Learning where to invest your money can leave you feeling overwhelmed.
Bonds? Stocks? Day trading? What does it all mean, and which one is right for you?
While investments can all look the same from a distance, their risks, returns, and level of commitment vary. Investing is essential if you want to see significant growth in savings over time, but before you take the leap, it’s a good idea to understand the differences.
Today we’re looking at a range of investment options to help you decide which is right for you:
Governments and corporations create bonds as a way of raising money. Purchasing a bond is like giving these entities a loan to fund their operations. The bond issuer agrees that you, as the investor, will be repaid the face value of the loan as well as market-rate interest.
Like most investments, there is a risk of losing money in bonds, especially if you sell it during a market downturn or before it matures. The most common bond risks include:
Interest rate risk: When interest rates rise, the value of bonds decreases. When interest rates fall, the value of bonds increases. When there is a sharp increase in interest rates over a short time, bonds can lose significant value.
Liquidity risk: If you want to sell a bond, there is a risk that you may not be able to find a buyer. The harder it is to sell a bond, the more you will have to reduce its price. Bonds that trade frequently show there is plenty of buying interest.
Reinvestment risk: There is a chance that you will have to reinvest your money from sold bonds into new bonds with a lower yield. To get around this, investors may purchase longer-term investments. However, this can lead to a higher exposure of interest rate risk.
Credit risk: As bonds are essentially a loan, there is a risk that the creditor will fail to make a repayment. The more a creditor defaults on repayments, the higher the risk of a bond losing value.
Bonds have the potential to supply a steady income stream, making interest payments to holders twice a year. If held to maturity, bond investors also receive their entire principal payment, making them a great option for preserving capital and a relatively secure investment compared with stocks.
Bonds also aren’t as prone to volatility as stocks, and their prices tend to rise when stocks fall.
In times of market downturn, bonds are considered a safe haven.
Like all investments, there’s a lot to consider when buying bonds. Firstly, make sure the creditor can pay its bonds. You can judge a creditor’s repayment ability by looking at their assigned credit rating. To avoid significant credit risk, choose bonds with an AAA, AA or A credit rating.
A stock is a share in the ownership of a company. Companies sell shares to raise money to fund their operations and grow their business. The trick to buying stocks is to invest in companies that you think will increase in value. The higher the value of a company, the higher the value of your stocks.
There is no such thing as a risk-free stock, and some are more volatile than others. Despite your best efforts, there is a risk of losing money if the company you’ve invested in goes bust. There are many risks involved in stocks, but the three most common risks are:
Volatility: Certain events can cause dramatic volatility in stocks, resulting in sharp increases or decreases in value. Events that cause stock volatility include:
Stock volatility creates risks out of your control, but there are several ways to protect yourself from significant impact.
Becoming overconfident: Treating the stock market as a gambling opportunity can have serious financial consequences. While savvy stock investors can have great success, there’s an element of luck for everyone in the stock market. Personal skill is not the be-all-end-all of stock success.
Timing risk: It’s almost impossible to know when is the right time to buy or sell stocks. While we all want to purchase at a low price and sell at a high price, there’s no way to predict when stocks will be at their “lowest or highest”. Following the stock market prior to investing will give you an insight into stock stability and help you time your investment.
If you’re not ready to leap into high-risk investments like stocks, experts from some of the world’s leading banks and credit unions including Bank of America, Barclays, and NZCU Baywide recommend starting with safer options such as certificates of deposit (CD), term deposits, or time deposits for a safer, short- or long-term investment.
Stocks have the potential to yield a significant financial return. While risk is prevalent in buying and selling stocks, careful and clever trading makes it easier to mitigate these risks and achieve long-term monetary gain. Stocks are a great investment if you have time up your sleeve and want to see earnings on investment over ten years or more. This also gives stocks time to recover from any dips in value.
Owning stocks also means you receive income from dividends. Dividends are paid even when stocks lose value, providing steady financial reward regardless of stability.
Unlike stocks and bonds, day trading is the buying and selling of assets over short periods. As we’re talking hours, minutes, or even seconds, day trading means having your finger on the pulse.
Day traders catch small fluctuations in highly liquid stocks and complete numerous transactions each day. Rather than wait for one stock to rise in value long-term, day traders cash in on small rises across many stocks each day.
Day trading requires a high level of marketplace knowledge and the ability to identify stock fluctuations quickly. The biggest risk is not knowing what you’re doing.
The cost of purchasing stocks to begin your portfolio is high, and amateur traders risk losing it all if they’re not equipped with the proper knowledge. There is no guarantee that a day trader will make money on any given day. It’s a process of following the marketplace carefully and hoping for the right price variations.
Many view day trading as a ‘get rich quick’ technique. However, this is only possible for educated traders. One small mistake can lead to major financial loss.
Along with the investment expense, day trading also requires specific software to access the correct financial information. This means day trading comes with high set-up costs, and you need to be prepared to make a loss in the early days.
Provided you’re prepared to take risks, day trading can be very lucrative. With a good knowledge of the marketplace, day trading can become your sole source of income. Once you find the strategy that works for you, you can work at your own pace.
All-day trading transactions are completed in one day, avoiding exposure to overnight risk. If the market fluctuates overnight, day traders won’t be affected.
Day trading has the potential to bring in large amounts of money as long as traders develop a high-yield strategy and remain disciplined in catching the right marketplace movements.
Bonds, stocks and day trading will never be risk-free. However, some risks are more manageable than others. Where you invest your money will depend on several factors, including age, income, and the level of risk you’re prepared to take. When you’re ready to enter the exciting world of day trading, take our FREE mini-course and get clued up!