Investments can grow wealth, but there are both risks and rewards. Risky investments can result in losses. As part of your own financial management, you also have the responsibility to be an informed investor, in order to maximize wealth and decrease risks.
Having knowledge about the range of investments and knowing how to research and obtain information about specific investmentProperty or other possession acquired for future financial return or benefit; also a commitment of time (e.g., to education or training). options are integral to financial literacy.
Investments make it possible for you to put your savings to work and increase personal wealthThe total accumulated value of the assets a person possesses. Financial assets include savings, stocks, and bonds. Physical assets can include real estate, rental property, gold, antiques, and other collectibles. . With investments your money can make you money. Investments also come with both rewards and risks.
An Overview of Investing
As investments increase in value from interest, dividendThe portion of a company’s profits that the firm pays out each period to shareholders. Also called distributed profits. s, or growth in value (appreciation), there is an increase in your wealth. However, without budgeting and saving, you will almost never have the opportunity for making investments and growing your wealth.
Three factors that most often influence investment decisions are:
- the financial goals of an individual or family,
- the time horizon (years that money can be invested),
- and the risk tolerance of the investors.
To reach your goals, you will have to budgetA budget is both a spending plan and a list of spendable funds. and make some important saving and spending decisions. (e.g., not taking on too much debt, keeping your job, watching your budget, etc.).
Deciding Where to Put Your Money
The general rule of thumb is the closer you get towards retirement, the more conservative, or less risky, your investments should be.
Two people with the same amount of money could make very different investment decisions (e.g., shares of stock versus a new business venture or antique autos versus real estate). There are numerous factors that influence how people invest their money (e.g., family traditions, respected advice, time horizon, goals, values).
Factors that often influence investment decisions:
Financial long-term goals — How much money you would like to accumulate over a certain period of time (e.g., a family might allow ten or more years to save for college costs, or an individual might have a wealth creation goal to meet by retirement). These can be either short-term goals or long-term goals. (For additional information see the section on Goal Setting in Managing Your Money).
Time factor — The time that money can be left invested could influence the type of investment (e.g., a person investing in the stock market for ten years might take higher risks than if the time period were only 12 months.). Investors are often concerned about liquidity The degree to which an investment or assets of a company can easily be sold or converted into cash. or being able to convert an investment into cash on a timely basis.
Risk tolerance — Investors also have to know how much risk they are willing to accept. For example, what is your “sleep at night” factor? In finance, risk refers to the potential financial loss of your investment.
Sample List of Investments
There is a wide range of savings and investments people can consider. These include:
- savings bond
- certificate of depositA CD is a form of time deposit at a bank or other savings institution. A time deposit cannot be withdrawn before a specified maturity date without being subject to an interest penalty for early withdrawal. Small-denomination CDs are often purchased by individuals. Large CDs of $100,000 or more are often in negotiable form, meaning they can be sold or transferred among holders until maturity. (CD)
- money marketA savings account that pays variable interest rates based on current conditions in the market for very short-term securities. These accounts are safe and easily liquidated and offer a higher interest rate than ordinary savings accounts. savings account
- Treasury billA T-bill is a short-term debt security issued by the U.S. government, having a maturity of one year or less. The interest earned is estimated by taking the difference between the price paid and the face value of the bond, and calculating that rate of return on an annual basis. Considered the safest securities available to the U.S. investor. Minimum investment is $100. (T-Bill)
- Treasury noteA T-note is a government debt security issued with maturities of two to ten years and traded in the capital markets. Treasury notes bear a fixed interest, paid semiannually. (T-Note)
- Treasury bondA T-bond is a long-term interest-bearing security issued by the U.S. government. Interest is paid semiannually. These securities mature in 10 to 30 years. Minimum investment is $100. (T-Bond)
- stockThe capital raised by a corporation by issuing shares of ownership; a certificate documenting a proportional share in the corporation’s assets and profits. (Also known as an equity.)
- mutual fundFunds from many investors pooled together to establish a diversified portfolio of investments. Mutual funds raise money by selling shares of the fund to the public. Shareholders are free to sell their shares at any time. Many employees invest in mutual funds through their employers, by setting aside some of their wages to invest in one or more funds on a regular basis.
- municipal bondA "muni" is a long-term, interest-bearing security issued by county, city, or state governments, having a maturity of at least ten years. Owners of municipal bonds pay no federal income tax on the interest.
Insurance of Savings and Investments
Savings accounts, insured money market accounts, and certificates of deposit (CDs) are generally viewed as safe because they are insured by the Federal Deposit Insurance CorporationAn independent agency of the federal government that insures accounts up to $250,000 per depositor at almost all United States depository institutions. This deposit limit was increased from $100,000 by the FDIC in October, 2008, in response to the banking system crisis. The insured amount of $250,000 is effective through December 2009. The FDIC has primary federal supervisory authority over insured institutions that are not members of the Federal Reserve System. (FDIC). If something happens to the institution holding your money, FDIC will cover your account up to $250,000 per depositor. However, it is important to note FDIC does NOT cover investment products in a brokerage accounts. However, investors are protected by the Securities Investor Protection CorporationThe SIPC protects investors’ cash and securities when a brokerage firm goes out of business, up to $500,000, including a $100,000 limit for cash. The SIPC does not protect against losses caused by a decline in the market value of securities. And it does not provide protection for investment contracts not registered with the SEC. (SIPC) when a brokerage is closed due to bankruptcy.
Securities Investors Protection Corporation (SIPC) – Provides protection to an investor if a brokerage firm is closed due to bankruptcy. SIPC will replace missing stock or other securities in customer accounts if the brokerage firm fails for any reason. You are not insured against investment risk or loss of value, however.
A general rule for every investment is the higher the risk of losing money, the higher the expected return. With less risk, an investor should expect a smaller return. This is often called the risk-return ratio.