Introduction to Investing
Investing may seem intimidating at first, but we can start to demystify it by learning some basic concepts.
Having a better understanding of these concepts can build your financial confidence and make it easier to make informed decisions about creating and managing your wealth.
Investing is the act of putting money to work by committing money to an entity or a financial product (for example, a stock or bond) in order to generate a potential profit.
Creating an investment strategy, or a plan for how to invest, that incorporates your financial goals as well as your tolerance for risk is essential.
Let’s start by understanding what a market is. A financial market consists of people buying and selling—that is, trading something that has value.
There are many different types of markets: a market for used cars, a market for commodities like gold and oil, and a stock market.
The stock market itself is made up of several exchanges. An exchange is a central location where investors can buy and sell securities in a regulated environment. Most stocks in the United States are traded on two exchanges: the New York Stock Exchange (NYSE) and the NASDAQ Stock Market.
Within the financial markets, there are four asset classes: cash and cash alternatives, bonds, stocks, and alternative investments.
Generally, the money you hold in cash (like in a savings account) is the most readily available and considered liquid, meaning that you have immediate access to the funds. It may grow by earning interest, but the interest rate is often low. Cash alternatives can offer higher interest rates than a checking account and tend to have a low level of risk. They include certificates of deposit, money market funds and US Treasury Bills.
Bonds, also known as fixed income, are similar to an I.O.U. When you buy a bond, you lend money to companies or governments for a certain amount of time. In return, the borrower will pay you interest payments or coupons, until they return the full amount of money they borrowed, the principal amount, at a set date in the future, known as the maturity date.
Historically, bonds have been considered less risky than stocks, but they also typically offer lower returns. They can be used to preserve capital and provide a steady income stream.
Stocks, also known as equities, represent a share of ownership in a company. Investors mainly hope to make money from a stock when the price rises, but many stocks also provide income in the form of dividends. These are periodic distributions of the company’s profits.
Stocks are generally riskier than bonds or cash, especially over shorter time periods. But they also have the potential for greater returns, which is why many investors use them to build wealth over a longer time horizon.
Any investment that is not a stock, bond, or cash equivalent is considered an alternative investment. These kinds of assets can offer additional ways to diversify your investments, which may help you manage risk. Examples of alternative investments are real estate, commodities such as gold and oil, art and collectibles and hedge funds.
Alternatives are generally considered illiquid investments because you often don’t have immediate access to the funds and they are sometimes difficult to sell quickly. They also tend to be more volatile than traditional investments such as stocks, bonds and mutual funds.
Mutual funds and exchanged traded funds are investment vehicles or managed funds. In exchange for a fee, a knowledgeable and experienced professional known as a fund or portfolio manager will do the heavy lifting for you by creating a diversified portfolio that you can buy into as an individual investor. Instead of purchasing hundreds of individual stocks and bonds, you simply buy a share in a fund that is already made up of a mix of securities. This is called a managed fund.
Volatility is essentially the frequency and magnitude of price movements up and down. The bigger and more frequent the price movements, the higher the volatility.
In addition to investment types, it's critical to understand some key concepts of investing, such as compounding interest, managing risk and reward and inflation.
One of the most important things to remember when it comes to investing is: The earlier, The better.
Why is starting early so important? Because of compounding interest.
Compounding occurs when the money your investment earns is reinvested, producing additional earnings, or what we call, earnings on earnings. The effect of compounding can help a small investment
grow larger because you have more money working for you over the years.
So why not invest all your money if you can earn more?
Because of RISK.
The balance of risk and reward is at the core of every investment decision. Different investments have different risk-return profiles – even investments within the same category can have varying levels of risk.
Generally, investors have to take on more risk to earn a higher return, and lower risk typically means lower returns. However, with no guarantees, the key is to create a portfolio of investments that balances your risk and the potential return.
Another important concept to understand is inflation. Inflation is the increase in the prices of goods and services over time—and it decreases your purchasing power.
For example, with a 4% annual inflation rate, a house that costs $250,000 in 2014 will cost $360,000 in 2025
Another key concept is diversification. This is the process of spreading your investments across multiple types of assets, which may reduce risk. The idea is to not put all your eggs in one basket. So, for example, if your stock investments are down, those losses might be offset by gains in your bond investments.
You achieve diversification with a process called asset allocation. This simply means deciding how much of each asset type you want to hold in your overall investment portfolio.
When it comes to investing, It’s Easy to Let Emotions Get in the Way
Even the most savvy investors fall prey to bias and emotional trades. Movements in the market may make you uncomfortable or emotional but developing a plan with your financial advisor and having the discipline to stay the course can help you avoid common mistakes, such as buying and selling at the wrong time, otherwise known as trying to time the market.
When considering investing, here are some of the questions investors should ask themselves and revisit upon major milestones:
• How long can I keep this money invested before I need to use it?
• What are my goals for using this money?
• Am I willing to risk losing money to seek a bigger reward?
As your life stage changes, so do your goals – look across your investment portfolio to adapt your strategy to align with your financial plan.
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Disclosures
This video is for informational purposes only. It does not provide individually tailored investment advice. It has been prepared without regard to the individual financial circumstances and objectives of persons who receive it. Morgan Stanley Smith Barney LLC ("Morgan Stanley") recommends that investors independently evaluate particular investments and strategies and encourages investors to seek the advice of a Morgan Stanley Financial Advisor. The appropriateness of a particular investment or strategy will depend on an investor’s individual circumstances and objectives.
An investment cannot be made directly in a market index. Asset allocation and diversification do not assure a profit or protect against loss.
Alternative Investments are speculative and include a high degree of risk. An investor could lose all or a substantial amount of his/her investment. Alternative investments are appropriate only for qualified, long-term investors who are willing to forgo liquidity and put capital at risk for an indefinite period of time. Alternative investments involve complex tax structures, tax inefficient investing, and delays in distributing important tax information. Individual funds have specific risks related to their investment programs that will vary from fund to fund. Clients should consult their own tax and legal advisors as Morgan Stanley Wealth Management does not provide tax or legal advice.
Morgan Stanley Wealth Management is a business of Morgan Stanley Smith Barney LLC.
Morgan Stanley Smith Barney (“Morgan Stanley”), its affiliates, Morgan Stanley Financial Advisors and Private Wealth Advisors do not provide tax or legal advice. Clients should consult their tax advisor for matters involving trust and estate planning and other legal matters.
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Understanding basic investing concepts and building financial confidence can help you make informed decisions about growing and managing your wealth. Discover more.
