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We all are exposed to the daily media coverage of financial news. The experts on television give recommendations on stocks, bonds, and other asset classes that we’re perhaps not so familiar with. For someone who is just beginning to invest in the securities markets, the myriad of information can seem overwhelming. But, the most important thing to remember is to start investing as early as possible.
Why is it so important to start early? One reason is the compounding effect of time. Growth in your investments could be re-invested and potentially contribute to more growth over time. Another reason is that there would be more time to ride out the market sell-offs that invariably occur and hold out until the market recovers. Yes, there is risk in investing in securities (more on that later).
There are numerous types of securities, but we'll only address stocks (also known as equities) and bonds (also known as fixed income) here.
Before starting to invest, there are some important factors to consider:
How long can funds be invested without being withdrawn? For those of you who are part of the millennial generation and just starting to think about saving for retirement, the time horizon can be measured in decades. In contrast, someone who is close to retirement has a shorter time horizon.
But why does time horizon matter? It matters because time horizon is related to an investor’s risk tolerance. An investor with a long time horizon may be willing to take on more risk in exchange for the possibility of higher returns because he or she has many years to ride out the ups and downs of the markets.
2. Risk Tolerance.
There are different types of risk. One is the risk that the investment will decrease in value, which can occur with stocks and bonds (as well as other types of investments). Another type of risk, typically pertaining to bonds (fixed income securities), is the risk that the purchasing power of the income generated by the bonds will be eroded by inflation. It’s also important to understand that volatility (fluctuation) of an investment’s returns is also a type of risk.
Different types of securities typically do not move up or down in value at the same time. So another important concept to consider is diversification. One example of diversification is investing in different asset classes (i.e. stocks and bonds).
Ultimately, investing is something personal and there is not any one approach that works for everyone. The important thing is to review your own financial situation and consult professionals, like Beacon Trust, when appropriate.