The Concept of Investing Money Explained

With pundits shouting dire predictions about the fate of Social Security and financial gurus spouting buzzword-filled advice, the concept of investingseems both extremely important and difficult to understand to the average citizen. Considering that investing is not taught in most schools and the vast majority of parents do not share financial knowledge with their children, many people are clueless as to why investing is so essential. Wading through all of the information available can be confounding, and many fear losing their money in a bad investment.

Investing, put in simple terms, is putting money into a resource that will appreciate in value or allow more money to be made in the future. Used effectively, investing enables people from all walks of life to ensure their own financial security. When contemplating how to invest money, diversification, access, and risk assessment and tolerance are the main proponents of a good investment portfolio.

Diversification in Investing

It would be foolhardy to allocate all of your money into high-risk stocks, yet many people lean far too heavily on a single investment. A balanced investment portfolio includes a good mix of options. For example, a college graduate who owns a modest home and has a savings account, a 401(k), a small stock portfolio, and a Roth IRA is far more diversified than an identical college grad who has all of their investment money tied up in owning a more expensive home.

The reason that diversification is so important in investing is that not every investment pays off. A house can lose value. The stock market is known for its precipitous dives. Even an education can lose value, especially in highly-technical fields that change quickly or becomes over-saturated. For the balanced investor, taking a loss on one facet of their portfolio is a small misfortune. For the unbalanced investor, such a loss can be financially ruinous.

Access to Investments

While long-term investments such as retirement accounts are essential to any financial plan, planning solely for retirement is a pitfall to be avoided. Short-term and mid-length investments can be used to save for a newer vehicle, a home, or other big-ticket purchases without forcing the investor to tap their retirement accounts.

Having access to investment monies at different times is also good in cases of emergency. Many people use a savings account to stash away emergency funds, with the option of pulling from a Roth IRA if the situation is dire. Parents often set up layered education savings for children where one is long-term and earmarked for college, and another account might be shorter-term and set aside for high school events, trips, and extracurricular fees and supplies. Staggering access to investments will ensure there are no early-withdrawal penalties and streamlines finances.

Risk Assessment and Tolerance

While the concept of investing is to make money, it is up to the individual to decide how much risk they can tolerate in order to do it. As a rule of thumb, most younger investors can take on more risk because they have ample time to recover from a setback. As the investor's age rises, their risk level usually lowers so that the margin for catastrophe shrinks. However, risk tolerance also weighs on the investor's personal views and situation.

For example, people who are planning on paying for college for multiple children, or believe their employment may not be stable may want to go with a less-riskier approach than someone with no dependents and an all-but-assured job future. Risk is a highly personal matter, and any investor should weigh their goals and future expectations before deciding on how much risk they are willing to undertake.

Investing doesn't have to be a frustrating or complicated process. Many investors start small until their understanding of the different facets of financial planning become clear. By being diversified, planning out access, and carefully considering risk factors, the average person can plan for their financial future with a minimum of confusion and frustration.

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