Investing For Beginners: Investing 101

Investing For Beginners: Investing 101

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Investing For Beginners: Investing 101

There are three big asset classes:
Stocks, Bonds, and Cash
Stocks are ownership in a company.
There are many ways to classify stock, but major ways are size or capitalization and location.
Each class has it’s own level of risk.
Large cap includes the 500 largest companies in the US like Walmart, Disney etc. These companies are generally considered the least risky.
Mid cap stocks include the next 400 or so companies and they are considered riskier than large cap stocks.
Take the next 2,000 companies and you have small cap stocks. While they have to potential for the greatest growth, they also have the greatest risk.
Then you have stock with companies that are outside of the US. Companies in more developed countries like Germany or Japan are considered less risky than companies in emerging market countries like India or Mexico.
As the value of the company goes up, so does the stock price, but if the value of the company goes down, so does the price.
Another way to make money in stocks is if the company shares it’s profit in the form of dividends.

Bonds: Bonds are a loan to a company or government.
When you purchase a bond you buy an IOU for the company or government to pay you back the principal and interest over some period of time.
The price of the bond depends on the level of interest rates. If the interest rates go down, the market value of your bond goes up and if interest rates go up, the value of your bond goes down.
The longer the time period of the bond, the more risk and more price fluctuation occurs on interest rate changes. Bonds are generally less risky than stocks.

Cash: Cash is usually in a 401k as a stable value fund.
Unlike other assets, cash has little risk of losing value short term. The longer you hold cash, the riskier it is that your cash will lose value due to inflation.
Most people that invest in 401ks hold mutual funds. Mutual funds hold many different assets in a portfolio that you can invest in. They can be stocks, bonds, cash or all of them. They are less risky because of diversification, but don’t generally appreciate as much.

Modern portfolio theory holds that you don’t put all of you eggs in one basket. In other words you diversify your money across many assets to lessen the risk.
More risk = More return
Less risk = Less return
A proper asset allocation involves getting an optimal rate of return for the risk you take. This is called the efficient frontier.

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