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6 Key Investment Concepts Beginners Should Know
The term "investment" signifies putting money into an asset with the goal of generating money. Financial investments encompass a range of options, including ELSS mutual funds, unit-linked investment plans, endowment plans, stocks, bonds, and others. Despite the diverse forms, the fundamental objective of all investments remains consistent: to increase the value of the invested capital.
How Does Investment Work?
Investing can increase your wealth and achieve your future financial objectives. When you invest, you can earn returns on your investment. These returns can be guaranteed or tied to the performance of the market, depending on where you choose to invest your money. Guaranteed returns are predetermined at the start of the investment, while market-linked returns allow you to invest in equity and debt markets. Equity markets have the potential for high returns but come with higher risks. On the other hand, debt markets offer lower risk and average rate of returns.
Understanding the key concepts of investment is crucial as it forms the basis of your investment journey and can lead to higher returns over time. These returns can serve as a potential income source, allowing you to achieve your financial goals.
The 6 key concepts of investment are listed below:
Financial Planning is the Key
The initial and fundamental step towards investment is to create a well-designed financial plan. Financial plans encompass various objectives related to wealth accumulation, such as purchasing a house or car, saving for retirement, preparing for medical emergencies, and more. These goals may evolve. Developing a financial plan for investing money can be advantageous in the long run. By establishing specific goals, we can dedicate ourselves to monitoring the challenges and milestones ahead, with early retirement being a common aspiration. This approach is often called FIRE (Financial Independence, Retire Early). Seeking guidance from experienced financial experts to manage funds and enhance asset growth is recommended for effective financial planning.
Commitment to goals is a key factor in achieving success, including financial objectives. In the realm of investments, prioritizing savings is crucial. Although beginners may find it challenging to start saving abruptly, it is essential for them to recognize the inherent value of saving money and allowing it to grow over time. Recurring Deposits (RDs) and Systematic Investment Plans (SIPs) are the best methods to invest & avoid overspending and regularly set aside a portion of income. Through these avenues, a predetermined amount of money is automatically deducted from the account at fixed intervals, facilitating consistent savings and investment.
Understand the Power of Compounding
Consistently saving and investing systematically, mainly when initiated early in life, enables individuals to harness the potential of compounding and maximize wealth accumulation fully. Although the current prolonged period of historically low-interest rates has somewhat reduced the impact of compounding, it has also underscored the urgency of beginning the savings and wealth-building process early. This is because investments that generate interest and dividends now require a longer duration to double in value compared to previous circumstances, assuming all other factors remain constant.
Investment Risk & Returns
Every investment carries a certain level of risk. Hence risk plays a big part in investments. Investors must evaluate their risk tolerance and consider the maximum loss they might sustain before investing. Beginners may find this concept daunting, but it is crucial to understand that risk is a fundamental investment component. There are low-risk investing possibilities, but they could provide different returns than moderately or extremely risky ones. As a result, it's crucial to consider both one's risk tolerance and desired objectives while setting investment goals.
There is wisdom in the saying, "Don't put all your eggs in one basket," which also applies to investments. Diversification is key, allowing you to spread your investments across options such as stocks, real estate, bonds, and more.
For instance, diversifying your stock portfolio among small-, mid-, and large-cap companies can be advantageous if you invest in stocks. Companies will behave differently depending on the market state, and if one stock falls, another might gain, balancing any possible losses. This approach serves as a risk management technique, ensuring that your investments are not solely dependent on the performance of a single investment avenue.
Invest and forget doesn't apply to the investment process. It is essential to periodically review and rebalance your portfolio to maintain the target allocation. After a specific investment period, you will adjust the holdings of underperforming assets and allocate funds towards investments that demonstrate growth potential. The objective is to establish risk control and ensure that the portfolio does not overly rely on a single asset class for either gains or losses. You can maintain a balanced and diversified investment strategy by actively managing the portfolio.
The Bottom Line
Knowing that no investment can be expected to perform well over the long term is critical. While an investment may have favourable or unfavourable results, its capacity to expand predictably over the long run is still uncertain. It is critical to prepare for the likelihood of both investment situations mentally. Create an emergency fund that offers financial support in such circumstances to navigate uncertain times. This fund serves as a safety net, ensuring that you have the means to deal with unforeseen occurrences.
Once you grasp the basics, investing may be straightforward. By putting the advice mentioned above into practice, you will be able to understand the investment schemes better and invest your money in things that will allow you to generate sizable returns on capital.
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