I had a couple of great questions posed to me on Instagram over the weekend, which prompted me to choose Investing as our next Money Monday series. The questions were:
1. What is the best way for a college student to invest in stock?
2. Will I please explain how investing works?
I’d like to start with how investing works. When you invest in something, you are putting your money into a venture in the hopes of making that money grow. The growth is called your gain. The amount of growth you have as compared to your initial investment is called your return, or your return on investment. The amount of money you put in, and could potentially lose, is the amount you risked.
Gains are expressed in their amounts as in, “I made $500 on that deal.” If you put in $1,000 and made $500, that’s fantastic. If you put in $100,000 and made $500, that’s not so great. Either way, you’re $500 ahead, but that’s only part of the picture. The amount you risked to get that $500 is also important.
Returns are usually expressed as a percentage of the amount invested. For example, if you put $100 into savings, and earn $3, you earned $3/$100 X 100% = 3%, or a 3% return on your money. Returns don’t have to be measured over a full year’s time, but that is the usual standard time frame used. You need a standard with which to compare your results. If you earned a total of 3% on your money over three days, that’s a lot different than earning a total of 3% over three years. If someone simply says they earned 3% on their money, I usually figure that’s the rate of return over a full year unless they say otherwise.
In almost every investment there is a potential to lose the money you put in. That’s the risk, and it is present in almost every investment. The degree of risk depends on how solid is the venture into which you’re putting your money. Your comfort level with the amount risk is your risk tolerance. Some people are comfortable with a large amount of risk; others are risk averse. The types of investments you’re willing to make without losing sleep at night help determine where you sit on the risk scale.
Usually, the more risky an investment, the better the return. Few people will place their money into a highly risky venture without the possibility of a larger payoff later, i.e. a higher return on their investment. Conversely, a very safe investment, such as a savings account or Treasury bills (T-bills) yields a very small return. You must balance your risk tolerance with the type of return you want to make and the amount of time you have to make it.
Investing is a very broad and very deep topic. Whole books are written on it. It’s going to take a few weeks to cover the things I think are important, and we’ll still only scratch the surface. If you’d like to move at a faster pace, I’d recommend reading a book on the subject. There are a huge number available. Browse online or at your neighborhood bookstore to find one that works for you. Otherwise, hang with me and we’ll keep working our way through the topic.
Please feel free to ask questions and suggest areas to go into with more depth. I write this blog for you and I want to make sure I talk about the things that interest you.
To your better wealth,