Financial literacy is the ability to understand and effectively use various financial skills, including personal financial management, budgeting, and investing. The lack of these skills is called financial illiteracy and is unfortunately common among young people all over the world. Some refer say we are in a “financial illiteracy epidemic,” citing the grim statistic that only 57% of Americans are financially literate. The only way to improve the numbers is by educating people and giving them one of the most valuable skills: managing money. The first part of becoming financially literate is learning how to save money. But once you have savings, the next step is investing it to make it work for you.
Types of Investments
There are many different types of investments available and they all have different pros and cons. There are some key terms that are associated with investments that are useful to understand when discussing the various possibilities. An asset is a resource that one owns and expects to increase in value. Holdings are the specific assets that are part of an investment portfolio. A portfolio contains an individual’s investments, as a group. The more diverse the portfolio, the more variety there is in one’s assets. Finally, asset classes refer to a group of assets with similar characteristics. For example, stocks, bonds and cash are all asset classes.
Most types of investments can be split into four categories: ownership investments, lending investments, cash equivalents and alternative investments. Ownership investments refer to stocks, real estate, precious objects and business – in these cases you own the asset and the risks tend to be higher with these. Lending investments, on the other hand, are debts that you buy with the expectation that you will be repaid. In this case, you act as a bank and can decide how much money to invest. This is generally a lower risk but also a lower reward investment. Lending investments include bonds, CDs, savings accounts and TIPS.
Cash investments refer simply to saving up cash in a standard savings account that can be used as you please. Finally, the alternatives include REITs, venture capital, commodities, precious metals and various forms of funds. Most successful investors make different types of investments. This gives them more opportunity to make money and to have a backup if certain forms of investments don’t work out.
Ownership investments are popular because they have high rewards. However, this also makes them equally high-risk. Stocks are a quick and easy way to take partial ownership of a public company. Depending on the company, stocks can be affordable and you can buy as many as you want. If the company does well, your stock will increase in price. If it doesn’t, then you may lose money. However, you can only lose as much as you put in. Plus, there are various stocks that have done well and remained stable over time. These make great investments if you are patient enough to wait.
Actual physical purchases can also be an amazing financial investment. Purchasing real estate, for example, is a great option. Even if the value of the property decreases, you still have significant equity. A house or building that has been purchased can be rented out for further profit or resold. While everyone generally agrees that real estate is a smart investment, there is always a possibility that the market will change and the work you put into a house won’t pay off. Hence, it is still considered a higher risk investment that has the possibility of equally high reward.
There are purchases other than land or property that can be financially lucrative. Previous objects, including precious metals, art and collectibles are a form of an ownership investment if the intention is to resell them from profit. Gold has frequently been purchased and kept under lock and key because, while currencies can change in value, gold is generally more stable. More recently, cryptocurrencies have also become an investment option. One of the most famous cryptocurrencies is Bitcoin, but there are countless others. These can be mined just like precious metals but come with a high risk of wild fluctuations.
When it comes to collectible items, they can be purchased separately or at a lower cost at second-hand stores or estate sales. They can then be resold as sets or individually for a hefty profit. Risks can include theft, counterfeit products and damage that can devalue the goods and even make them completely worthless.
Finally, starting a business is another popular form of ownership investment. Starting a business costs money and takes time, whether you are selling a product or offering a service. There are many different forms of businesses and all of them can succeed or fail. There is no guarantee that any single business will do well, which makes investment in them risky. On the other hand, a business can boom beyond expectation and turn into a bigger profit than ever imagined.
Lending investments are basically debts that you buy and expect to be repaid for. It allows the investor to basically act as a bank at a low risk. Unfortunately, the reward is also generally low, making it a safe investment that won’t make much money. One of the most common lending investments is a bond. “Bond” is an umbrella term for any type of debt investment. It refers to loaning money to an entity that can be either a corporation or the government. They then pay you back over a set period of time with a fixed interest rate.
Another type of lending investment is a CD or a certificate of deposit. This is basically just an agreement issued by the bank that in exchange for your money, you will get a higher interest rate. It is simply a case where the investor commits to leaving a certain amount of money for a set period of time. Depending on how long and how much is invested, the bank will offer a higher interest rate. If you cannot guarantee that you won’t withdraw the money, a simple savings account is a safe way to go, but it has a much lower interest rate. Since the return is incredibly low, many don’t consider this a true investment.
Finally, there is TIPS, or Treasury Inflation-Protected Securities. These are exclusive to the USA, although there may be similar opportunities in other countries. TIPS are bonds backed by the U.S. Treasury and they are designed to be protected against inflation. When a TIPS investment matures over time, you get the principal and interest back with a reflection on the rate of inflation. While this makes them a safe investment, they don’t necessarily make a lot of money.
Having money in a simple savings account can count as a cash equivalent. Having cash on hand isn’t the best way to invest but it can have its advantages. For example, having money in a savings account that allows you to withdraw as you please allows for flexibility. Having money that can be withdrawn or easily moved into other investments is considered ‘as good as cash.’ Usually this is only a small percentage of a good investor’s portfolio, yet it is still great to have.
The most traditional ways to invest may be stocks, bonds and cash, however there are other options. These shouldn’t be used as primary methods of investments but can be a great addition to an investment portfolio as long as they are only a small percentage of it. One of these alternative investments are REITS or Real Estate Investment Trusts. These are a way to invest in real estate without buying property. It requires working with a company that earns profit from their own real estate investments. It is possible to share in the real estate inself or invest in the mortgage of a property.
Another popular alternative investment is venture capitalism. To explain it in simple terms, it requires giving money to a startup or a small business. The expectation is that the business will grow and the money will be returned. This also gives the investor the opportunity to become partners in the company and make certain decisions as well as own part of the equity. If the business doesn’t succeed, all the money invested could be lost.
Commodities are another option for alternative investment. Basically, this involves investing in resources that affect the greater economy. Examples of popular commodities include, but are not limited to oil, coffee beans and beef. Since these have had value and affected the economy steadily for years, it is likely a secure investment.
Finally, there are funds, which can fall under any of the main categories of investments but are not specific investments. If you work with an investment company, they can help you pick a collection of similar assets on your behalf. These can be either a group of bonds or stocks and the fund can be specific to certain products or types of companies. There are many different types of funds including mutual funds, index funds, exchange-traded funds and hedge funds.
Factors to Consider When Investing
It can be overwhelming to go from saving to investing, even if you’ve done a lot of research. With so many options out there, it isn’t always clear how to start. Before you decide to invest, it is important to determine why you are investing. Once you have some clear long and short-term investment goals, it becomes easier to determine how much money to invest and for how long. Depending on this, picking an investment strategy becomes much clearer.
The factors to consider before investing even a penny are your age, your income, your financial goals, your risk tolerance, and your time horizon. For example, most people invest to secure that they have enough money for their retirement. It can be easy to forget while we are young, but one day we will be older and tired, unable to keep up our busy lives and wanting to spend our days relaxing and not working a 9 to 5 job. In the USA, it is estimated that 20 years of retirement will cost at least 1 million dollars.
Photos: Shutterstock / Photomontages: Martina Advaney