Investing for the Absolute Beginner; Part I. Why Invest?

Why invest your money? Everyone knows that saving money is a good thing, but why ought one not only save but also invest one's money? After all, banks pay interest on savings accounts, so an ordinary savings account should be enough, right?

Wrong!

There are two key concepts behind investing as opposed to ordinary saving: investment returns and compounding (although in truth compounding and investment return are closely related). The idea behind investing is not just to squirrel away money in a bank, in a jar, or under a mattress. Investing is about putting your money to work for you to make even more money.

Although there are numerous forms of investments, they all share the same basic qualities. When you invest your money, you are actually buying a piece of an enterprise. That enterprise could be a specific company, as in the case of an individual stock, or it could be a complex bundle of enterprises, as in the case of a mutual fund or an index fund. By investing your money, you are supplying the recipient of your investment with capital to pursue a particular project. As such, you become part-owner of the project and are entitled to share in the returns (i.e. the profits) on that project.

The profits from an investment are returned to you in one of two ways. They are either paid back out to the investors in the form of dividends (which may then be reinvested to own a larger share of the project, known as compounding), or the value of the individual shares of the investment may appreciate (i.e. increase). In either case, a profitable investment results in a significantly higher return than can be obtained through the interest in an ordinary savings account.

An ordinary savings account will yield a usual return of three to four percent annually. Long-term investment accounts, by contrast, will usually yield somewhere between six and ten percent annually. It might seem at first glance that a couple of percentage points are not that big of a deal, but over the course of a lifetime (say, 30 or 40 years until retirement), those couple of percentage points can make the difference between being comfortable and being wealthy.

Of course, it goes without saying that investing is also riskier than saving, but increased risk comes with the territory of the potential for increased returns. There are ways to mitigate the risk, however, and I will explain those strategies in later parts of this new series.

In part two of "Investing for the Absolute Beginner" I will be covering the basic types of investments, explaining their advantages and disadvantages, and offering my own view about what forms of investments are appropriate for the beginning long-term investor.

In the meantime, feel free to ask any questions as I enter into this new series. You may use the comments section below, or you may always contact me directly at my email address listed in the right-hand column above. There is no question too silly, since I too was once a novice with the same questions.

The hardest part of investing is taking the initial first step to opening an investment account (more from fear than from anything else), and this series on Investing for the Absolute Beginner can be your guide to taking that first step toward a more prosperous financial future. So if you are looking to join the ranks (in the non-elitist sense) of long-term investors, follow me through this series for the beginning investor and I will guide you through the complete process of opening an account and setting up a simple diversified portfolio that can serve as the foundation of your investment strategy. Part II of the series is coming soon, so stay tuned!

Here are the entries in this series:

-Part 1- -Part2- -Part 3-