Three Basic Financial Concepts for Investors
The basic financial concepts that investors need to get a handle on in order to be successful are not very complex. For starters, successful financial planning starts with spending less than you earn, minimizing or eliminating debt, building an emergency savings fund, and understanding and planning for future financial needs. With these basic steps in order, investors can develop strategies for building wealth through investing. In achieving these larger, longer-term goals the following three financial concepts should be kept in mind and considered as you implement your investing strategies.
Time Value of Money- The time value of money is a basic financial principle that applies to both personal and corporate finance. This concept says that money you can have right away is worth more to you than the same amount will be in the future. The reason for this is that money you have access to today offers you with potential for earning and growth through investing or paying off debts. The time value of money concept is similar to the idea of opportunity cost which instructs investors to compare an investment opportunity against any opportunity they will have to forego in favor of choosing that investment opportunity.
Risk v. Return- The risk/return tradeoff expresses the idea that rational investors expect to be properly compensated for taking on investment risk. Simply put, the greater the return sought by an investor, the more risk they will likely need to endure. It is important for investors to understand that higher risk only allows for the possibility of higher returns and that these greater returns are not guaranteed. This rule should also serve as a reminder to investors that they need to implement an investment strategy that they are comfortable with in terms of the level of risk they can tolerate.
Quiz: Determine your risk tolerance
Diversification- Diversification is the financial implementation of the idea that you shouldn’t “put all your eggs in one basket”. For investors, diversification is about reducing risk by investing in a number of assets with varying characteristics. Asset classes including stocks, bonds, certificates of deposit, real estate, and more might be included in a well-diversified portfolio that seeks to maximize investment returns while minimizing risk. The precise mix of investment classes will depend upon the investor’s risk tolerance and their investment timeframe.
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The above information is educational and should not be interpreted as financial advice. For advice that is specific to your circumstances, you should consult a financial or tax advisor.
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