The world of investing can be confusing for most people. Hearing words like stocks, bonds, and principal can seem like a different language. But the more you understand about investing, the higher chance of success you can have. Here are just a few of the general concepts you should know when investing:
Risk is an inevitable part of investing. The key is to balance that risk with reward. “The risk/reward ratio helps investors manage their risk of losing money on trades.”1 For example, if you have a risk ratio of 1:3, you’d have three units of expected return for every one unit of additional risk.1 Everyone has a different risk tolerance level and it’s important to understand yours before investing.
“Diversification is a risk management strategy that mixes a wide variety of investments within a portfolio.”2 Diversification can also be described as not putting all your eggs in one basket. Many people diversify by placing their money into different investment vehicles such as stocks, bonds, real estate, exchange-traded funds (ETFs), etc. It’s a way to help protect from downside risk over the long-term.
“Rebalancing is the process of realigning weightings of a portfolio of assets.”3 Through this process, investors monitor stocks to buy and sell based on their risk tolerance. If a certain stock is projected to go up soon, one option could be to sell a stock that is not doing as well and reallocate those funds. A financial professional can help by keeping a close eye on your portfolio and helping you make the decision on when and how to rebalance.
“A bull market is the condition of a financial market in which prices are rising or are expected to rise.”4
This occurs when stocks rise by 20% after two declines of 20% each.4 The term applies not only to stocks, but bonds, real estate, currencies, and commodities as well. Investors are generally more optimistic during a bull market, but it’s important to remember that what goes up must come down.
“A bear market is when a market experiences prolonged price declines…in which securities prices fall 20% or more from recent highs.”5 The decline typically comes from negative expectations of companies in the stock market. During this time, many investors turn to other investment vehicles or rebalance their portfolio. No investor likes a bear market, but it’s something we have to prepare for.
If thinking about these investing concepts leaves you overwhelmed, you’re not alone. The good news is a financial professional can help walk you through each of these concepts and more, as well as help you make the best decisions for your financial situation. You can also learn more general investing concepts by registering for an American Retirement Institute course here!