Investments for Beginners
Although there’s no one answer that’s perfect for everyone, here are some ideas that will simplify matters for you.
First, you need to have some idea of when you may need to use the money. If you’ll need it for college next year, you’re going to be limited to investments that make it certain that your money will be there when you want it.
If, on the other hand, you’re saving for retirement 15 years down the road, you can afford to take a little risk that you might even lose money in some years.
Your Risk Comfort Zone
Next, consider your ability to take risk. There are two components that determine how much risk you should assume. We just looked at one, how soon you will need the money.
If you don’t need the money for 10 years and your investment loses money one year but gains the other nine it’s not a big deal. If you’ll need the money next year you don’t have that luxury.
The other consideration on risk is your own personality. Some people are mountain climbers. Others prefer a day at the beach.
If you’re a cautious person you won’t be comfortable with a risky, high-flying investment. Even if the investment does well, the sleepless nights and money you’ll spend on ulcer medicine will make it unsuitable for you!
Finally, will you have all of the money to invest at one time? Or do you plan on saving $50 a month? Also consider how you will ultimately use the money. Will you want it all at once to buy a house? Or will you be using the money a little at a time when you’re retired?
Knowing this will help you select the right investment. For instance, if you’re saving $50 a month don’t buy individual stocks – commissions will take all your money.
Certificates of deposit (CDs) aren’t practical, either. You should consider savings accounts, money funds, or mutual funds.
By comparison, if you’ve just received an inheritance of $20,000 and want to use that as a down payment for a house in two years you’ll be able to consider individual stocks, bonds, CDs, treasury bills, and notes.
All of these investments require a sizable investment to be made at one time and sold or redeemed in one transaction.
Now let’s talk a little bit about the vehicle for your investment. You must remember to separate what you’re investing in from how you’re investing in it. What does that mean? Let’s take a simple case that demonstrates how there can be confusion.
In both cases you own either part or all of a business and would expect to benefit if the business does well.
On the most basic level, there are really only four kinds of investments:
You can be a business owner. You would expect to make money if the business prospers. Typically, you’ll find that this type of investment is best if you have a longer-term view.
Owning a piece of the action is called for if you believe in the future of a business, an industry, and/or the economy generally. For me, this is mostly online assets until recently, as I have begun diversifying and buying some “hard” real estate by buying up a few Houston Heights homes for sale nearby my current home.
2. Debt Instruments
You can loan your money to someone for interest. Here, you give them a dollar today with the expectation that they will give you $1.05 or $1.10 later. It could be a loan to your brother-in-law or a bond issued by General Motors.
When you consider a debt instrument (loaning your money) there are a number of important variables. Safety, for instance.
Money loaned to the U.S. Treasury should be safe. Your brother-in-law will not be so safe. Typically you can expect to earn more interest from a borrower who is less safe.
You’ll need to balance the interest you earn with the risk of losing your money.
A key variable is the term of the loan. A certificate of deposit is for a relatively short period of time, say a few months or years.
By comparison, a corporate bond could be issued for 20 or even 30 years. You’ll find that shorter-term loans are usually safer, but pay less interest.
Again, there are a number of different ways to make this kind of investment. You can buy individual CDs or bonds, or you can buy bonds through a mutual fund.
A similar category is called cash equivalents. That’s where you loan your money for a short period of time (usually one year or less) and expect that your principal will be there whenever you want it without risk of loss. CDs, savings accounts, and money funds are good examples.
4. Hard Assets
Hard assets are things that are usually found in the earth and/or that cannot be easily reproduced by man. Gold, oil, and real estate fall into the category. This type of investment will do better in inflationary times. Again, you can either buy ounces of gold or buy a mutual fund that invests in gold companies.
Beginner’s Plan of Action
Most beginning investors should begin with cash equivalents until they have a fund big enough to meet unexpected family expenses. After that, you’ll want to consider equity and debt investments. Finally, some hard assets for balance.
Although not the only good answer, mutual funds often are a good selection for beginning investors. Most make putting money in or taking it out in small amounts easy.
Many mutual fund companies have choices in each of the categories, making it easy to match your needs.