How Investments Work

Many people hear about investments all the time, but actually investing can be daunting and disorienting. There are many forms of investing and many benefits, but you need to learn which investments offer what benefits to optimize your personal investment strategy.

Investing

An investment is a way to get money for your money. Investing is the act of giving money to an entity with the expectation of receiving more money back than the amount you gave. There are many types of investments but the main categories of investing are debt and equity.

Investing in debt

Investing in debt, also known as bonds or securities, is the safest form of investment on the market. When you invest in bonds, you are effectively lending your money to a company or a government. Bonds are safe investments because you are almost guaranteed to have your money returned. The tradeoff to investing in bonds is that the returns on your investment are significantly lower than the alternative, being equity investments. Bonds are a safe bet for people looking to earn a modest amount of money on a long term investment. For bonds to be effective investments, it’s best to plan on investing your money for multiple years.

Investing in equity

Investing in equity, also known as stocks, is high risk high reward. When you invest in equity, you own a share of the company you invested in. As such, you make money on your investment when the company pays dividends or the share price increases. Normally, this means that when the value of the company increases, the value of your stock also increases. This increase can be quite large, meaning that instead of making money on interest like with bonds, you earn money on the value of your share. To monetize the value of the share, you need to sell your share. This can be frustrating because you never know if the value of the stock will continue to rise. Alternatively, it’s also possible that the value of your equity investment will fall below what you bought the share for or the company will go bankrupt. For this reason, it’s possible to lose your entire investment when dealing with stocks. The value of a stock is mainly determined by market forces. By interpreting news and business events and relating them to how they influence the value of a company, you can earn significant returns on stocks. However, this is easier said than done.

Other investments

There are many flavours of investment which haven’t been mentioned, such as mutual funds, hedge funds or real estate. These all fall under the same umbrella of investment as equity and debt investments, but with subtleties that need to be understood before investing.

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