All the money you will ever earn will be used in two ways. You will either spend it on services or products or you will save them for future use. Your expense amount will play a huge role here. If you live in a costly area, you will need to spend more, and vice versa. But without investment, you will be doomed to work forever to provide for yourself and your family. And an even worse scenario is you can fall short on money.
That is why I will give you insights on investment and its importance in today’s article. So, let’s delve deeper into it.
Investment:
There is a distinct difference between savings and investment. First, we need to clear our ideas about it.
The money you save from your earnings by spending less is called savings. It helps you to create a financial resource pool.
On the other hand, when you commit those resources to achieve a goal that is expected to generate a benefit outweighing the cost, it’s called investment. There are mainly three types of investments, Human Capital, Home Ownership, and Financial Freedom.
Human Capital:
Human Capital refers to the economic value of one’s skills and knowledge. For example, you can develop your skills via an educational program to learn a new set of skills. By investing your time and money in the educational program, you will achieve knowledge and skills that can later be used to earn a higher income.
You should always ensure that the future payoff which is the higher income will be greater than your investment of time and money. Otherwise, it will be a waste.
Home Ownership:
This is also considered as an investment. The reason behind it is, it’s expected that the total cost of building it such as taxes, mortgages, insurances etc. are far outweighed by the long term economic and emotional value of the home.
If you think it is false in your case, then there is no point in building a home for yourself.
Health Insurance:
Also, you should have invested your money in health insurance.
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Financial Freedom:
Some of us don’t want to learn a new skill set or buy a new house at this point. Maybe you are one of them. maybe you just want to have better and more financial resources so that you can change your job, retire early, or just live freely.
To create that financial picture, again you need to save more and invest more in the financial assets that are assumed to give you benefit in the future as more wealth.
In case the future benefit is larger, you will, of course, be more willing to save now. If it’s lesser, you will not be willing to save as much as that.
Reasons To Invest:
There are two basic reasons that you should invest for, inflation and compounding.
Inflation:
By definition, inflation is a steady increase in the price of products and services over a time period. Thereby it decreases the purchasing power of all the currencies.
For example, if you spend $100 in your grocery shopping now, and the inflation rate is 3%, you will have to spend $103 for your groceries the next year.
If you put the $100 in a savings account, it won’t give you the needed interest to keep up with inflation. So, you won’t have the necessary money to pay for your groceries.
On the other hand, if you put those $100 in a bond with 4% return rate you will have $104 the next year. It will enable you to buy the groceries and have an extra dollar at your convenience.
In this way, investments remain your purchasing power intact.
Compounding:
Compounding lets you create additional wealth through investing. You will receive a financial gain on your investments over time. In case you reinvest your earnings, the growth will be exponential. You will always retain the purchasing power as well.
Savings And Investment:
Maybe you have already started saving, that is, your income is more than your spendings. Now you will have to decide how much to save and what portion of it should you invest. This will highly rely on your own preferences, such as goals, risk profile, and expectations.
Goals:
This is the primary factor to think about. Every investment decision will depend on your financial goals. Saving and investing are the ways of you to achieve your financial goals. For example, if you wish to retire early and travel the world, you will need to save and invest a good amount of money. This will help you create a financial portfolio that will support your lifestyle.
Risk Profile:
So when you have a specific goal in mind, you need to decide the ways to invest to acquire it. A lot of varieties of investment are out there in the market. Every single one of them has risk factors. Reward and risk are both inevitable when it comes to investing. As per the rule, the possibility of risk increases with more future benefits. The risk here is basically a possibility of loss.
Expectations:
The expectation on the investment is a key factor to consider. When there is a possibility of a larger future benefit, you will naturally be more willing to invest. For example, if you get 10% annual return on your investment you will invest more. On the other hand, if the annual return is 5% or 6%, you won’t be much willing to invest.
Ways of Investing:
There is a wide range of ways to invest. You need to choose one as per your financial goals. The most common paths of investing are bonds and stocks. These are well tried and tested methods. On the other hand, ways that are more obscure are susceptible to risk and has extra costs. They are also hard to assess. Some of the famous ways are stocks, bonds, real estate, collectibles, commodities, and cash equivalents.
Stocks:
Stocks are the oldest of them all. They have highest returns and risk factors. You can either buy stocks from diversified stock funds, especially if you are a beginner and directly if you are accustomed to it.
Bonds:
Bonds have less return than stocks. They also have a lesser amount of risks. In the case of bonds, companies pay you interest for your investment capital for a specific time period. After that time period is over, they return your investment capital.
Real Estate:
Real estate investments can be made through Real Estate Investment Trust (REITs) and also in the physical real estate. They have proved to have an amazing return.
Collectibles:
Collectibles include coins, wine, art, stamps, and much more. These are hard to evaluate as the demand is somewhat limited.
Commodities:
Agricultural products, oil, gas, precious metal such as gold and silver are some of the examples of commodities.
Cash Equivalent:
This category includes cash along with cash equivalents such as savings account, certificate of deposit, and money market accounts. Most of the times these are insured by the Federal Deposit Insurance Corporation (FDIC). This makes them extremely safe. However, as a downside, they offer much lower return rates than the others.