Investing Basics
August 26th, 2005It’s amazing to me that this simple financial concepts is still mostly unknown to most people. The most important is called the Rule Of 72. Simply stated, the Rule Of 72 says that if you take any interest rate on money that you are receiving, and divide it into the number 72, the result is the approximate number of years it takes for your money to double. Seems pretty simple, huh? It is. So simple in fact that if you understood how easy and powerful the concept is, you could become wealthy over time.
Most people need to feel ‘safe’ and they place their money in banks, universal life insurance, CDs and money market funds. All of which pay minimal rates of return – generally 2-4%. At that rate, your money only double every 18 to 36 years, which will get you nowhere very fast.
If you want to retire wealthy, or maybe you just want to invest for the long term, there are a few key points you need to understand. I will just highlight the basic fundamentals without going into too much detail. However, understanding these key fundamentals will help make you save a fortune over the years to come:
Ownership vs. Loanership: When you place money in a savings account or a CD, you are ‘loaning’ your money. This is not the way to profit. You need an ownership interest in something. Ownership is the way to go. Examples of ownership are mutual funds, ETFs, and stocks. With each of these, you own shares, or pieces, of a company or companies. Some of these pay dividends based on corporate profits. Bonds are not an ownership product. With a bond, you are loaning your money.
Dollar Cost Averaging: Investing should be an ‘all the time’ thing, not just a one time thing. As we all know, the stock market fluctuates every day, and we can not ever predict what a mutual fund or stock will be worth at any time. We don’t know if we are buying at the highest time or the lowest time. So, if we purchase each and every month, regardless of the price of the stock or mutual fund, we diversify our purchases over time and we average our cost. This is the best and safest way to invest.
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Pay Yourself First: No matter how many bills you have, it is very important that you pay yourself as a bill every month, no matter what. You can find $50 to start with. Remember this. You will always have bills, but you will not always have time! Even if you do not have much money to invest, you may still have time. Time can be either your ally or your enemy. The longer you wait, the more it will cost you!
Diversification: We’ve all heard this cliche: Don’t put all of your eggs in the same basket. It’s true. Spreading out your investments minimizes your risk. While there is always risk in investing, a diversified portfolio is smart. I suggest you start with mutual funds, which are nothing more than a professionally managed large selection of stocks and other investments. A mutual fund itself is generally diversified, usually among 50, 100 or even more stocks. Then, by purchasing multiple mutual funds, you spread your risk out even more. I generally do not recommend direct investments in stocks. Certainly not for new investors. While I am not 100% opposed to it, it’s not for the inexperienced or faint of heart. If you have interest in stocks, I would recommend starting with multiple blue chip stocks to start, and use an online broker like ShareBuilder which has low fees and allows regular people to make small, systematic investments each month.
You don’t have to have a degree from Wharton to begin investing. But you do need to start to educate yourself. You can begin by buying a few books or reading Money Magazine. Just start to take an interest in your financial future, and start now. Do not wait until you know everything before you start. If you are unsure, you do have avenues available to you.
Many banks have investment counselors with whom you can talk to for free. (Unless you are already well-to-do, I would not hire a fee-only financial advisor at this time.) You can also ask friends or relatives about a recommendation. Or you can deal direct with companies like Fidelity or Janus. These companies usually require a little more money to get started, but having accounts with both of them, I feel that they are very good companies to work with.