The decision to start investing is one most people make with excitement. The idea of saving money, potentially earning double-digit returns, and figuring out a plan for when you can retire are all great motivators. But when you look at all the options out there, having only a basic idea about what is investment, and all the definitions and terms are enough to put a person off the topic. With so many different places to put money, different financial services companies, and different products, where do you even begin? Let’s start with the definition. To invest is to commit (money or capital) in order to gain a financial return. This can include a great number of places to put money, but there are some misconceptions on what investing really is and is not.
An investment account is not a savings account. Investing is saving for the future and future expenses. Savings accounts are kept because people want their money safe, and often are used for shorter periods of time. The easiest way to spot a savings account (a money market account is also a savings account) is to look to see if the account has the seal of the Federal Deposit Insurance Corporation (FDIC). By putting money into an FDIC insured account people are sacrificing some of the gains they could make, for the government backed guarantee that their money will be there when they need it, even if the institution holding the money fails. This is not to minimize the importance of an emergency fund, however. A safe and secure cash holding is an important part of any portfolio, and most experts will agree that 1 to 2 years living expenses should be held in a liquid (easily accessed without penalties) holding.
Investing, especially in individual stocks, is often seen by many as gambling. There is a big difference between playing games of chance with the hope of winning, and investing money. When a person gambles the odds are all on the house. The majority of the time the casino will win, and they will pay out to some of the players to keep them enticed and coming back for more. Investing, on the other hand, is taking a calculated risk in order to make a return on investment. When a person gambles they enter the casino with the hope to come out ahead. When a person invests they expect to come out ahead.
Investing is not taking the safe and secure route, and it is not throwing money away in the hopes of a big win. What every investor does is buy a small portion of a company. By owning a piece of the company, the investor will then share the burden if the company performs poorly, and they will share the prosperity if the company does well. There is no business model around that does not seek to maximize profits, and when a company has a great business model, such as those followed by many of the major successful corporations, they are more likely to yield great profits.
Investing is setting aside money for the long term. There are no savings or money market accounts that will pay the same amount in interest that a person can get when they make smart investments. So when a person is saving for a big purchase, such as saving for retirement, they need to make better gains in order to meet their goal in a timely fashion, something that a savings account yielding just 1% or 2% interest cannot provide. With the futures of programs such as social security and employer sponsored pensions uncertain, people must provide at least a part of their retirement income themselves. Understanding what is investment is only half the battle, knowing where to put money is also important.