You might often hear people around you talking about stocks, bonds, and banking accounts but have little or no idea what these things are. These are all examples of investments and in this article, I will help you to understand some of the most basic types of investments, banking accounts, the stock market, and mutual funds.
Bank Accounts
One of the most basic types of investments is using a savings account. Unlike the stock market or more complex bank accounts, savings accounts make money by gaining interest. This happens because when you put your money in a bank account, that bank is able to use that money to give loans to others. These loans accumulate interest over time, which means the person who takes out the loan has to pay more money than they took from the bank, and the more time goes on, the more money that person owes the bank. This is one of the biggest ways banks make money because they gain profit from this interest, but they also share some of the interest with the bank accounts involved in the loaning process. For example, if someone were to take out a loan for $1,000, the bank would take money from a banking account and lend it to the person taking out the loan. A few months later, the loan is fully paid off at $1,500 because of interest. Depending on the interest rates of that bank, the bank account involved in the loan would get its $1,000 back plus a percentage of the $500 interest. This is how banks incentivize people to keep their money in bank accounts because these accounts are expected to grow exponentially over time due to the accumulation of interest. This is a very reliable way to make money because the FDIC (Federal Deposit Insurance Corporation) ensures that money left in a bank will not lose money up to a certain amount (currently protected up to $250,000 per account owner). There are many types of savings accounts, some that are riskier with better rewards and those that are more reliable but have less reward. Researching and thinking about what your ideal banking account would look like is essential to getting the right type of account for you.
The Stock Market
A more risk-reward based way of investing is using the stock market. Investments in the stock market are not FDIC protected, which means you are able to lose money and have more risk, although the stock market can also produce greater rewards. In the stock market, investors can buy and sell stocks, or shares of ownership in a public company, to make a profit. A public company is one in which regular people can have ownership of a company in the form of shares. These shares only hold a small amount of ownership in the company, but allow for these companies to reach a wider audience of investors. Most companies start off with a group of private shareholders that help to start up the company in hopes of a great profit and these investors tend to have a lot of shares in the company. Companies may decide to go public for a number of reasons such as to raise profit for future growth, to replace a private shareholder’s stocks in the company, or just to enhance the company’s reputation. While this is a benefit to the company, it is also a great investment for regular people too. The stock market runs as an auction house where people can negotiate prices and trade shares. The prices of these shares fluctuate based on supply and demand. For example, if a lot of people are buying shares at a company, the company’s shares will become more expensive, and if fewer shares are being bought at a company, the price of the shares will become cheaper. To gain a profit in the stock market, people tend to buy cheaper shares and sell them when they become more expensive so they can gain a profit. Investing in the stock market is better for long term investments because companies tend to grow and get more expensive shares over time. Simply buying and selling stocks quickly doesn’t make a great profit and can be riskier while waiting over time tends to have less risk and more reward.
For example, when Apple first went public in 1980, one share was equal to $22. As of September 9, 2020, an Apple stock is worth $117.32. After forty years, an Apple stock is worth about five times the starting price, and if, for example, someone bought 100 shares of Apple in 1980, today those shares would be worth about $11,732 with a profit of $9532. Another great example of growth over time is Amazon. When Amazon first went public in 1997, each share was just $18. As of November 27th, one share of Amazon is worth $3,213.93. If someone were to buy 100 shares of Amazon in 1997, today they would be worth $321,393 with a profit of about $319,593. These examples do not even include shareholder dividends which I encourage you to learn more about on your own. Companies grow exponentially over time and the longer you wait to sell your shares, the more profit you are likely to make.
Mutual Funds
One way people invest in the stock market is through mutual funds. A mutual fund is a type of investment that consists of a portfolio of stocks, bonds, or other assets in the stock market. Mutual funds give investors access to diversified portfolios that can be customized to represent many types of categories of investments, types of investments, investment objectives, and the types of returns investors want, all for a low price of maintenance. Basically, a mutual fund is a way to invest in things, but without the research and risk involved with choosing individual investments.
Many people invest in the stock market using index funds. Index funds are a type of mutual fund. Index funds are preset portfolios of stocks that try to mimic the composition and performance of the whole stock market. These funds usually have lower expenses and fees to maintain and are often used in retirement accounts such as 401(k)s and IRAs. Index funds are great for long term investments and because they tend to have diverse portfolios of shares, they have less risk and more reward. For example, if someone only invested in energy companies such as ExxonMobile or BP (oil and gasoline companies), but electric cars are becoming more popular, their shares might decrease in value and they will lose money, but if someone were to invest in a wide range of energy companies including companies such as ExxonMobil, BP, and Tesla, while one group of stocks might be having lower values, another would be able to make up for those losses. Because index funds have many different types of shares in their portfolios, these shares can make up for each other’s losses and over time, make more money.
Hopefully, this article helped you to understand the basics of investing more easily. Please feel free to research more about these topics to help you learn more about investments and which ones are right for you.