Investing Primer: Risk, Asset Allocation, Diversification

This is my third post in my investment series.  The first post is about saving and the second post is about stocks and bonds.

Today I will talk about risk, asset allocation, and diversification.

Risk

As I discussed in my previous post on stocks versus bonds, you need to take some stock market risk in order to get the larger returns necessary to provide you with a comfortable retirement.

With investing, the more risky an investment is, the more rewarding it may be.  When investing for retirement or for other reasons, we want preserve the original amount we invest (principal) and we also want to see some nice returns (gains) as well. 

Investment Primer: stocks and bonds

This is the second post in my investment series.  The first post is about saving to invest and can be found here. 

Most investments fall into one of these three main asset classes:  stable value investments (cash), stocks (equity), or bonds (fixed income).

Stable Value Investments (Cash)

These include Money Market accounts, Certificates of Deposit (CDs), and U.S. Treasury Bills.  These are essentially loans to a financial institution which pay you interest on your money.  Stable value investments are generally very safe, have little to no risk, and generally earn very little return compared with other investments.

Today I will be talking mostly about stocks and bonds.

Stocks (Equity)

Stocks represent an ownership interest in a corporation.  When you buy stock in a corporation, you buy fractional shares (ownership) in that company.  Corporations use money from your stock purchase to fund their business.  As a partial owner of the company, you share in both the company’s profits and losses.  When a company profits or loses money, the value of your stock share increases or decreases. 

Investing Primer: save, save, save

This next series of posts will be on Investing.  But before you can begin to invest, you need to start saving money.  After all, you can’t invest money if you don’t have any saved up.  Saving is the key to wealth: the more you save and invest, the sooner you can achieve your financial goals. 

It’s not just about how much income you make; it’s about how much money you keep.  

Saving more offers multiple benefits:

• Having more money to invest for long-term growth
• Living on fewer expenses now will permanently reduce your living costs in the future
• Protection from financial emergencies 
• When the stock market is down, you can pick up more shares when they are “on sale” instead of selling your investments at the worst time possible (when stock share values are low)

If you are spending everything that you earn, you have zero net worth and are adding nothing to your wealth.