The challenge of answering how to invest money is quite daunting. Why? Because our ‘future financial well-being’ is at stake. Hence figuring out how to invest becomes a challenge.
So investing money is daunting, challenging, and things are at stake. Am’I trying to solve a problem or raising fear? Sorry for my ‘tone’, but I am only trying to make a point. Investing can be overwhelming for some.
In this state of overwhelming thoughts, what’s the first step a person takes to learn investment? Searches the internet. Here the information is endless. But often the reliability of such info is questionable.
I will try to help you…
How I will help? By simplifying the complexities of investing. How? I will explain investment in simple colloquial language (no jargons).
This article can be a good guide for beginners.
How to invest money…
In my endeavour of figuring out how to invest money, I decided to take baby-steps. Why? Because I could not afford to learn it in a wrong way. Afterall it’s our hard earned money that we invest, right?
So how I did it? What was the first step? It was year 2007-2008 when I first read the book “Rich Dad Poor Dad”. It explained me the necessity of having financial intelligence.
The next essential step was to learn the basics of investing.
Frankly speaking, investment is a long subject. To make it concise, specific and practical I have broken down the basics into following three (3) logical questions:
- What is investment?
- Why we must invest money (goals)?
- Where to invest money?
Why we are answering these questions? Because if we can answer these basic questions, it will automatically trigger right investment decisions in times to come.
#1. What is investment?
Investment is a process of buying an asset with the following two objectives:
- Income generation (like interest, dividends etc).
- Capital growth.
Key is to remember that, both these objectives cannot be realised immediately. It will only start happening gradually over time.
The concept is like this:
- You already have some spare money.
- Use it to buy assets.
- These assets will yield returns.
- In turn, assets will grow with time.
How much spare money one must have to start investing? Even with very small sums of money one can start investing (like Rs.500 per month).
Such small-small amounts invested regularly can build great wealth over time. How? By the power of compounding.
The truth of investing money correctly hides in a very special concept…
Always buy assets at undervalued prices.
What it means by undervalued price? It is a price at which the assets can yield best returns.
#2. Why we invest money (goals)?
Investment of money is essential for “wealth building”. It is also important to buy “right assets”. But all these must be done with a purpose (goal).
A goal-less investing will eventually loose its steam, and the process will come to an abrupt stop. Even worse, the invested money will get spent on needless things.
This is one reason why experts often recommend to first fix a goal, and then start investing in accordance with it. This way there will be both a ‘plan’ and ‘purpose’ of investing.
It is extremely important to practice “goal based investing“.
#3. Where to invest money?
This is where this quick guide on “how to invest money” becomes practical. How? It will tell you various investment alternatives available for us to buy in the market.
We are investing money to buy what? Assets. There are many types of assets which we can buy as investments. Let’s see which are these different types of assets.
What is equity? Stocks and mutual funds.
What a beginner must do? Equity is a good investment alternative for all. But here the ‘risk of loss’ is also high.
How to manage this risk? In two ways:
- By buying equity at undervalued price.
- By holding equity for long term.
How does this help? Equity is basically a portion of a company. When we buy a portion of it (as stocks), we become eligible for a share of profit in the company.
Companies shares their profits in two ways:
- As dividends.
- By assuring stock price growth over time.
But dividend and price growth cannot start to yield immediately. It takes time for the companies to convert the equity money into profits. Hence investors must wait (at least a year) to see returns starting to flow-in.
In case of good companies, the longer one stays invested better will be the returns.
Example: Berkshire Hathaway, Coca Coal, TCS, RIL, Infosys etc. Read more about the equity returns here:
Remember: For beginners it is a point to note that, equity is the best available alternative for long term wealth creation. In equity, one can start with smaller amounts of money getting invested regularly over a period of time. Moreover, the return of equity is best.
#3.2 Other Investment Alternatives…
No investment plan can be tagged as a superior option compared to the other. Each has their own utility and importance. Depending upon ones goals, a right investment must be picked.
For beginners, who has only limited spare money available for investing, and is also investing for long term goals can go with equity.
Essential Precondition before one starts to invest…
This is a rule which is worth remembering. I consider it even powerful than investing itself. What is it?
Becoming debt free before starting to invest…
There is always this dilemma, whether to pay-off debt first or invest the spare money?
For beginners it is always better to clear debt first. Becoming debt free and then starting to invest can be a big confidence booster. Read more about it here:
Why debt shall be paid-off? Because debt is something which is gradually draining our money. Tapping this drain-hole before investing is only logical, right?
Trading and investing are not same…
There are two types of people available in the world of investing.
First, people who invest money to earn their livelihood. They are called traders.
Second, people who invest money to build wealth gradually. They are called investors.
As a beginner, I will advice my readers to aspire to become an investor (Warren Buffett, Rakesh Jhunjhunwala etc). Read more about value investing.
Why to consider investing over trading? Because in trading the risk of loss is too high. Why? Because in trading, one deals with ‘shorter’ holding periods.
When one is dealing with equity, expecting positive growth in short term is like expecting a win in a game of gambling.
When one is holding equity for longer periods, risk of loss is greatly minimised. How? Read more: The advantage of long term investment.
Note: In short term one can only make smaller gains. Over a same period of time, even several small-small gains with be less than one long term gains. Why? Because in short term investing the power of compounding is lost.
How tough is making money from investment?
Frankly speaking, earning smaller returns from investing is very easy. The difficulty creeps in when we aspire for higher returns.
What’s the need for higher returns? To beat inflation.
Let’s understand it like this, there are investment alternatives in India which can yield small returns with almost zero risk.
These are called “debt based investment plans”. Few examples of debt based plans with their potential returns are as below:
- Savings account: 3.5% p.a.
- Fixed deposit: 7% p.a.
- Retirement plans: 8.5%
- Debt based mutual funds: 9% p.a etc.
Zero risk and reasonable returns. All is looking fine, right? But the problem with these investment alternatives is that they cannot beat inflation.
What is the issue with inflation?
Due to inflation, our expense increases over time. Hence it is essential for us to build wealth to keep pace with the rising prices.
In this situation, if one is investing in low return investment options (risk free options), it will not beat inflation.
Hence we must take “calculated risks” and invest in equity. How to take calculated risks?
- By buying assets at undervalued prices.
- By staying invested in equity for long term.
Investing money in a ‘right way’ is a necessity, it is not an option. Why? Because our financial well being is dependent on the success of our investments.
How to invest money? Buying few stocks and mutual funds here and there in the name of investment will not work. What is essential is the following:
- Building a strong foundation of investment know-how.
- Using this knowledge to build a strong equity portfolio.
Why equity? Because it is equity which will help us to beat inflation in long term, also build required wealth.
Have a happy investing.