One of the first things to understand in personal finance is the difference between saving vs investing. Budgeting helps you manage your income effectively so that after you meet all your expenses, you have some money left and that’s your savings. Once you have money saved, the best way to utilise it is to invest it in different assets such as mutual funds. But before you begin investing, here are some basic investing concepts you should know:
- Risk vs reward
Returns are the reward when it comes to investing and the higher the risk, the higher the reward will be. Every investment product comes with its own risk-return profile, and you need to consider both aspects before making an investment.
Compounding or compound interest helps your money earn you more returns. When you invest in a certain product, you earn interest or returns on it. Compound interest not only earns you more money on the principal amount you invested but also on the interest that investment has earned, and this cycle continues.
Inflation is a general increase in the price levels of goods and services in an economy. So, effectively, what inflation does is reduce the value of money you have right now over time. Investing in certain assets such as stocks and different types of mutual funds can help maintain your money’s real worth over time by earning returns at a rate that is higher than the inflation rate in the economy.
- Market volatility
You must have constantly heard that the stock market is volatile. But what does this mean? Simply put, market volatility is the stock price fluctuations – by how much the price moves up or down in a given period. Stock price fluctuations can be triggered by a variety of micro and macro level factors like geopolitical disruptions, inflation, the announcement of the company’s financials, etc. While the stock market as a whole is volatile, some stocks tend to be more volatile while others are more stable.
- Rupee-cost averaging
This involves investing a fixed amount of money at regular intervals irrespective of how the market is performing. This allows you to lower the impact of market volatility on your investment as you buy less when the price is high and buy more when the price is low. Systematic Investment Plans (SIPs) in mutual funds allow you to leverage rupee-cost averaging so that you don’t have to time the market and you can keep saving and investing in a disciplined manner.
Not all asset classes or investments come with the same risk-return profile or are impacted by the same factors in the same way. So, by investing in different types of asset classes, you are hedging the risk of one investment underperforming by others that perform well so that your overall investment portfolio is not hit. People invest in mutual funds because mutual fund investments are known for their benefit of diversification as a mutual fund scheme has a basket of underlying securities and is well-diversified.
- Market capitalisation
Every company has a market capitalisation and essentially it is that company’s market value. Market capitalisation is based on the market price of the company’s shares and its outstanding shares. Based on market capitalisation, companies are categorised as large-cap, mid-cap, and small-cap. There are different types of equity mutual funds that either solely invest in stocks of companies of one type of market capitalisation or invest across market capitalisations. You can select an equity fund based on which market segment you’d like to invest in.
- Growth vs value investing
These are two primary strategies that investors tend to follow. In growth investing, investors look for companies that are focusing on rapid growth and expansion either through new product lines, new markets, acquisitions, etc., and they tend to reinvest most of their profits for funding expansion plans. Value investing involves conducting a thorough analysis of a company’s financials and fundamentals to identify stocks that are undervalued in comparison to the company’s real worth. Here the investors believe that the stock prices will rise at some point to align with the company’s real value.
These investing concepts are good to get you started. Once you begin investing, you will gradually learn more investing concepts that will help you in your journey to wealth creation.