A Beginner's Guide to Investing

 

Getting into investing can be daunting for beginners, this is mostly due to the ever-evolving rules. However, among the basic principle that each aspiring investor should understand is the different types of investments and the risk factor associated with each.

The main types of investment Risks

 

Market Risk

This form of risk is caused by a disruption in the market due to economic development or other factors. Other factors that can cause this kind of disruption include currency risk, interest risk, and equity risk.

Currency risk affects foreign investors when their investments experience a loss due to changes in the exchange rates.

Interest risk. This is the risk of loss to assets likes bonds that could be caused by changes in interest rates

Equity risk entails a loss that is caused by a drop in market prices.

Liquidity Risk

Liquidity risk happens when it may be impossible to sell your investment and get your money back. In some cases, it could even be impossible to sell your investment at all.

Credit risk

This type of risk affects bond buyers when the government or company that sold the bond is at risk of experiencing financial problems and fails to pay the principal or interest when the bond matures.

Reinvestment risk

Your investment is exposed to this risk when you reinvest you at a lower interest rate. Reinvestment risk also happens when you have to reinvest the principal from your bond at less than 5%. Your investment is however safe from this type of risk if you choose to spend the interest or principal after maturity.

Concentration risk

This is the risk you are exposed to when you have used a large sum of your money to invest in a single investment or a single type of investment. The way to avoid this type of risk is by diversifying your investment portfolio. With diversifying, comes spreading out the risk factors that your investments are exposed to and therefore lowering your chances of suffering heavy losses.

Inflation risk

This is the decline in the purchasing power that happens when your investment fails to keep up with the rate of inflation. Inflation risk mostly affects people with cash or deal in debt investment like bonds. Investing in stocks or real estate however protects their investors since landlords can hike their rental rates and companies can pass the hike in prices to their customers to keep share prices constant.

Horizon risk

This refers to the risk that your investment horizon could be cut short due to the emergence of an unforeseen event. What follows is that investors are forced to sell off their investment before the due time. Selling before maturity leads to losses. This loss is caused by horizon risk.

Foreign investment risk

This is the risk that affects foreign investments that may not be in your country of residence. A good example of this is the risk of nationalization.

Longevity risk

This refers to the risk that an investor could live longer than expected. This type of risk affects retirees or people close to retiring.

 

Investment Risk Ladder

Cash

The safest form of investment is depositing some money in the bank and having it grow on interest. The reason for this is because the investor knows what he will earn and it also guaranteed that he will get his capital back. The one major downside to cash deposits is the low-interest rates that are rarely above the inflation rate.

Bonds

Bonds are also seen as safe investment options for investors since they are dependent on interest rates and they are often to governments and corporations.

Mutual Funds

In a mutual fund investors pool, their money together to buy a security. A portfolio manager controlling the funds then distributes the money into bonds, stocks, etc.

Mutual funds operations depend on how they are set up. Some mutual funds are designed to follow other indexes like the S&P 500 or the DOW index. Others are carefully monitored and adjusted in their allocation depending on the markets.

Exchange-Traded Funds (ETFs)

ETFs follow the exchange rates. Relying on the exchange makes them volatile and dependent on the behavior of the stock market. ETFs can track an index like the DOW index depending on what basket the issuer of the ETF want to underline.

 

Stocks

Shares of a particular business allow the public to get involved in the company's success through increased prices and dividends.

 

Other investment options

Real Estate

Investing in real estate takes different forms. Investors can buy commercial or resident apartments or they can buy shares in a real estate investment trust (REITs). REITs like mutual Funds refer to a group of investors pooling resources to buy property.

Hedge Funds/private equity funds

This fund could be invested in a wide variety of assets but they are designed to deliver returns higher than market returns. The results are however not guaranteed and they often could have returns far less than market returns. Hedge funds are only available to accredited investors. They also require a high initial investment of $1 million.

Commodities

These are investments that involve tangible assets such as gold, silver, agricultural products, crude oil, etc.

 

How to Invest like a pro

Expert investors always opt to diversify their investments across the above-mentioned classes of investments. The particular blend of investments for every investor depends on their risk tolerance. For you, as a beginner, it would be wise to start with the simplest least risk-prone option you can find. After sharpening your skills and learning the different sides to the game then you can climb up the ladder. ETFs or mutual funds are great options, to begin with before moving on to the other options. People who are too busy to monitor their investments daily should focus on index funds that mimic the market. Experts advise most people to have three index funds. One for the international equities, another for the US equity markets, and the last one for the bond index.

The thing to keep in mind for beginners is first to diversify your investment to spread out the risk you are exposed to as you invest. Secondly, avoid all investments that you don't fully understand. Get an experienced investor to guide you while you invest and avoid making investments based on untrustworthy 'hot tips'