Every novice investor is uneasy with the amount of education that entering the market needs. The language and gatekeeping terms that litter the subject of investing often deter people from even starting to participate. But investing is an important vehicle to building and creating wealth. You probably even have started investing with your job’s 401(k), 403(b), 457(b), or SIMPLE IRA plan. Don’t let your lack of knowledge be the stumbling block to investing in your future. Investments like stocks, bonds, and mutual funds have historically had 7% -10% annual gains. That type of increase isn’t guaranteed, but it will likely beat out the interest payments you receive on most savings accounts, even High Yield Savings Accounts. As an investor, you should understand risk tolerance, diversification, investment accounts and what they consist of, and fees.
Risk tolerance is how you are personally able to live with losing the money you have invested. This tolerance will change throughout your lifetime. If your risk tolerance is higher, there is more opportunity to profit from gains but more potential to lose your original contribution. If a risk tolerance is lower, then the gains will be slower, but the probability of losing money lessens. As you entered the workforce in your late teens/early twenties, your risk tolerance might have been higher because you had plenty of time to earn more money or wait for a rebound if your investments took a heavier loss. Now think about how your tolerance might change as you reach 65 and are about to retire. It will probably lessen because you will be relying on that money for living expenses soon. When you start to invest, it is essential to realistically understand how much risk you can handle and adjust your tolerance as your life changes.
Diversification is how varied your investments are within your portfolio. This variety is used to help diminish the effects that an investment has on your money. Let’s say that you have invested only in oranges. Every time anything affected oranges, the weather, natural disasters, farm labor strikes, invasive pests, transportation delays, or stories on the news, there would be a shift in oranges’ price, therefore changing your investment worth. What happens if oranges were found to decrease the body’s ability to fight COVID? What happens if the next week it was learned oranges prolonged life by two years? Your portfolio would be volatile- pushed and pulled in value by only oranges. Now substitute oranges with tech, bitcoin, or even GameStop, and you can see why diversification helps an investor create safety nets within a portfolio so that your money isn’t at the whim of one investment.
Investment accounts or portfolios create diversity and fall into your risk tolerance by being made up of different investments. Investment accounts are either retirement or taxable, and each has its place in your financial life. Most people have more than one type of account because each account is geared towards different goals, has different rules, and has different tax burdens. But within any investment account, there will be a mix of stocks, bonds, mutual funds, and exchange-traded funds. Real estate and commodities are also valuable parts of investing but differ from the latter investments in key ways.
- Stocks are a purchase of a part of a company, which allows you to enjoy that company’s profits.
- Bonds are essentially loaning money to a company or government organization through your bond purchase for a set amount of profit with a yearly amount of interest paid to you.
- Mutual Funds offers a mix of investments (stocks and bonds) packaged together, and this often takes some of the chore of diversification away. Mutual Funds often have a minimum purchase amount for individual investors, usually $1000 or more.
- Exchange-traded funds (ETFs) are like mutual funds with investments bundled but they are basically like stocks. The ETFs are purchased as a share of the total fund, not the individual investment within the fund. ETFs, because of their design, are less expensive than Mutual Funds to start investing in.
- Real Estate investment can be an outright purchase of properties for your use or to rent to others, purchase to renovate and resell (aka flipping), Real estate investment groups (REIGs), real estate limited partnership (RELP), or Real Estate Mutual Funds. For REIGs, RELP, or Real Estate Mutual Funds, you are part of a larger group of investors that own properties. You don’t necessarily own a specific real estate property, though sometimes you do. You are using a group’s purchasing power to buy properties beyond most people’s reach.
- Commodities are either the purchase of physical raw commodities, such as precious metal or investing with futures contracts or exchange-traded products (ETPs) that directly track a specific commodity index. Commodities are complex and volatile investments that are best done by knowledgeable and experienced investors.
Fees are a part of investing. Whether you choose to get help from a financial advisor, have a self-directed investment portfolio, work solely with your company’s retirement plan, or use a Robo-advisor, there will be some fees taken on your investments. Understanding how fees are taken, what transactions incur fees, and the number of fees you are paying for is vital before investing. If you choose to work with an institution or person who can’t clearly show you what fees you will be paying, that is a huge red flag. You should not invest with them until you understand what you are paying for.
With an understanding of the building blocks of investment, you are on the way to utilizing a historic catalyst for wealth building and financial stability. Help with risk tolerance and changing your investment diversification as it changes is one of the jobs a financial advisor is trained to do. They also carefully look at your short- and long-term goals while doing the leg work on investment research. Working with a fee-only advisor, they get paid a percentage on assets they manage for you, which can help validate fees because their goal is in line with yours, which is to grow your assets. If you’d like to learn more about investing, Scarlet Oak Financial Services can be reached at 800.871.1219 or contact us here.
Advisory services offered through Capital Asset Advisory Services, LLC, a Registered Investment Advisor. This material has been prepared for informational purposes.