Investing: How to
choose the best investment
Choosing the best investment for you will depends on your
personal circumstances as well as your financial goals. For example, a good
investment for your retirement may not be a good investment for your kid's
college education. There are three major qualities each type of investment have
and those are liquidity, safety and return.
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Liquidity - If you can convert an
investment easily and quickly into cash, with little or no loss of value, you
have liquidity. For example, you can typically redeem shares in a money market
mutual fund at $1 a share. Similarly, you can cash in a certificate of deposit
(CD) and get back at least the amount you put into it (though you may forfeit
some or all of the interest you had expected to earn if you liquidate before the
end of the CD's term). It can also used to describe investments you can buy or
sell easily. For example, you could sell several hundred shares of a blue chip
stock by simply calling your broker, something that might not be possible if you
wanted to sell real estate or collectibles. The difference between
cash-equivalent investments and securities like stocks and bonds, however, is
that securities constantly fluctuate in value. So while you may be able to sell
them quickly, you might get back less than you paid to buy them if you sell when
the price is down.
If you are saving your money for financial emergency, you'll need to be
concerned about liquidity. Money market funds, savings accounts and CDs are very
liquid. But if you are investing for a long term goal such as retirement, then
liquidity is not an issue. What you are after in that case is growth and stocks
and stocks mutual funds are considered growth investments.
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Safety - When you invest, you are taking
some risks. To many people, the biggest risk is losing money, so they look for
investments they consider safe. That usually means putting money into bank
accounts, CD's and U.S. Treasuries. These are safe because money in the accounts
are guaranteed, in the case of bank accounts they are insured by FDIC up to
$100,000 in deposits. With U.S. Treasuries, its backed by the "full faith and
credit" of the U.S. government, which has the power to tax it's citizens to pay
its debts. On the other hand, investing in safe investments exposes you to an
inflation risk, the gradual increase in the cost of living. The best way to
fight this risk is to invest in equities, which as proven to beat inflation over
the long run by a wide margin. But the biggest risk is not investing at all.
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Return - Your return is the profit you
make on your investments, usually expressed as an annual percentage. That lets
you compare the return of different investments or investments you have held for
different periods of time. For example, if you bought a stock at $25 a share and
sold it for $30 a share, your return would be $5. If you bought on January 3,
and sold it the following January 3, that would be a 20% annual percentage
return, or the $5 return divided by your $25 investment. But if you held the
stock for five years before selling for $30 a share, your annual return would be
4%, because the 20% gain is divided by five years rather than one year. Safe
investments often promise a specific but limited return on investment. Those
that involve more risk offer the opportunity to make or lose a lot of money.
The Tale of Three Men...
Three men, each thirty years old, each
earning $30,000 a year. Each worked for a period of thirty-five years until the
age of sixty-five. Man number one never worried about money. He never saved a
penny. Living paycheck to paycheck, he just never seemed to be able to "get
ahead." Content with his lifestyle, he resigned to the fact that one day he'd
retire and social security would take care of him. Finally, upon reaching the
age of sixty-five, he retired. Shortly thereafter, he died...penniless and
deeply in debt.
Man number two decided that he would
save for that rainy day. He decided to save at least ten percent of
his income ($3,000 every year); which he did. He didn't trust
anyone, especially banks. So instead of depositing his savings or
putting his funds to work in investments, he literally socked away
every penny he saved. He stored his money in a safe at home, under
his mattress and even buried some in the back yard. Sure enough, at
age sixty-five he had saved up a nice little nest egg of $105,000.
Man number three vowed that he, too,
would save at least ten percent of his income every year. At the
same time, he also decided that his money would work as hard as he
did. Instead of putting his money in a low-paying bank account, he
decided that investments were the way to obtaining wealth. So each
year, for thirty-five years he invested $3,000. He earned 12 %
average return on his money. After thirty years he had accumulated
almost $1,300,000!!!!
Lesson:
It's not how much you make but rather what you do with what you make
that counts. With proper planning, literally anyone can
become financially independent over time. America is truly the "Land
of Opportunity" because it offers so many opportunities to become a
financial success. In fact, it's easy to build a net worth of more
than one million dollars. As you have seen, you can even do it on
your present income. If you are highly motivated, it is even
possible to do it fast enough to retire in fifteen or twenty years.
Don't get me wrong. I'm not talking about a get-rich-quick scheme,
I'm talking about a slow but sure way of becoming wealthy through a
conservative and sensible plan and investment program.
There is absolutely nothing wrong
with a plan for getting rich quick. However, even if you do make a
lot of money fast, you need to have a sound investment program that
will build and protect your fortune. People who spend every penny
they make usually end up broke. Everyone needs to know the
correct way to save and invest to guarantee their financial
security. But the sad fact is that most people don't. Remember that
business are not created, buildings are not built and destinations
are not reached without a plan.
Also Something to Consider:
If you're looking for a magic
formula that will make you rich beyond your wildest dreams, here it
is: Spend less than you earn. It's the only way to start
accumulating true wealth. The problem is, we all struggle so
much in our daily lives that we feel richly deserve any convenience
or nicety. And perhaps we do. But while spending on all the little
things may feel good at that moment, it's hardly satisfying over the
long run. Rarely will any CD or DVD you buy today comfort you in
your old age the way $1 million in cash will. While it's easy to get
financially lost in the aisles of some department store or
electronic store in my case, it requires discipline to spend less
and save more. But that's precisely what you have to do to become
wealthy.
Related link:
Five costly
financial mistakes
Next -->>
Concept of investment return and Rule of 72
Table of Contents
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What is investing?
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How to choose the best investment
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Concept of investment return and Rule of 72
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Investment Risks & Rewards
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Different types of Risk
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Benefits of Diversification & Asset Allocation
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Questions you need to ask before investing
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