Below are summaries of some basic principles you should understand when evaluating an investment opportunity or making an investment decision. Rest assured, this is not rocket science. In fact, you’ll see that the most important principle on which to base your investment education is simply good common sense. You’ve decided to start investing. If you’ve had little or no experience, you’re probably apprehensive about how to begin. Even after you’ve found a trusted financial advisor, it’s wise to educate yourself, so you can evaluate his or her advice and ask good questions. The better you understand the advice you get, the more comfortable you will be with the course you’ve chosen.
Don’t be intimidated by jargon
Don’t worry if you can’t understand the experts in the financial media right away. Much of what they say is jargon that is actually less complicated than it sounds. Don’t hesitate to ask questions; when it comes to your money, the only dumb question is the one you don’t ask. Don’t wait to invest until you feel you know everything.
IRAs hold investments – they aren’t investments themselves
As a preliminary matter, let’s address a source of confusion that immediately throws many new investors off: If you have an individual retirement account (IRA), a 401(k), or other retirement plan at work, you should recognize the difference between that account or plan, and the actual investments you own within that account or plan. Your IRA or 401(k) is really just a container that holds investments and has special tax advantages. Folks often get confused when that distinction is not pointed out.
Understand stocks and bonds
Almost every portfolio contains one or both of these kinds of assets. If you buy stock in a company, you are literally buying a share of the company’s earnings. You become an owner, or shareholder, of the company. As such, you take a stake in the company’s future. If the company prospers, there’s no limit to how much your share can increase in value. If the company fails, you can lose every dollar of your investment.
If you buy bonds, you’re lending money to the company (or governmental body) that issued the bonds. You become a creditor, not an owner, of the bond issuer. The bond is in effect the issuer’s IOU. You can lose the amount of the loan (your investment) if the company or governmental body fails, but the risk of loss to creditors (bondholders) is generally less than the risk for owners (shareholders). This is because, to stay in business and continue to finance its growth, a company must maintain as good a credit rating as possible, so creditors will usually pay on time if there is any way at all to do so. In addition, the law favors a company’s bondholders over its shareholders if it goes bankrupt.
As a matter of jargon, stocks are referred to as equity investments, while bonds are considered debt instruments or income investments. A mutual fund may invest in stocks, bonds, or a combination. Before investing in a mutual fund, obtain and read its prospectus (available from the fund) so you can carefully consider its investment objectives, risks, fees, and expenses before investing.
Don’t put all your eggs in one basket
This is the most important of all investment principles, as well as the most familiar and sensible. Consider using several different types of investments for your portfolio. Examples of investment types (sometimes called asset classes) include stocks, bonds, commodities, art, and precious metals. Cash also is considered an asset class, and includes not only currency but money market instruments, (for example, very short-term loans). These classes are often further broken down according to more precise investment characteristics (e.g., stocks of small companies, stocks of large companies, bonds issued by cities, bonds issued by the U.S. Treasury).
This information is educational in nature and is being provided with the understanding that it is not intended to be interpreted as specific legal or tax advice. Individuals are encouraged to consult with a professional in regards to legal, tax, and/or investment issues.