What are the basic concepts of successful investing?

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Answered by: Mark, An Expert in the Investing 101 Category
Investors need to understand the four basic concepts of successful investing when starting out. These concepts are: risk, timeframe, equity, and debt.

"Risk" refers to the investor's psychological sensitivity to the changes in prices that most investments undergo on a day-to-day, and even second-by-second, basis. Investments whose price swings very wildly are perceived to be high risk. Investments whose price barely changes are perceived to be low risk. The changes in prices themselves are called the "volatility" of the investment. Low volatility investments do not undergo dramatic swings in their prices, while high volatility investments almost constantly experience dramatic increases and decreases in their price. But please do not confuse volatility with risk: the later is a matter of the investor's own perception and preferences. An investor with a high risk tolerance will be able to buy and hold a very high volatility investment, without being troubled by the often wild swings in the investment's price.



"Timeframe" refers to the investor's expectation of when in the future they will need to withdraw the money that they are investing. A short timeframe implies that investors should prefer safer, less risky assets. While a long timeframe implies that investors should prefer riskier, more volatile assets. Of course, in both cases we are assuming that investors want to maximize the return from their investment!

"Equity" refers to the purchase of shares (called "stock") in a company, which allows an investor to participate in the growth and market success of the company. Equity investments tend to be very risky, as their price can move dramatically depending on how the market perceives the business which issued the shares. Equities reward investors who purchase them by paying a dividend, which is usually around 2% of the market value of a share of the company's stock. The return from investing in company stock, then, is the total dividends paid in the timeframe over which the stock is owned by the investor plus the gain (or decrease) in the market price for shares of the company. Since some companies can grow their business very quickly, owning equities, especially over very long timeframes, can be very profitable for investors.



"Debt" refers to the act of lending money--usually to either a company or a government--in exchange for routine interest payments and, eventually, return of the original amount of money lent (which is called the "principal"). Interest payments are often paid out monthly, and their value is proportional to the chance that the company or government not be able meet all of its obligations to pay interest or, eventually, return the principal. High risk debt obligations pay greater interest (sometimes as high as 10%), while very low risk debt obligations pay very little interest--and in recent years, some debt obligations have even started to pay negative interest!

Those concepts--risk, timeframe, equity, and debt--are the four basic concepts of successful investing. An investor who has a long time frame and can accept high risk should buy and hold only equities, and an investor who has either a very low tolerance for risk or who is investing only according to a short time frame should buy only debt. Most investors fall somewhere in between, and for them, the appropriate investment should be a mix of debt and equities. But the only sure thing in investing is that the longer an investor's timeframe is, the more likely that they will make profitable investments, no matter which mix of equity and debt is chosen.

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