The current article starts with a question
Why do people invest?
If you could answer me, you would probably say, in an obvious manner, that people invest to achieve their financial objectives.
And we do agree with that statement. However, we also agree that most people don’t possess the level of knowledge they would like about financial investments. And to change that we’re going to try to clarify and simplify, in a series of articles, some essential financial knowledge everyone should have.
Let’s begin with some essential investing concepts.
What exactly is investing?
Investing is the act of applying our money/capital, in a way we’re able to generate an added value throughout a certain amount of time. The most well-known ways are creating a business, but we’ll be focusing on financial assets, like stocks or bonds. Something we’ll be explaining in more detail later on.
- Inflation – One of the reasons is the time value of money. As time passes, when money isn’t invested, it loses its purchasing power. In other words, using merely hypothetical values, due to inflation, a product that cost 10 cents in 1980 would cost 1$ in the current time. Inflation, to put it simply, reflects the rate of how fast the price of goods and services rise. To mitigate this devaluation, the most commonly used instrument is savings deposits, something with easy access that can be done in pretty much any bank. However, by doing so, these savings accounts only provide us with some actual profit if the offered interest rates stay above inflation, something that’s not always a guarantee. Therefore, it would be wise to do a detailed examination of the conditions each bank offers.
- Compound interest – Compound interests are achieved through the act of reinvesting the yield obtained in an initial investment, in other words, interest on interest. To better understand what compound interest, let’s use a practical example. In this example an initial investment of 1000$ is made, with a yearly interest rate of 10%, by year’s end, we would have 1100$. So, the initial investment of 1000$ generated a 100$ profit in a year. Instead of withdrawing that profit, we’ll be reinvesting it in the following year, assuming the same 10% yearly yield. The return will be 110$ instead of 100$, and by the end of the second year, the total would be 1210$. Thus, with this example, we understand the importance of investing early. The growing profits created by compound interests enable us to generate an exponential higher return throughout the years.
- Conflict of interest – Why leave the management of our own money to someone else who might not have our interests in mind? By learning and investing our own money, this is an issue that ceases to have any influence. No one has our best interest in mind than ourselves, especially when it comes to our own money.
- Knowledge – There are always contradicting opinions when it comes to investment sectors, the use of financial assets, and current tendencies of the economic cycles. Everyone has different backgrounds, be it financial or educational, which molds each person’s risk profile. There are people who are willing to take on a bigger risk to obtain higher yields. On the other hand, there are those who prefer to invest more safely and use less risky assets but attain a lower yield. Hence the importance of knowledge, so we can make an educated financial decision that fits our investing profile.
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