Overview
This chapter explains the basics of investing, reasons to invest, risk considerations, investment strategies, and various investment choices, aiming to help individuals make informed decisions for their financial future.
Basic Investing Concepts
- Investing uses long-term savings to earn financial returns and build wealth over time.
- Investing protects against inflation by seeking returns higher than the inflation rate.
- The Rule of 72 estimates years to double your money by dividing 72 by the annual rate of return.
- Stages of investing: put-and-take account (emergency fund), initial investing, systematic investing, strategic investing, and speculative investing.
- Diversification spreads risk by investing in different types of assets.
- Types of risk include interest-rate, political, market, nonmarket, company, and industry risk.
- Investment strategies evaluate safety, liquidity, dividends/interest, growth, cost, and tax benefits.
- Wise investment practices: define goals, proceed slowly, keep good records, seek advice, stay informed, and know your risk limits.
Making Investment Choices
- Sources of investment information: newspapers, investor services, magazines, brokers, annual reports, financial advisers, and online resources.
- Full-service brokers provide advice; discount brokers offer lower fees without advice.
- Low-risk investments: corporate and municipal bonds, U.S. savings bonds, and Treasury securities.
- Medium-risk investments: stocks, mutual funds, annuities, and real estate.
- High-risk investments: futures, options, penny stocks, and collectibles.
Key Terms & Definitions
- Investing — using long-term savings to generate financial returns.
- Inflation — the rise in general price levels, reducing purchasing power.
- Rule of 72 — technique to estimate years to double investment (72 ÷ return %).
- Portfolio — a collection of investments.
- Investing risk — the chance an investment’s value will decrease.
- Diversification — spreading investments to reduce risk.
- Temporary investments — investments held short-term and reevaluated within a year.
- Permanent investments — long-term investment choices held for 5+ years.
- Annual report — yearly summary of a corporation’s financial results.
- Bonds — debt obligations of corporations or governments, paying fixed interest.
- Discount bond — bond purchased for less than maturity value.
- Stock — unit of ownership in a corporation.
- Mutual fund — pooling money from many investors to buy securities.
- Annuity — contract providing a series of regular payments.
- Futures — contracts to buy/sell assets at a set price on a future date.
- Option — right to buy/sell an asset at a specific price within a certain time.
- Penny stocks — low-priced stocks of small, high-risk companies.
Action Items / Next Steps
- Establish an emergency fund before starting to invest.
- Regularly review and update your investment portfolio.
- Seek reliable sources of investment information before making choices.
- Complete assigned reading and exercises from the chapter assessment.
- Use the Rule of 72 to calculate investment growth for homework problems.