How do investments work?


How do investments work?

Investments are not a game of chance. As with many other areas of life, the same applies here: Information is half the battle. Anyone who invests money should know in advance exactly what things are important. This requires a certain amount of specialist knowledge. Newcomers in particular should familiarize themselves with the basics of investing. Here are some of them for those interested in the stock market:

Inform yourself thoroughly in advance

Investors can learn financial knowledge through specialist media, stock market seminars, and training programs. In this way, valuable stock market knowledge can be acquired, such as how stock market trading works, which asset classes, and which financial products are available. When it comes to investing, is also a matter of lifelong learning. Anyone who knows the basic workings of markets and financial products has no choice but to stay informed with the latest news before he or she invests capital. An investor who wants to invest in the shares of an automotive company, for example, should take a closer look at both the current general economic situation surrounding the industry and the business of the company in question. After all, the success of equity investments depends crucially on how profitable the companies in question will be in the future. Because - and this is also part of the basic knowledge of the stock market: Shareholders are shareholders of the company. If the company makes a profit, investors can profit from this in the form of dividends and share price increases.

Do not put all your eggs in one basket

The basic goal of investing is clear: to make as high a profit as possible and suffer as few losses as possible. However, investors should not put all their eggs in one basket. Time and time again, there are tragic examples of investors specializing in just one stock or in just a few stocks in a particular sector. A well-known example in Germany is the Deutsche Telekom share, which triggered a veritable hype at the end of the 1990s - even among stock market newcomers. After a veritable price rally, the stock plummeted a few years later. Basically, it wasn't Deutsche Telekom that was to blame, but the investors themselves. Had they not focused on just one stock and instead invested in many shares from several countries and sectors, they would have fared better. It would have been even better if they had also invested in other asset classes such as bonds and real estate, i.e. diversified their portfolio. The principle behind this is simple: If one asset class loses value, other asset classes could compensate for the loss or at least reduce it. One asset should develop itself as independently as possible from the other asset classes. This is the case, for example, with equities and bonds.

Investors ask themselves often, what percentage of their capital they should invest in equities. In principle, equities are more volatile than bonds, but they also offer higher potential returns. At the same time, the greater range of fluctuation also means that the risk is higher. How high the ratio should also depend above all on the investor's willingness to take risks. The higher the equity ratio, the more offensive the investment. In the end, everyone must decide this for themselves. In addition, there is a rule of thumb: 100 minus age. Accordingly, a 30-year-old would invest 70 percent of his capital in stocks. A 60-year-old, on the other hand, would invest only 40 percent. The idea behind this is: With increasing age, the share quota decreases because one has less and less lifetime to be successful with the volatile asset class of shares. If you have more time, you can invest your money for longer and ride out price dips in equities better. For example, it would be tragic for a retiree if his assets suddenly lost a large part of their value due to price dips. For this reason, older people are advised to switch their portfolios from equities to less volatile assets at an early stage.

Only invest in available capital

If you invest money in the financial markets, you should only invest with freely available capital. In other words, money that you do not need to finance your life. For example, an investor who wants to buy a new car in two years' time would be best advised to put aside the money already available for this purpose, for example in a savings account or call money account. If he were to invest it in shares instead, in order to finance the car later from the proceeds of the share sales, this might not work. Namely, if the prices go down and he ends up with less money than before the investment. Investors can determine their own liquidity status by calculating all fixed monthly costs and expenses in advance.

Patience is required when investing money

It is important that investors are convinced of their investment decision. Of course, it may happen that their (market) expectation is not fulfilled and the returns fail to materialize. Then it is a matter of selling the position or continuing to hold it. When making this decision, it can help if investors make it clear in advance what loss exceeds the pain threshold. In this case, you know exactly when you should part with your investment. However, many investors make the mistake of quickly panicking and pressing the "sell button" when the performance of their investment is unfavorable to them. Example of equity investment: The investor uses index funds to focus on leading indices of developed regions such as the USA, Europe, and Japan. In the next year, the global economic crisis occurs and the stock indices collapse. The investor is disappointed and gets out of the stock business with a big loss. However, experience has shown that major stock markets perform positively over the long term - ten years or more. If one assumes that companies in large economies will in future do what they were created to do - namely generate profits - one should be patient and remain invested. In this way, investors can ride out periods of crisis and get into the black in the long run.

Remain skeptical about stock tips

How often do you read, hear and see something about so-called price rockets and shares in which you absolutely have to invest now in order to be able to participate in high, if not exorbitant, profits? At the latest then investors should become suspicious. Why should someone reveal their "ultimate" stock tip? If the recommended share were really so profitable, he or she could invest his or her own money and cash in on it. It is better to form your own opinion about a company or a share. For example, you should ask yourself: Does the stock have price potential, and why? Does the company in question have a promising business model? When looking for promising stocks, it makes sense to look at well-founded reports and assessments by established stock market experts or media. For example, specialist editorial departments, analysts, and stock market professionals usually have a better and deeper insight than you do. Nevertheless, at the end of the day, investors have to weigh up the possible advantages and disadvantages of investment and assess for themselves what the chances are of making a profit with this or that share.

A guideline for Investors:

  • The investor is himself. It is hardly possible without acquiring certain specialist knowledge.
  • It is always advantageous to spread one's capital across different stocks, regions, and industries. In this way, investors spread the risk over several shoulders.
  • You should invest only the money that you do not need for everyday life.
  • Sensible investors should keep a cool head in the face of declines in value and take a strategic approach to their investments.
  • Take note of stock market information and inform yourself, but judge for yourself whether the stock investment makes sense or not.

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