Few people stumble into financial independence. Most save money then invest it prudently over time. Investing is making money work for you. Essentially, money can produce interest, dividends, and capital gains.
Money earns income from interest. When you lend cash to a borrower; the borrower pays you rent to use the money, and when the term of your agreement ends, the borrower returns the money, so you receive the principal investment and interest income.
Money earns income from dividends. When you buy a part of a business, you become a shareholder of the enterprise. As the company earns a profit you receive a portion of the net earnings as dividend income.
Money also earns income from capital gains. When you buy an asset, you become the owner, and if the asset increases in value over time and you sell it to someone who pays you a higher price than you paid for it, then you have realized a gain from the capital.
Compounding is a key to investing. When your investments earn income from interest, dividends, and capital gains, and you re-invest those earnings, then your earnings can also earn interest, dividends, and capital gains. This compounding of small amounts of money over time, can multiply the value of assets.
Remember, all investments involve some degree of risk. A few risks include the loss of purchasing power due to inflation, the risk of loss from a default borrower, and a capital loss when selling an asset for less than its cost basis. It is important to understand the risks involved before investing money. The reward for taking on risk is the potential for a greater return.
Individual investors supply capital to the securities markets yet, unlike federally insured deposits in checking and savings accounts, where depositors’ money has a guarantee of principal, up to $250,000, if the bank or credit union files for bankruptcy, investments in securities fluctuate every day. No one can guarantee a profit. Remember investments may lose value.
Therefore, here is some general investment advice.
QUESTION: What is your tolerance for risk?
Chris Bryant is an American financial advisor.