Part One: Understanding the Basics
Mutual funds are a wise investment choice for people of all ages, education and income levels. They are professional money managers that pool your money with thousands of other individuals to create a large pool of assets that can be invested in stocks, bonds, and other securities.
By utilizing mutual funds, you can invest your money in high quality investments that match your financial goals and allow your funds to perform better than you could have done researching and investing stocks and bonds all on your own.
In order to be a successful investor, you need to be aware and understand what you are investing in and how they work can for you. Investing is a terrific way to grow your money, however takes time, patience, understanding, and is by no means guaranteed. Buying or selling mutual funds means understanding how a particular fund fits within your overall financial objectives and personal situation. An individual looking to invest in mutual funds needs to understand:
- The risks and objectives of investing in mutual funds
- How to analyze them properly
- How to separate the winners from the losers
- How to establish a portfolio to accomplish your goals
- How to stay informed
Key Investing Concepts You Need to Understand
Why Invest? The basic reason for investing is this: to obtain a return on your investment. An investment’s return is simple: how much your investment has grown (or on the downside, shrunk) over a specified period of time. Returns are usually calculated as a rate of change in percentage terms that simply measures the change in the investment’s value over the stated time period. Simply put, if a $1,000 investment has a 10 year annualized return of 5 percent, then every year for the past ten years on an average basis, has grown by $50. It has grown 5 percent larger than what is what the year before.
Investment rates of return can vary substantially depending upon the investment vehicle chosen. Historically, placing funds within savings accounts has returned roughly 3-4 percent, bonds around 5 percent, and stocks and real estate an average of 8-10 percent.
What is volatility and why should I be concerned? Volatility is very basic concept, but can definitely be scary for investors. Simply stated, volatility is the size of fluctuations in the value of a particular investment. An investment is not guaranteed to make a stated return each year. The value may fluctuate from one time period to the next and although at the end of the year may be positive, it necessarily was not positive throughout the entire year. For instance, let’s say you purchased a stock of ABC Corporation in January for $100. At the end of the year, the same stock could be purchased or sold for $110. Your one share of ABC Corp earned a return of 10% for the year. However, let’s say you needed some cash and had to sell your share May, when it was trading at 98. Your investment would have netted you a $2 loss had you sold in May. But since you didn’t, your investment was able to recover and grow to $110 at the end of the year netting you a gain of $10 or 10 percent on your initial investment. Your share of ABC Corp experienced volatility in its price during the year.
Diversification: Where do I place all my apples? Diversification is an extremely powerful investment concept that all investors should and need to be aware of and understand. Diversification is basically placing the funds you are investing into more than one basket, i.e. different investments with returns that are not completely correlated. What does that mean? By placing your money in investments in different places and objectives, you have better odds of minimizing that ugly word volatility. Diversification can take place by investing your money within different types (or classes) of investments, such as stocks, bonds, precious metals, money market funds and real estate. Another level of diversification can take place by investing in assets that are located in different geographic locations. And finally, you can also diversify your investments by style class or objective (i.e. growth vs. dividend). Diversification can be looked at in two simple ways:
- Diversification can reduce the volatility your portfolio may experience and help minimize the risk of a possible bad investment. You can potentially achieve a similar rate of a return that any one single investment can make, but with a reduction in possible price fluctuation and volatility.
- Diversification allows for the opportunity of possible higher rates of return with a lower level of perceived risk.
By understanding the basics of investing and these three key concepts, you are well on your way to becoming a well informed and successful investor.