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The Basics of Investing

 

Your Initial Financial Plan:

 


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Invest $100 and your investment will grow to $700 after 25 years, assuming an 8% rate of return.  Sounds good, but what will things cost in the year 2025?  If inflation remains at 4% over the next 25 years, you'll spend $267 for a basket of goods or services that costs you $100 today.  If inflation averages 6%, that same basket would cost you $429 in 2025.  When building your investment portfolio, one of your goals should be to beat inflation by as much as possible while taking on only as much risk as you're comfortable with. 

Risk and Reward

What is risk?  Within the context of investing, risk represents the possibility that your investments might decrease in value.  So why should an investor ever take on any risk?  Because, as a rule of thumb, the more risk (within reason) that you're willing to take on within your investment portfolio, the greater the potential for a higher return on your money.  And the longer you can keep your money invested, the better prepared you'll be to withstand some volatility within your portfolio, especially during unpredictable market downturns.

Safety First

In everyone's portfolio, there's a need for safe investments.  Whether its your emergency fund or money set aside for the down payment on a new home, you probably have some savings that you can't afford to have go down in value.  Examples of safe investments include bank savings accounts, certificates of deposits (CDs), and United States Treasury bills and notes.  Because the risk associated with these investments is so low, they typically pay an interest rate that barely outpaces inflation.

Mutual Funds

For longer-term investments, including 401(k) savings accounts, mutual funds are by far the most popular type of investment.  Mutual funds pool the money of many investors and use that money to purchase a portfolio of stocks and/or bonds.  For a small charge built into the fund's performance, funds provide investors with access to professional management and a diversified portfolio. 

Because mutual funds fluctuate in value based on the performance of their underlying portfolio, they are inherently risky investments.  Certain types of funds are more volatile than others, so visit a site such as www.morningstar.com to evaluate the risk and performance of the funds you plan on purchasing.  Even though there is a risk to owning mutual funds, if you invest prudently and for the long-term, a portfolio of mutual funds should outperform safer investments and inflation over time.

Investing in Stocks

People looking to take on additional risk generally invest in individual stocks.  Even though stocks have the potential for a higher return, stick to mutual funds unless you plan to either work with a qualified financial professional or diligently follow the market. For most casual investors, the risk associated with owning a handful of stocks outweighs the potential returns by a wide margin.

It's a Balancing Act

Balancing risk and return takes a lot of thought and research.  Keep both concepts in mind as you build your investment portfolio.

  

 

 

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This article was written by Andrew D. Schwartz, CPA for YourWriters.com and had previously been posted on Collegexit.com.