Fundamentals
of Investing
Investing is simply
the process of acquiring assets that you hope will grow in value. Investments
can include owning a home, owning a business, owning real estate or having money
in savings accounts and CDs union. This article addresses investing in stocks
and bonds and various ways to own them.
Basics
Owning a share of
stock is owning a portion of the company. If you buy 100 shares of General
Electric stock, you actually own a portion of GE. You can profit by owning
shares when the company pays a dividend or if the value of the shares increases
while you own them. You can also lose money if the value of the shares goes
down before you sell them.When you own a bond, you are lending money to the company or institution issuing the bond. You profit when you receive interest payments and if the value of the bond increases while you own it. You can lose money if interest payments are not made, if the principal of the bond is not repaid when it is due or if the value of the bond falls and you sell the bond.
When you buy mutual
funds, you are buying shares in a company that in turn owns stocks in other
companies or owns bonds issued by other companies or institutions. By investing
in mutual funds, you get the professional services of the mutual fund manager
who decides where and when to invest. You profit when the mutual fund
distributes dividends (and capital gains and interest) and if the value of your
mutual fund shares increases because of the increases in the underlying values
of the stocks and bonds it owns.
There are several
ways you can own investments. Most people start out with individual accounts
set up at brokerage firms or mutual fund companies, in their IRAs and through
their company retirement plan. If you invest through an individual account, the
income (dividends, interest and capital gain distributions) from the account is
taxable. If the investments are within an IRA or a qualified plan, you will
probably not owe any tax on the returns until you take funds out.
Some common sense
Understand that there are risks
with investing.
When you make the
decision to invest, you are leaving the world of insured and guaranteed returns
found with savings accounts and CDs from a bank or credit union. The values of
stocks rise and fall depending on the success of the company and the overall
direction of the stock market. The value of bonds can rise and fall depending
on changes in interest rates and the financial condition of the institution
issuing the bonds. In return for taking these risks, you hope to earn returns
greater than what you would have earned in a savings account or with a CD.
Be realistic in your
expectations.
Take a long term approach.
The returns from investing will
vary greatly from year to year. It is only by viewing your investments as
long-term can you hope to earn returns to justify the risks
Use an asset allocation strategy.
You should also consider how you
divide your investments among the different types of investments. How you
divide your investments among stocks, bonds and cash investments is called
asset allocation. It can serve as a logical starting point for your investment
strategy. Individuals should base their asset allocation on their time horizon
and risk tolerance. Here are some sample allocations based on age.
Diversify your investments.
If you are investing in stocks,
you should try to have investments in at least 3 or 4 stocks in at least 4 or 5
industries.Spreading ownership over different stocks in different industries
reduces the risk that the particular stock you choose in a good industry turns
out to be the wrong one. It also reduces the risk that you invested in the
wrong industry.
Consider the diversification
benefits of mutual funds.
When you buy mutual fund
shares, you are buying into a broad portfolio of stocks that the portfolio
manager has selected. In addition, most mutual funds offer a system of
purchasing called "dollar cost averaging." With this, you buy an
equal dollar amount of shares on a periodic basis.
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