What is investing?

Author: Steven posted in Investing basics tagged with Investing 101, Stock market

For all those people who keep almost all their money in checking accounts, be aware that you are not investing your money and are likely losing purchasing power each year because the inflation rate is almost certainly higher than the interest rate your are receiving. I’m not saying that checking accounts are useless because they enable you to manage your short-­term living expenses. You should also have an emergency fund of three to six months of expenses in a safe liquid account such as a checking account but once you have that amount put away why would you want to keep more than that in your checking account when it will be worth less after inflation?

Checking accounts provide such a low level of return you should look into investing your “extra money” to generate additional income and capital gains. Investing money is all about placing your money in an investment vehicle with the expectation that it will generate a positive income and increase or at least preserve its value. An example of a safe way to earn more income would be to put savings into a certificate of deposit (CD) where you earn income based on periodic interest payments. Since this is still considered to be a very safe investment your expected rate of return will still be relatively low but better than keeping your excess funds in a checking account.

If you want to reach for a higher potential return you must take on additional risk. Nothing is more true in the world of investing, risk and expected return go hand in hand. You can’t expect to get a higher rate of return without accepting additional risk. There is no such thing as a free lunch! The most common way individual investors seek a higher rate of return is by investing in the stock market. Investing in the stock market involves buying stocks of companies that you value in order to generate a return on investment through a combination of dividends and/or price appreciation.

When you buy stock in a company, it means that you value the future benefit from that company more than other companies. By buying stock you become an equity holder and own a fraction of that company.

The stock market is a fascinating world and has been very profitable over the long-­term. The average annual rate of return of the US stock market for the past century has been 10.4% meaning that if you had invested $1000 back in 1900, it would have grown to more than $19 million by the end of 1999. Personally I think that anyone not investing in the stock market is missing out on a great opportunity. At the same time we all have different personalities, objectives and react differently to increasing levels of risk. Just remember that the greater the risk the greater the potential return. If you are risk averse and prefer keeping your money in your savings account to earn that safe 1% it is understandable but you should at least consider the possibility of investing in other vehicles as well. No doubt the stock market is risky as no one can predict the future and stock prices are heavily influenced by the opinions of investors but this is also why the rate of return is much higher than a savings account. Even within the stock market there are companies which are less volatile in terms of stock price movement and provide a great stream of income through dividends. A lot of the large cap and mature companies offer this opportunity. Again, it all depends on what you are looking for and how much risk you are willing to take.

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