistently provide you with 7% returns. Therefore it will only make sense to start investing after using your money to clear your high-interest loans or debt.
Investment can grow but it can also fall in value which means you may actually have less than you have invested in. For most investment to be successful it has to be invested with a long term view. By that, I mean at least over a 5 year period.
Therefore investment has to be from your spare money which is not required in the immediate future to maximize your growth potential. So do ensure that you are financially ready before you start investing.
The second preparation that you need before you start investing is gathering the investment knowledge exactly what you are doing right now.
Having some basic knowledge of investment is vital before you start. For example in stocks and shares, understand how the stock market works, why the volatility, why cycle of recessions, the importance of emotionless investing, some of the basic terminology such as shares, funds, passive or active investing.
In real estate, it is the understanding of the housing market, how to finance deals, how to work out the profitability, and so on. But you have to have a balance between how much knowledge you want to have and how much time you will be spending gathering them.
Many will be learning and analyzing but never taken any action. We call it analysis paralysis. Every professional investor was a beginner investor.
The right time is when you have done your research, have a good understanding of the investment, and be comfortable with the risk involved with it.
How to invest?
The foundation of any successful investment strategy is to have a clear financial goal. If you do not have a goal how do you measure success?
You need to have a target and work towards it. I do not think a goal should be a number or figure on its own. Your financial goals should be from what you want in your life. For example, for buying a dream house, two holidays per year, or retiring at 50 years old.
Establishing a clear goal will assist you in determining how much money you will need, and this should be reflected on the choice of investment, with the potential return you need to be achieving and how long you should be leaving your money invested for.
By having a goal you will have a clear incentive to work towards, the amount of money required set, the amount of risk you may need to take on, and a time frame for achieving it once you have all these clarified from the start.
The type and proportion of a location to each type of investment will be defined much more easily.
Emotions of Investing:
We are all social animals and expressing emotions is just part and parcel of being a human. Through natural selection or evolution, we have maintained two emotions which were vital for our survival as humans, Fear, and Greed.
They ensure our survival for many thousands of years. During our evolution, humans that have a heightened fear were quicker to react to dangerous situations and are more likely to survive and reproduce. It is a trait that we have inherited through natural selection.
Similarly, the emotion of greed has been naturally preserved to ensure personal and family survival by denying or defending competitors from obtaining the same opportunities. The huge volatility in the stock market is mainly a result of investors fear and greed.
Unable to overcome and allowing your emotions to govern your investment behavior can cost you a lot of money. First, except we humans have an in-built weakness and get automated, and stick to the long-term investment plan.
Essentially be disciplined, our emotions have no place in investing. If you are interested in understanding how emotions link to poor performing investors, there’s a video that I made that details this human factor in investment.
These are some of the investing fundamentals every investor should know. Remember procrastinating will be costing you money due to inflation.