Investing Basics Everyone Should Understand

investing basics

When I graduated from college, I felt like I was on my way to knowing everything about investing. I had taken several courses teaching deep investment analysis; crunching data in large, complex spreadsheets.

As I’ve continued to learn, I have realized (and extensive, academic research has confirmed) smart investing isn’t nearly as complex as it’s made out to be. Anyone can do it themselves, if they learn a few guiding principles.

In this article I’d like to share how to approach investing. I’ll first walk you through the most fundamental issues investors face, and conclude with a few simple steps to investing wisely. I’ll also provide links to several other articles I’ve written on these topics in case you’d like to dive a little deeper.


We need money for the things we want to do (or don’t want to do)

I know this statement sounds obvious, but given how unprepared many Americans are for retirement, there’s a definite disconnect.

We all have stuff we want and need to buy--from toothbrushes to a new home. Some of these things are inexpensive and can be purchased immediately, while others are expensive and take a long time to save for. We tend to be great at affording and saving for things in the near-term, but poor at affording and saving for things in the long-term.

For most of us the most costly, longest-term expense is retirement. In most cases it takes about 40 working years to get there, and retirement can last 30 years or more! Think about that for a minute. Most of us have the expectation that we can work for 40 years and NOT have to work for another 30! Throughout the vast length of modern civilization this idea would have been laughable, but here we are...and it’s doable!

But how do we comfortably amass a large enough sum of money that we can live off of for 30 years (and not run out after 20 or 25 years)? Our money needs to grow...a lot.

Affording expensive things is easier if our money grows

My 3-year-old has a green piggy bank that is gradually getting stuffed with dollars and coins. She’s a great “saver” but there’s no growth happening. The money just sits. This is a silly example, but in many cases our money sits as well, or something close to it.

Historically the United States economy has experienced roughly 3% inflation per year. This means that a dollar today buys only 97 cents worth of things tomorrow. It’s why I still grumble when I pay a dollar for a Snickers candy bar, when I swear they were much cheaper “when I was a kid” (they were).

If you want to retire and do other great things with your money, growth has to happen to at least exceed inflation, otherwise you could actually be left with fewer future dollars than you started with. The only problem is, growth is risky.

Growth involves risk

It would be wonderful if our money could grow at a high rate of return year after year, but unfortunately that’s not how growth works. Over long periods we can experience growth, but with ups and downs along the way. Generally speaking, the more we want our money to grow, the more risk we must assume. This means there will definitely be ups and downs, but the risk of complete loss may exist too.

For most investors, taking risk means using a variety of investments that can grow over time. Some investments will be less risky--like bonds and CDs--while other investments will be more risky--like stocks or real estate. Less risky investments typically experience a lower rate of return over time than more risky investments.

What are some guidelines of investing wisely?

Since we know that affording expensive things (like retirement) requires at least some investing, how can we invest as wisely as possible? While there’s no absolutely perfect, fool-proof formula, there are several principles that every investor should follow.

Start as early as you can

This point is the first for a reason. Even not-so-great investments can be a great thing if you start early. With time on your side, you allow compounding interest to have a greater overall impact on your wealth.

Start to save and invest as early as you can. If you’re at a point in your life where you realize you should have been saving earlier, start today! Getting started now is always better than waiting until tomorrow.

Here are two more articles on this topic that may be helpful:

Consistently save

I’m currently training for a half-marathon and after missing several days of training runs, I’ll get a painful reminder this evening of how advantageous consistency really is. It will be a tough few miles tonight as my legs and lungs try to play catch-up, and it’s because I took too much time off.

I’ve met some pre-retirees trying to play catch up as well. It’s doable and most retirees have options, but it’s far easier to be consistent over time than to painfully try to do all your saving over fewer years.

Here’s another article on this topic that may be helpful:

Choose a wide variety of investments

By diversifying your investments, you spread out your risk. Most investors should have a wide variety of stock and bond investments. This is most easily done through mutual funds, which invest in hundreds or even thousands of individual company stocks or bonds. This means that if one company fails, all of your dollars aren’t tied to the fate of a single business.

Most homeowners should also realize that a large portion of their net worth is tied to one specific investment: their home. This undiversified asset is a big risk, and if you don’t think so, just ask a homeowner in Flint, Michigan or Paradise, California what they think. This isn’t to say we shouldn’t own our homes, but we should have other assets, or investments, as well to add diversity to the whole pot.

Here are two more articles on this topic that may be helpful:

I hope this article has been helpful. Investing doesn’t need to be hard. Identify what you’re saving for (for most of us, the BIG expense is retirement), accept the fact that growth requires at least some risk, and try to follow the guidelines of investing wisely. If you have questions or comments, please let me know and reply below!