The investment environment can be extremely dynamic and constantly changing. But those who take the time to understand the basic principles and different asset classes will surely reap significant benefits in the long run. The first step is to learn to distinguish between different types of investments and the position each type of investment occupies on the “risk ladder.”
- For starters, investing can be a daunting prospect because there are a variety of possible assets that can be added to the portfolio.
- The investment “risk ladder” determines the asset class based on the relative risk of the asset class. Cash is the most stable, and alternative investment is usually the most unstable.
- Sticking to index funds or exchange-traded funds that reflect the market is usually the best way for new investors.
How to invest in stocks: a beginner’s guide
Understand the investment risk ladder
The following are the main asset classes on the investment risk ladder, arranged in ascending order of risk.
Cash bank deposits are the simplest and easiest to understand investment assets, and they are also the safest. Not only does it allow investors to know exactly the interest they will receive, but it also guarantees that they will get back their principal.
The downside is that the interest earned on the cash deposited in the savings account rarely exceeds the inflation rate. A certificate of deposit (CD) is a very liquid tool, very similar to cash, which usually offers higher interest rates than savings accounts. However, funds will be locked for a period of time and may involve early withdrawal fines.
A bond is a debt instrument that represents a loan provided by an investor to a borrower. A typical bond will involve a company or government agency, and the borrower will issue a fixed interest rate to the lender in exchange for the use of its capital. Bonds are common in organizations that use them to finance operations, procurement, or other projects.
The bond interest rate is basically determined by the interest rate. Therefore, during the period of quantitative easing or when the Federal Reserve or other central banks raise interest rates, their trading volume is large.
A mutual fund is an investment in which multiple investors pool their funds to purchase securities. Mutual funds are not necessarily passive because they are managed by portfolio managers, who allocate and allocate pooled investments to stocks, bonds, and other securities. Individuals can invest in mutual funds for as low as $1,000 per share, allowing them to diversify their investments in up to 100 different stocks included in a given portfolio.
Mutual funds are sometimes designed to mimic underlying indexes such as the S&P 500 or the Dow Jones Industrial Index. There are also many mutual funds that are actively managed, which means they are updated by portfolio managers, who carefully track and adjust the allocations within the fund. However, these funds usually have higher costs — such as annual management fees and front-end fees — which may reduce returns for investors.
Mutual funds are valued at the end of the trading day, and all buying and selling transactions are also executed after the market closes.
Exchange Traded Fund (ETF)
Since its launch in the mid-1990s, exchange-traded funds (ETFs) have become very popular. ETFs are similar to mutual funds, but they are traded on the stock exchange throughout the day. In this way, they reflect the buying and selling behavior of stocks. This also means that their value may change dramatically during the trading day.
ETFs can track the underlying index, such as the Standard & Poor’s 500 Index or any other ETF issuer’s wish to highlight a “basket” of stocks in a particular ETF. This can include anything from individual business sectors such as emerging markets, commodities, biotechnology or agriculture, etc. Due to convenient trading and wide coverage, ETFs are very popular with investors.
Stocks allow investors to participate in the company’s success through rising stock prices and dividends. In the case of liquidation (ie company bankruptcy), shareholders have the right to claim the company’s assets, but they do not own these assets.
Ordinary shareholders have the right to vote in the general meeting of shareholders. Holders of preferred shares do not have the right to vote, but they do have priority over ordinary shareholders in the payment of dividends.
The scope of alternative investments is very wide, including the following areas:
- Real estate: Investors can obtain real estate by directly purchasing commercial or residential properties. Or, they can buy shares in a real estate investment trust (REIT). The role of REITs is similar to a mutual fund, in which a group of investors pool their funds to buy real estate. They trade like stocks on the same exchange.
- Hedge funds and private equity funds: Hedge funds can invest in a series of assets designed to provide returns beyond the market, called “Alpha.” However, performance cannot be guaranteed, and the returns of hedge funds may undergo incredible changes, sometimes significantly lagging behind the market. Usually only available to qualified investors, these tools usually require a high initial investment of US$1 million or more. They also tend to impose net worth requirements. Both types of investment may occupy investors’ funds for a long period of time.
- Commodities: Commodities refer to tangible resources, such as gold, silver, crude oil, and agricultural products.
How to invest wisely, appropriately and simply
Many sophisticated investors use the asset classes listed above to diversify their investment portfolios, which reflect their risk tolerance. A good advice for investors is to start with simple investments and then gradually expand their investment portfolio. Specifically, mutual funds or ETFs are a good first step before turning to individual stocks, real estate, and other alternative investments.
However, most people are busy worrying about monitoring their investment portfolio every day. Therefore, insisting on using index funds that reflect the market is a feasible solution. Steven Goldberg, head of Tweddell Goldberg Investment Management and long-term mutual fund columnist at Kiplinger.com, further believes that most people only need three index funds: one covering the US stock market, the other covering international stocks, and the third Track bond indices.
Investment education is essential-avoiding investments that you do not fully understand is the same. Rely on reasonable advice from experienced investors while rejecting “hot tips” from untrusted sources. When consulting professionals, seek independent financial advisers who are paid only on time, not those who charge commissions. The most important thing is to diversify your holdings among a wide range of assets.