Investing can seem daunting, especially if you’ve never done it before. While there are many resources out there to help you get started, the best way to become an investor is actually to start investing. Learning by doing is often one of the most effective ways to master a skill, and other personal finance and investing options are no different. In this article, we have a beginner’s guide to investing basics – from the importance of a diversified portfolio to steps for every beginner to remember when they begin investing.
Learning the Investing Basics
Investing is an activity that involves putting money into assets in the hope of generating returns on investment (ROI) over time. This can include stocks, bonds, exchange traded funds (ETFs), mutual funds, real estate properties, real estate investment trusts, or investments such as cryptocurrency. These investments are typically made to earn a return over time—typically in the form of interest or dividends paid out by the investment, and can help create a diversified portfolio for any investor.
You can also learn more about investing topics like:
- Stock Market: What is it and How Does it Work?
- A Beginner’s Guide to Passive Investing
- How Do the Top 10 Common Investments Work
Why Should I Invest?
While the answer to this question varies from person to person, for many, investing is a way to generate long-term returns—in other words, make money. Other include preserving capital and mitigating risk, preparing for retirement or other long-term goals, and taking advantage of potential tax benefits. Generally speaking, when done correctly and strategically, investing can be an effective way to build wealth over time and protect yourself against inflation and market volatility.
The Importance of a Diversified Portfolio
Diversification means having multiple types of investments within an investment portfolio. This can mean different types of assets, like stocks and bonds, or investments in different industries, sectors, or mutual funds. The goal of diversifying a portfolio is to spread out risk by not putting all your eggs in one basket.
By having investments in various areas, you create balance, which helps protect you from significant losses due to stock market cycles or if one particular sector or asset class experiences an unexpected downturn. Additionally, having multiple assets within your portfolio allows you to take advantage of tax benefits; for example, if you hold both stock and bond investments in the same account, any gains from one type are offset by losses from the other—helping reduce your overall taxable income.
What are Market Cycles?
As any experienced investor will tell you, financial markets are far from predictable. It goes through cycles of highs and lows, often in ways that seem difficult to understand or anticipate. That’s why understanding three different types of market cycles investors most commonly discuss can benefit your investment strategy.
The productivity growth market cycle consists of four stages: expansion, peak, contraction, and trough.
During the expansion phase, businesses expand their operations as demand for products or services increases. This usually leads to higher levels of employment and wages as well as rising profits for businesses.
During the peak phase, businesses are operating near capacity, and demand for their products or services has reached its maximum level; this often leads to higher prices due to increased competition among businesses for customers’ dollars.
During the contraction phase, businesses begin cutting back on production due to decreased demand; this often leads to lower levels of employment and wages as well as reduced profits for businesses.
Finally, during the trough phase, business activity has declined markedly as demand has waned; this often leads to lower prices due to decreased competition among businesses for customers’ dollars.
Short Term Debt
The short-term debt market is a cyclical process whereby governments and companies borrow money from investors, use it to finance operations or projects, and repay it with interest. This cycle typically takes place over months or years, depending on the terms of the loan agreement. When governments issue bonds to finance their operations or projects, they borrow from investors like you and me. We lend our money in exchange for a fixed rate of return (the “interest rate”). Then we wait for repayment with interest at some point in the future.
This is known as “fixed income investing” because we know exactly what our return will be. Companies may also issue bonds with shorter maturities, such as three or six months, depending on their needs. As borrowers repay their loans, new ones are issued to replace them. This keeps the cycle going and helps keep liquidity flowing into the market—a critical component for its health and stability.
Long Term Debt
The long-term debt market cycle is an economic cycle that affects debt markets over the course of several years. Similar to short-term debt, this borrowing creates a cycle where one party takes out money, pays it back with interest, and then passes it on to someone else who does the same thing. This process continues until someone defaults or decides not to renew their existing loan.
In times of economic growth, interest rates are low, encouraging borrowing since people are more likely to take out loans when they know they can pay them back at lower costs. On the other hand, when economies slow down, and people become more cautious with their spending habits, interest rates tend to rise as lenders try to protect themselves from interest rate risk by charging higher rates of return on their investments. As a result, borrowers tend to be less inclined to take out loans during these times because they know they won’t get as good of a deal elsewhere.
Beginner Steps to Investing
- Be patient: past performance history has shown the market will slowly increase over time, despite periodic setbacks.
- Invest responsibly: a few successful investments may have you feeling invincible but remember only to invest what you can afford to lose.
- Invest wisely: take advantage of your general knowledge of a given market rather than trying to force your way into a market you’re unfamiliar with.
- DYOR (Do Your Own Research): pundits will engage in sensationalism for ratings…don’t fall victim to panic or fear of missing out. Double-check the facts before diving in or pulling out.
- Timing: Time in the market is more important than timing the market. In other words, an investment left to ride fluctuations is better than erratic buying/selling (especially with fees).
- Dollar-cost average: When you find an investment you like, investing small amounts of money in this investment over time can help growth while weathering market fluctuations.
- Greed and fear: Be fearful when others are greedy and greedy when others are fearful. If people are dumping money into a particular investment, chances are it will be overvalued. Similarly, if people are pulling their money and running away from an investment, it may be undervalued.
- Diversify: As stated previously, a diversified portfolio helps hedge against losses in a particular sector, company, etc.
The Bottom Line
Learning to invest requires knowledge and experience, but you don’t need extensive knowledge of complicated investment strategies to begin investing. If you’re interested in becoming an investor but don’t know where or how to start – take advantage of available resources such as books and online articles. Don’t forget about learning through experience as well as any investing that involves risk.
Before embarking on your investing journey, be sure you understand your risk tolerance level so as not to expose yourself to too much financial danger down the line. If you have questions or want more information on various investment vehicles, balancing your portfolio, or want to learn more about how a financial advisor can help you, become a member of Planning Made Simple. As a member, you have access to resources, professionals who can provide you with guidance, and fellow community members who can help to answer questions you may have when beginning your investing journey.