How to Start Investing: Basic Types of Investments
The financial adviser explained that when he puts money in the bank, that money is called the “Principal”. It’s a confusing word but comes from the Old Latin term “principalis” which means first or original. Hence, the Principal of your investment is simply the first or original amount you put in your investment.
Then there is the “Investment” itself. And that could be absolutely anything, but most investments are broken into one of three types:
Investment in something you own. In this type of investment you pay money to buy something and hold on to it, because you think it will go higher in price. Example, a house, or a Stock, a business, or even some people even spend money buying Gold or other Precious Metals and Art.
Investment by lending your money. Here you lend your money to someone and in return they pay you some interest. A good example is a Savings Account. You give the bank your money to keep. They in turn, give you some “interest” to keep the money with them. However, the bank also loans that money to someone else for a higher rate and makes money. In this case, your investment in your savings account was making money, as was the same money that the bank loaned to someone else.
Another example is a Bond. The term Bond comes from the Old English word “bind” and it’s basically an agreement that binds one party to pay a sum to another party. Essentially it is a loan or an IOU which is why it is called “Debt”. Now, in a bond, the investor is basically loaning money to the government or company. In return they will get some money back. So if they invest in a bond for $200, they are essentially loaning $200 to the company issuing the bond. On the bond, it will be specified that at a certain time in the future, the investor who has the bond can return it back to the company or government that issued it and get $205 back. So the return in this case is 2.5%. The holder of the bond, is guaranteed by the organization issuing the bond that they will get a certain amount.
Keep your money in Cash. If you left all your money in Cash, you know it will not go down, but it also will not go up. There are also other types of accounts which are just the same as keeping it in cash. These include Checking Accounts where you don’t earn any interest on it, Money Market Accounts where you earn very little interest and is basically a checking account. The only difference is that the Money Market Account gives you a little bit more interest than a Checking Account. A Money Market Account however usually has restrictions on the number of transactions you can make.
“Now”, he continued, “the whole point of investment is to make more money. So the amount you get at the end is the “return on investment”. It is basically the money you made at a certain point. So, if you invested $200 and after one year you had $210, you made a profit of $10 which is the same as a 5% profit. In this case you would say that your “Return” is 5%.
However, sometimes, you can also make a loss. So, if you had invested $200 and after one year you had only $190, your loss would be -$10 (notice the minus before the number). This is the same a 5% loss. In this case you would say that you have a “Negative Return” of 5%.