Personal Finance: The Basics of Investing
Many people are known to have got great earnings in their lives and ended up poor in their late ages. Acquisition of financial freedom does not purely depend on the incomes earned but also how well the individual can manage the incomes to build or accumulate wealth. Improper management of incomes is the basic cause of consistent financial insecurity facing many in the US today. Unless a plan is developed on how the income will be utilized, saved and invested, financial security remains a mirage. This paper discusses the basic information required for an individual to successfully invest in the various investment options available. It discusses some events which should happen before investment, the investment options available for individuals outlining the most important features and the basic considerations in establishing suitable investment portfolio.
The choice of this topic was informed by the experiences witnessed across the US. People guided by greed and ignorance jump to the next available investment options without taking to full consideration the finer details which should guide such investments. The results have been catastrophic. A significant proportion of depression and suicide result from the inability to acquire financial stability. Many people grow old to become dependants of their families and the government despite the high incomes they earned in their youth.
Personal finance refers to the use of rational financial principles in managing the personal or household finances. The basic elements involved are incomes, taxes, savings, credit (loans), retirement plans and investments.
The first crucial step before engaging in investment activities is saving. Under normal circumstances, investment money is got from accumulation through savings. Even in cases where loans are used, savings are well used as collateral. Accumulating substantial savings for investment is never an easy task. It requires the adoption of strict budgets and elimination of excessive spending from incomes. A comprehensive budget should be developed and adhered to over a period of time with all excess funds put into savings. Care should be taken not to get additional credit to supplement consumption as this is counterproductive. The time value of money is an important encourager to savings. Overtime the saved money gains interest which boosts value hence shortening the accumulation period (Vohwinkle, 2009, Par 4).
Prudent investing is largely hinged on three different but interrelated concepts. The first and most important is maximizing returns. Returns are the gains made from the investment process. They come in the form of interests, profits or even capital gains for stock market investments. Investment options with higher returns are preferred to those with lower returns. Still, there are investment options whose returns are in the form of streams or flows while for others, returns are in the form of lumpsum. The options chosen should reflect the prevailing circumstances and personal preferences. However, great care should be taken to consider the time value of money in choosing the investments options.
Secondly, there is the need to minimize risks involved in investment. Risk is the probability of making unexpected losses. Usually, high risk investments yield higher returns compared to low risk investments. The question is thus on how well to balance the need to obtain high returns but also minimizes the level of exposure to risks. A critical component of managing risks is acquisition of as much information as possible concerning the investment option, the prevailing economic environment likely to affect the investment positively or negatively. Taking into consideration such information can significantly reduce the level of risk.
Thirdly, there is the need to establish any requirements for sustainability in the investment. Entering into an investment contract for a longer period than the individual is able can be counter productive.
The basic investment options available for individuals to invest in are stocks, mutual funds, bonds, Real estate, insurance policies and business ventures. Stocks are equities and represent ownership in public companies. The gains resulting from investment in stocks are dividends which are paid out from the profits of the company owned in proportion to the level of shares owned. Capital gains arising from the market valuation of shares which is dependent on the level of accumulated value and the dynamics in the economic environment affecting the company. When the share prices are rising, the gains are high and when the shares are falling, losses are incurred. There are two categories of markets for stocks: the primary market and the secondary market. The primary market is made of stocks being introduced in the stock exchange. They are the best stocks to invest in as they are normally introduced at discounts. Secondary market is composed of stocks already being traded in the stock exchange. Investing in these stocks requires better knowledge on the factors affecting share prices and the future of the company invested in. Again the rate of returns for particular stocks calculated using the price earnings ratio and the dividend yield should be understood before engaging in stock trade. The more information the investor has the better the investment decisions he/ she makes (Investopedia, 2009, Par 2-4).
Mutual funds are pooled funds brought together and managed by knowledgeable asset managers. The fund managers are well informed about the economy and engage or disengage funds in investments like stocks, bonds and real estate to maximize returns and minimize risks. They do this on behalf of individual investors at a fee. This is ideal for individual interested in investing in real estate but has limited knowledge. They are closely related to insurance policies though policies are paid in installments while mutual funds are paid in lumpsum. For both options, the power to manage is given to third parties.
Bonds are debts extended to the government or private sector usually through the exchange markets. They give yield to constant returns in the form of interest. They are low risk investments but whose returns are predetermined hence guaranteed.
Individual investors can also invest in real estate which is best known for its low risk but high returns. The rental income from real estate is in the form of streams and is deemed to be perpetual except in cases where the individual wishes to resell the property. However, unlike the above mentioned options, entry into real estate requires huge sums of money which may not be available to many. Finally, an individual may opt to start up a personal business with accumulated funds. This is another high risk high return option available. Care should always be taken to invest in areas where one has sufficient knowledge (Vohwinkle, 2009, Par 6).
As can be seen, there are several investment options available for individuals. Choosing only one investment option in which to invest all available funds is highly risky. One should develop an investment portfolio composed of several of these options in a bid to enhance security.
Even more importantly, there should be considerations for the various stages of life. The younger years of working should be used to save to avail more money for spending on acquiring a family. Still, contractual commitments with institutions such as insurance and fund managers should take to consideration any anticipated occurrences such as marriage or the birth of a child to reap maximum benefits and avoid frustrations.
Accumulation of the investments should help the individual acquire the important assets such as housing and automobile, secure a decent retirement for the individual. It is therefore important that plans to engage in investing be developed as early as possible to increase the effect of time on the value of money and also have an easier time reaching targets and making adjustments to optimize returns.
In conclusion, getting rich is often not by default. It requires an understanding of the intricate balances required to enhance value on acquired incomes. Understanding the different options available and the suitability of certain options to achieve certain goals is critical to financial advancements. The basics discussed above should be internalized by all investors to achieve optimal results.
Investopedia, (2009). Stocks Basics: Conclusion. Web.
Vohwinkle, J., (2009). Personal Finance 101. About.com: Financial Planning. Web.