How to: Investing basics
Saving, investing, trading
In this How to series, I will walk you through the basics of investing. As the series progresses, a more detailed and in-depth understanding will be developed so that anyone can start on the path to becoming a conscious investor with the funds they need.
In the Modern Wealty Surway by Schwab, 65% of respondents are willing to sacrifice their spending to save for the future. The same research shows that people who make a financial plan (only 28%) are also more conscious about paying cheques, saving for an emergency fund, and avoiding loans. Of those who have a plan, 74% automatically allocate a specific portion of their income to savings.
Unsurprisingly, those with a financial plan also have many better investment characteristics, which will be discussed in more detail later. These include portfolio rebalancing, individual risk tolerance, attention to the costs associated with investing, and conscious portfolio diversification. Unsurprisingly, they are much more confident in achieving their planned financial goals than those with clear, well-defined, and short-cut objectives.
From all perspectives, making a financial plan and using it as a basis for spending, saving, and investing is better in the long term.
Saving, investing, trading
First, clarifying the conceptual differences between saving, investing, and trading is crucial. Many laypeople confuse these or don't know the clear distinction, so it's an excellent place to start.
Saving is setting aside a portion of your income for short-term goals or, in case of an emergency, typically in the bank account. On the other hand, investment is the allocation of a portion of income to various assets in a way intended to generate future profits. When an asset is allocated with a shorter-term objective of making a profit, usually within one year, it is called trading. When it is assigned with a longer-term objective, it is called investing. These time horizons are not set in stone since short and long-term are different for everyone, but over five years, we can talk about investing and over one year about trading.
In addition to whether a part of the revenue is invested in an asset or the time horizon is shorter, the comparison can be examined in other ways. These may include:
Risks and return opportunities: Savings are usually placed in a bank account or a low-risk asset, whereas investing and trading involve taking on a certain amount of risk to achieve a potential return. The form of the instrument also determines the degree of risk and return potential, which generally moves in parallel, i.e., low risk indicates lower return potential, and increasing the degree of risk increases the rate of return available.
Inflation protection: Savings are generally not inflation-proof because, in most cases, they lose a significant part of their purchasing value when held in cash in a bank account. Investments are much more protected against inflation, varying degrees depending on the type of investment. This is an essential difference in preserving purchasing power over the long term.
Savings offer few opportunities for diversification due to the low-interest rates available on cash and bank accounts. Investments provide a range of opportunities in terms of time horizon, regional exposure, and instruments, and specific instruments, such as equities, offer further diversification opportunities.
From a liquidity perspective, savings are an almost instantly convertible, accessible source of funds. Investments are often different, as a stock or a bond can be converted into cash quickly but possibly at a high cost. In other cases, such as real estate or high-value assets like paintings, the conversion speed cannot be guaranteed, so this should also be considered when allocating to them.
It is a crucial decision in terms of knowledge. Taking the first step and saving at least part of your income does not require any particular financial expertise but rather a determination. Investing requires a broader body of knowledge in many respects, but this can be acquired with diligence and perseverance.
It can, therefore, be concluded that saving is the first important step towards a more careful and conscious use of revenues. Savings tend to help in the shorter term, providing lower risk, lower return opportunities with almost immediate liquidity. Investing requires a higher level of knowledge, with different potential returns depending on the individual's risk tolerance. We are talking about short-term trading and longer-term investing when different types of financial instruments are available, which are also important for building a diversified portfolio.
The Super Stocks Newsletter is provided for general information only. It should not be construed as an invitation or offer to purchase or sell any financial instrument, nor should it be considered a recommendation for any investment. More: Disclaimer