Understanding the Basics of Investing

Investing is the process of buying assets [short or long term resources] such as stocks, bonds, treasury bills, mutual funds, exchange traded funds, etc with the expectation that they will generate income or appreciate in value over time, helping to build wealth and outpace [rise above or beyond] inflation.

Investing follows a set of fundamental principles that must be adhered to by persons seeking financial freedom and aiming to build wealth overtime. Key among the fundamental principles for investing include;

·      Setting Clear Goals and Time Horizon

·      Understanding Risk vs. Return

·      Diversification of Assets

·      Compound Interest Effect

·      Setting Clear Goals and Time Horizon

When it comes to investing, setting clear goals for the investment and the time horizon [timeline or time frame] within which you would want to undertake the investment is critical. Before you start investing in any asset, you first need to ask yourself these questions :

-       What am investing for? Is it to buy a house, a car, a land or to secure my children’s tertiary education in Ghana or abroad?

 -       For how long do I plan to invest for without withdrawing any part of the investments? Is it for 2 years, 5 years, or even 10 years?

Deciding what you intend to invest for and how long you plan to invest for, marks the beginning of your investment journey.

·      Understanding Risk vs. Return

Another fundamental principle you need to know and understand when it comes to investing is the concept of risk and return.This concept, in simple terms, seeks to communicate that, higher monetary returns on investments is associated or linked to higher chances of losing money from investments made. An investment with low risk [lower chances of losing money from investments] comes with low returns [low or small monetary gains from investments]; on the other hand, an investment with high risk [high chances of losing money from investments] comes with high returns [high monetary gains from investments]. So, ask yourself; which one am I comfortable with? Potentially losing some significant money in order to gain more [high-risk, high-return] or losing little to no money in order to gain little [low-risk, low return]?

Your decision with regards to the level of risk you would want to take, will form the basis for the type of investment to undertake. Investments such as mutual funds, treasury bills, and government bonds are low risk and as such have low returns. Investments such as stocks/equities are high risk and as such have high returns.

·      Diversification of Assets

Ever heard of the saying, “Do not put all your eggs in one basket”?, well, that popular saying is a common idiom that means you should not rely solely on one option or type of investment, but rather you should have multiple investments. Because, if you rely solely on one option or type of investment and should that investment go bad due to negative macro economic conditions, causing you to lose a significant portion of your money, you would be in BIG TROUBLE.

So, it is always advisable that you spread your investments across different asset classes or investmenttypes like stocks, bonds, treasury bills, mutual funds, real estate, derivatives, etc to reduce the risk of losing most or all of your money as a result of investing in one particular asset.

·      Compound Interest Effect

The compound interest effect, is what I personally like to describe as the “money magic” in investing. The compound interest effect, if allowed over time, creates exponential growth in the value of investments. Compound interest is the process of earning interest on both an initial principal and the accumulated interest from previous periods,creating significant growth in investments.

It allows investments to grow significantly faster overtime, with the effect intensifying the longer the money remains invested. As an investor, this is the surest way of growing investments to significant levels and attaining your set target or goal for investing.  

So remember, before you decide to undertake or participate in any investment-related activity, make sure you have applied the four principles discussed above.

You first set clear goals and time horizon, you then make sure you understand the risks and returns involved in the investment you are about to undertake. Don’t forget to also invest in multiple assets and not just one asset type. Then, be disciplined by continuously investing [contributing money] in the asset and allow the compound interest effect work its magic by significantly growing the value of your investments.

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