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Do you know what passive income and socially responsible investing are? What about dividends? Would you like to understand investing better?
If you want to make sure you have enough money for the rest of your life, you’ll benefit from understanding investing terminology and basic principles. Knowing the ins and outs of risk tolerance, investment fees, and the like will give you—and your money—an advantage.
Read on to understand investing better.
Understand Investing to Maximize Your Financial Security
Imagine having enough money coming into your life through passive income that paid employment is optional. It’s not about getting huge amounts of money but about knowing how to invest so that you have enough money for the remainder of your life.
The more you understand investing terminology and principles, the more you’ll have a handle on smart investing.
Investing Terminology
Passive Income
Passive income is another way of saying “investment income”—money you don’t work to earn.
You can earn passive income from investments in five different ways (and you can see that passive income has investing terminology of its own):
- Interest. If you invest capital in certificates of deposit, bonds, or savings accounts, the money accrues interest over time.
- Rent. This is any payment you receive from renting out estate property that you own. It is the money you received, minus any associated expenses, like taxes or repairs.
- Dividends. You’ll get paid dividends, or a slice of profits, if you’re the owner of a private company, or if you invest in ETFs, stocks, or mutual funds.
- Royalties. If you own a patent, natural resources, or a franchise, you’ll earn money through royalty payments when others use the property.
- Capital gains. If you sell stock or real estate, you’ll earn capital gains: earnings from the sale that exceed the money you invested when you purchased it.
Risk Tolerance
Risk tolerance is your willingness to make risky investments. It’s a spectrum from not wanting to risk any capital to wanting to risk all of your capital in return for large gains.
Your willingness to make risky investments depends on many factors, which include:
- How you were raised
- Beliefs about money
- Age
- Time horizon—how quickly you expect to need access to your investments.
- Crossover point—you may take more risks to build wealth quickly ahead of reaching your crossover point (though not in all cases). After your crossover point, you’ll want to invest in less risky instruments to preserve your wealth.
Age and time horizon are the two most significant factors. If you have multiple decades to go until you retire, it’s customary advice to invest 90 percent of your capital in stocks and 10 percent in bonds. Later in life (or if you’re more conservative) you might invest 20 percent in stocks and 80 percent in bonds. Conservative investing ensures that your monthly investment income is greater than your expenses, no matter the state of the economy.
The more you understand investing, the more this sense of risk will come naturally.
Fees
To avoid incurring lots of fees, choose investment options that aren’t actively managed. Not only do they have lower fees, they generally outperform actively managed options.
Financial Advisor
Investing can be time-consuming. As someone who can understand investing on a higher level, a financial advisor provides expertise and aligns your investments with your risk tolerance as markets shift. Take time to research financial advisors to make sure you get your money’s worth.
Socially Responsible Investing (SRI)
Socially Responsible Investing is investing in companies that align with your environmental and social values. It began during the Vietnam War, when people sought to divest from companies supporting the war effort. SRI financial advising services research company practices to ensure that they align with best practices, like paying workers a living wage. Today, SRI investments account for 22 percent of all professionally managed money.
SRI investments generally match or exceed the return of traditional investments. However, the research involved generally makes it more expensive than conventional financial advising. If you’re unsure whether to pursue this or standard financial advising, look at the cost difference over the long term and assess if it would be worth it given the quality assurance inherent in SRI.
Understanding investing terminology and principles is key to smart investing. Now you know the basics.
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