There are investment concepts every investor needs to know. These are part of the foundation of investing. One of the reasons Americans are so unprepared for the retirement years is a lack of attention to basic investment concepts.
Some spend more time researching a new smart phone than they do the concepts that will determine what kind of life they live in their later years. Delve into the links provided in each subject and learn how to apply them to your portfolio.
Basic Investment Concepts
1. The Importance of Time
Time is the investors best friend. The question: When to Start Investing? is easy when you understand how much more money you have to save per month if you start early versus late.
It is the investment concepts of exponential or compound growth that provide the “miracle” that grows your investment portfolio over time. Because the earnings, profits, interest, or dividends are added to the principal each time period, the value of the investment increases by a greater amount each time period.
2. Preservation of Principal
The biggest risk of investing is losing your principal. You have to understand how devastating it is to a portfolio to accept large losses. If your portfolio falls 50% and increases 50% you are not at break even. You have lost 25% of your portfolio. Volatility is a portfolio value killer.
The investment concepts of systematic and unsystematic risk, probability, and expected value allow an investor to understand the types of investment risk and how to mitigate the ones that destroy portfolio value. A basic understanding of risk puts a focus on one of the most important aspects of investing: risk management.
4. Risk Management
There are many risks to investing. Interest rates, default, inflation, economic, and political are some of the risks that need to be considered. Fortunately a sound risk management plan can mitigate some of the risks.
Portfolio Risk Control Strategies such as maximum drawdown, portfolio rebalancing, adhering to diversification rules, and implementing a tactical asset allocation can play a major role in risk management. Having a risk management plan is essential to successful investing.
You can’t just throw together an investment portfolio. I have developed 32 Investment Rules and Strategies to Make You a Better Investor. These will go a long way towards getting you started with the investment concepts that are vital for portfolio management.
5. Asset Allocation
Most people put great effort into picking stocks, but it is your asset allocation that will determine over 90% of your returns. It makes sense to spend more effort in determining the right asset allocation.
Asset allocation is one of those investment concepts that is not given the attention it deserves. The financial community has touted a fixed asset allocation at the peril of most investors. A tactical asset allocation is an active strategy that gives investors the flexibility to invest when the odds are heavily in their favor by considering asset valuation.
We know from historical data that when assets are bought at high valuations they produce below average rates of return. But when assets are bought when valuations are reasonable they produce average or better than average returns.
Understanding Basic Investment Concepts
These are basic investment concepts that all investors should know, understand, and apply to their financial planning. Investment management is not always easy; but worth it. Don’t short change yourself and your future.
Related Reading: Investment Diversification Definition, Purpose, and Implementation