Author: Steve Geoffrey
Are you interested in investing but not confident with your skills? Then it would be best if you learn more about the basic concepts involved in making investments.
In this guide, we’ll be discussing five basic concepts you must know before investing. Let’s get started.
Five Basic Investment Concepts
1. Risk and Return
Some people may consider “risk” as the possibility of losing part of their capital. In contrast, others may think of risk when their assets are not producing any income.
It is important to remember that risk cannot be eliminated in investments, but you can measure and manage the amount of risk within your investment portfolio. The key is to understand the risk you are taking and how it can affect you.
Return is closely related to risk. Generally, when an investment has a high level of risk, it will require higher returns to convince investors to accept the risk. Although, low-risk investments offer relatively low returns but provide an excellent level of security. This methodology is known as the risk/return trade-off.
There are a few types of risk you should consider when creating a portfolio. They include:
- Investment market risk
- Investment specific risk
- Market timing risk
- Credit risk
- Interest rate risk
- Legislative risk
- Liquidity risk
- Currency risk
- Hedging risk
- Derivatives risk
- Opportunity cost
2. Diversification and Asset Allocation
Almost all investments comes with risk, but they can be managed by diversifying. The idea here is that a range of investments should minimize the risk of each investment in your portfolio because one asset class may perform better than another.
Asset allocation shares a similar concept with diversification in reducing risk. In asset allocation, the focus is to distribute your portfolio across major investment categories like bonds, stocks, and cash.
3. Compounding
To investors, compounding is when a certain amount of money exponentially grows by repeatedly adding earnings to the initial investment. For instance, one round of earnings is added to an initial amount, to allow the moneyinvested to generate even more earnings.
The earnings can also be invested back into the grown sum, and the process can be repeated, in order to grow savings.
You should start building the act of saving & investing early, and regularly to benefit from the power of compounding.
4. Rebalancing Portfolio
Rebalancing your portfolio is the process of changing the risk weighted-assets in your investment portfolio. Rebalancing involves selling and buying portions of assets in your portfolio to change the weight of each asset to its original state.
Furthermore, rebalancing can be implemented if an investment strategy or risk tolerance has changed or included a newly devised asset allocation.
5. Prioritize Savings
Aggressively saving money is a priority in building wealth (especially in investing). To save more, you need to learn how to spend with caution and live frugally.
Conclusion
Whether you’re a beginner or intermediate, you need to learn the basic concepts involved in investing. You can reread this guide to learn more about the five basic investment principles discussed.
