In this post, I will discuss why and how people make investments. I will also briefly describe various forms of traditional short-term and long-term investments.

Why to Invest your Money

There are various reasons why you should invest your money. The most common are to save for retirement, to pay for your kids’ college education, to acquire a down payment for a home, or to save up to go on holiday.

However the crucial underlying motive behind all these reasons, why you should invest is to create wealth. And one of the surest ways of creating wealth is by investing in the stock market.

If you invest in the stock market over a long period of time you benefit from what is called the law of compounding. This means that….
…..If you invest your money in something like a stock, and you earn interest in that investment.
…..And rather than spend that interest, you add it to the original money you invested.
…..And time and time again you keep repeating the same action….taking the interest and adding it to your original sum.
….Then your investment can start to grow very quickly. And before you know it, you can accumulate a lot of money.
….This is known as the law of compounding.

To explain this better lets look at an example.

Lets say you have 100 dollars that you can commit to investing.
After a number of years of saving this amount at 10% interest, this is how your money will grow:

Year 0 – $100 – start
Year 1 – $115
Year 2 – $132.25
Year 3 – $152.09
Year 4 – $174.90
Year 5 -$201.13
And
Year 10 – $405
Year 15 – $814
Year 25 – $3292

Another example is if when you are in your early twenties and you start investing $1000 every year. And you keep investing that $1000 dollars every year for 46 years. And every year that investment grows, or rises in value by over 11 percent. Then after 46 years that investment will be worth 1 million dollars.

And by the way the stock market has risen in value by on average 11 percent every year since 1926.

How to invest your Money

To get the maximum value from the hard earned money that you earn, you must first pay off any high interest debt you have such as credit cards, loans, or store cards.

The reason you should get rid of all high interest debt is because high interest debt is affected in the same way by the law of compounding. However, the law of compounding works in the reverse way. The more debt you have, the quicker it grows till it becomes a very unmanageable burden. So by getting rid of your high interest debt you are actually starting the process of saving and investing.

After you have gotten rid of your debt, the next thing to consider is your goals for saving.

People are different from each other. People have different needs. People are at different stages of their lives. People have different tolerance levels for taking risks. Some don’t mind high-risk investments, while others prefer to be cautious.

You have to think of all these issues and then pick the right kind of investments or combinations of investments that suit your purpose.

In general however, most people make two kinds of investments. These are short-term investments and long-term investments.

Traditional Short-Term Investments

If your intention is to invest for short-term purposes there are a variety of ways you can do this. Two of these include:

Opening a savings account at your bank, credit union, or with an online savings company. These however earn very small interest rates ranging from 0.1% to 5%. You should consider opening an online savings account from a bank or other financial company offering these kinds of accounts. Online savings accounts in general tend to pay higher interest rates than savings accounts opened with high street brick and mortar banks.

Investing in Certificates of Deposit (CDs), which are money deposits you make at a bank or other financial organization for a fixed period of time in the short or immediate term. For example there are CDs that have a life of 6 months or one year. Once you make this investment, interest is paid on your CD at regular intervals, for example at the end of every month. Once the term of CD expires…. for example a 6 month CD will expire in six months. Once the CD expires, then you are paid the original sum you invested in the CD plus all the interest earned over the life of the CD.

Traditional Long-Term Investments

If your intention is to invest for the long-term, there are a variety of ways you can do this. These include:

Buying Bonds, which are also known as fixed-income securities. Bonds are called fixed-income securities because the amount of income the bond earns every year is fixed…it is decided when the bond is sold to you.

Investing in mutual funds, which are investments that allow people to put their money together to buy stocks, bonds and other kinds of investments. Professional money managers manage mutual funds. When you invest in a mutual fund, you hand over a certain amount of money to the managers of the fund you choose. The manager of the fund then uses your money together with those collected from other investors to buy stocks, shares and other kinds of investments. For this service, the fund charges a fee in the form of a percentage of the money you invested.

Investing in Index Funds, which are collective schemes that have the goal of replicating the movements of an index of a particular financial market. The Dow, S&P 500, Nasdaq 100, and the Wiltshire 5000 are all particular kinds of indexes. Each of these indexes represents a broad sampling of US traded stocks. For instance, if you invest in an index fund that represents S&P 500, you are investing in a fund that tracks the movements of average value of 500 large cap common stocks traded in the United States. The main advantage of index funds is that they have lower management fees than other types of funds. Their expense ratios range from about 0.18% to about 0.25%, while for other types of funds the expense ratios range on average from about 1.5% to 2.0%. And the reason for this is that they are not actively managed funds. Another advantage of investing in managed funds is that they are deemed to perform better than actively managed funds.

Investing in Exchange Traded Funds (ETFs), which are collections of shares, packaged for sale on the stock market. In other words, ETFs are index funds that are traded like shares on the stock market. The underlying assets of an ETF can mirror the price movements of an underlying share portfolio of an index such as the Nasdaq 100, a sector such as utilities, or a commodity such as corn. The advantages of investing in ETFs are that they have low costs, are tax efficient, and have the qualities of stocks. In addition, when you own an ETF, you bring diversification in the form of an index fund to your portfolio. ETFs also have the advantage of being a form of investment with easy access, in the sense that small savers can gain entry by buying just one share, or as much as they are able to afford.

Investing in Stocks, which are proportionate shares of the ownership of a company which is listed on a stock exchange. Acquiring a company’s stock makes you part owner of that company. And ownership means that you are entitled to the earnings that company produces, as well as the right to vote on matters pertaining to that stock. If a company makes good business decisions and it does well, then in most circumstances, the price of the stock goes up. If it makes bad decisions, the price goes down. So, there are a number of important issues to consider when deciding whether to invest in the stocks of a particular company. These include whether that company is making good business decisions, has good management, and is profitable or has the potential to be profitable in its business endeavors.

Contributing to a Retirement Plan, which for many employed individuals entails making good use of company sponsored schemes such as 401Ks, pensions plans, and superannuation schemes. These schemes are normally very good options for investment because many companies and organizations partly or fully match the contributions their employees make to them. This means the relative returns that employees get on these retirement schemes are much higher than other forms of traditional investments.