Many dream of financial freedom. That freedom is the moment in which you can finally stop worrying about how much money you have in the bank. It is also the moment when you can start spending more time on things that matter most to you: family and friends, hobbies, charities, etc. The lucky ones inherit wealth or win the lottery. For the vast majority of us, however, investing is the most reliable path to financial freedom.
The basic principles of investing for beginners are in fact simple. They are simple to understand. But you need the desire to learn, will-power and the discipline to start investing. Getting started is the key. You might ask: how can I get started without capital to invest? What follows is a roadmap of investing for beginners that can set you on the path to financial freedom.
First things first: the self-check
The start line of investing for beginners is drawn before you even make your first investment. It doesn’t start with your money but it starts with you. It starts with how you imagine your financial freedom needs to look like.
For some, freedom might mean having a steady inflow of money and securing enough of it for a comfortable retirement when you are 65. Security more than complete freedom is what you might desire. For others, it might mean quitting their jobs at 50 and living the rest of theirs lives travelling and playing golf. So how you go about investing will very much depend on what kind of future you want for yourself and your family.
The second proposition certainly sounds a lot more attractive. Being able to afford quitting your job at a relatively young age is something a lot of folks desire. But having a very long and luxurious retirement as a goal, necessarily comes with risks. What sort of goal should strive for?
To answer that fundamental question, you should take two factors into account. One is straightforward: your age. If you are in your early 20s and life expectancy in your country is around 80, it is likely that you have 60 more years in front of you. If this is the case, you should plan how to secure enough financial resources for the most important events in those years (starting a family, buying a home, retiring, etc). The more time you have, the better.
If you are 40 however, and aim to retire at 60 living comfortably thereafter, you will need to save a lot more money every year or take riskier bets (or most likely a combination of both). If you start at 25, you do not have to put aside a whole lot of money from your paycheck or gamble with your savings in risky investment. Alarmingly, the savings rate of Americans under 35 is actually negative 2% (they are getting into debt) and of those between 35 and 44 it is a meager 3%.
So rule number one of investing for beginners is to stop procrastinating and start as early as possible. Average life expectancy in Europe and the US is around 78. Thus, an American who aims to retire at 65 can make a good guess that she/he will need enough money for almost 15 years of retirement period.
Time can be a powerful advantage in your investment strategy and that’s down to compound interests. Albert Einstein once said that compound interest is the most powerful force in the universe. The math involved in it is fairly simple. If you invest $100 today and you are promised a return of 10%, in a year from now you will have $110. For the second year, the rate will apply to the original $100 you put in plus the $10 you gained in the first one.
In 8 years, the initial investment would have more than doubled. Even those new to investment should use this force to their advantage. Try an online compound calculator to see how much your money can grow over time.
The second factor is not as straightforward because it is quite subjective: your risk tolerance. While you will definitely know your age, you might not necessarily know how much you can tolerate risk. If you rather let a professional investor do the investment for you, you can expect that she/he will first try to understand how much risk you can stomach. Are you young, with few financial liabilities, and can therefore afford to invest aggressively? Or are you happy making slow but steady progress towards a retirement period almost free of financial troubles?
Here’s rule number two: know your risk tolerance. If you have never thought about this before, there are some tools on the web that will help you make that assessment. One of them is provided by Merril Lynch Wealth Management.
Getting ready to make your first investment
Once you have gone through the basic self-assessment, the process of investing for beginners should start to become less complex. But there are two more basic rules you need to keep in mind. For sure, you cannot invest if you do not have some capital available. If your income comes from your job, you need to save early, as we already learned.
But you won’t be able to save if too much of your income is going to expenses associated with debt.
Rule number three is to pay off your debt as early as possible. Pay those loans and credit card debt that have higher interest rates first. Debt is not bad in itself. However, too much of it can significantly slow you down as you try to reach your financial goals. Note that the Americans who graduate from university start off with a serious financial burden. Average student loan debt there is about $30,000. No wonder the savings rate for Americans under 35 mentioned earlier is so low.
The fourth rule of investing for beginners is often ignored. It is a good idea to have a rainy-day fund in case you lose your job, become unable to work or face large unexpected expenses like medical bills. The rule of thumb is to have enough savings for 6 months to pay for basic expenses while you get back on your feet. You should decide how much you want to put into an emergency fund. But you should have one regardless. An unexpected misfortune can derail your investment plans. So build a defense mechanism before you play offense (read: investing).
Investing for beginners: where to invest
Now that you know your goals and risk tolerance, and have paid most of your debt off and saved enough to withstand a financial misfortune, you can now focus on investing. Up to this point, you have worked for money and now you have the opportunity to let money work for you. Most of the information available that serves as a guide for investing for beginners concentrate on the most obvious investment channels.
Let’s go very briefly through some of the traditional investment channels. You should already be familiar with a savings account. A money market account is something similar to a savings account; the difference is that it requires a minimum amount to be put in, and the yield is higher than experienced with a normal savings account. Still, you should not expect to gain much by putting money into savings and money market accounts because the rates are very low. On the plus side, your investment in those accounts is virtually risk-free. In the United States, for instance, up to $250,000 is insured by the government. Remember, the lower the risk, the lower you can expect to gain.
A similar, almost risk-free investment option are bonds. By investing in bonds, you are in essence lending a government (might be the national government or a municipality) money. In exchange, that government promises to repay you the original amount plus interest after a pre-determined amount of time has passed.
Countries with rock solid economies pay quite low interest rates for the bonds they issue. The interest rate is tied to their ability to pay you back (plus interests) later down the road. While the interest rate for German bonds is 0.79% (as of 5/9/2015), the interest rate of Greek bonds stands at 9.39%.
A riskier but potentially more profitable option are stocks and mutuals funds. When you buy a stock, it is basically like buying a piece (a share) of a publicly traded company. The stock value of a company can vary significantly even within a day so you can win or lose a lot. Most of the loss or profit will come from the change in the stock value because many companies don’t even pay dividends.
Dividends are the earnings of a company that are distributed to its stockholders. Stocks come in many shapes and forms but this is basically what they are. I am not going to get into the topic of which stocks to buy. In a short video, the famed hedge fund manager Bill Ackman provides a straightforward list of factors to consider when deciding what stocks to buy from which company.
A final option of investment for beginners are mutual funds. They are the closest you can come to hiring a professional investor to manage your money on your behalf. You investment is pooled with the investment of other people and the pooled amount is invested in different options. Like stocks, these also come in different shapes and colors but the basic idea is that your money is invested so as to maximize profits and minimize risks. If you definitely do not want to spend the time researching where to invest your money, mutual funds are a reasonable option of investment for beginners.
Innovative investment options
The level of trust placed in financial institutions like banks took a severe hit after the 2008 global financial crisis. Trust has been in decline ever since. According to the Edelman Trust Barometer of 2015, only 4 out of 10 in the UK trust the financial services industry. It enjoys marginally higher trust among Americans but it is still low: about 1 in 2. Such high levels of mistrust have likely fueled the desire among investors to circumvent banks and try alternative investments in order to accomplish their investment goals.
For sure, traditional financial institutions still dominate and control most of the flow of money. Many are not even aware that there are alternative ways to invest. A study shows that roughly 40% of the UK’s population haven’t even heard of alternative investments. And of those who have, about 60%, only 14% of the total, have first-hand experience. However, even with low public awareness, alternative investment options have been making wide strides in the last years. The same study puts the market size of alternative investments at £1.74 Billion in the UK alone. The number represents a eye-popping growth of about 160% between 2013 and 2014.
These numbers should call the attention of bankers. But why should you care? Technology has expanded the options of investment for beginners. Now it is a whole lot easier to become an investor. Banks and other traditional financial institutions have been the main gatekeepers of investments. But now you are not forced to ask them (read: pay them a fee) to let you start investing.
Due to space constraints, the following list is by no means exhaustive. However, it does shine a light on the best ways for beginners to start investing . At number 1 on the list are peer-to-peer (P2P) lending platforms. There is business P2P, which is lending to small to medium-sized businesses looking for loans. And there is personal or consumer P2P in which ordinary folks looking to finance their education or the purchase of a new car.
P2P platforms, as the names suggests, do not borrow or invest any money themselves. They simply provide the platform for borrowers and investors to meet and interact with each other. And they ensure that their marketplace functions efficiently and transparently. In the United States, P2P platforms issued $5.5 billion in loans in 2013; by 2050 this market could reach $150 billion.
Other platforms for beginners to invest on are invoice trading, equity crowdfunding, community shares and pension-led funding. More exist,but P2P represents the lion’s share, especially business P2P platforms:
Source: Nesta (2014)
Conventional p2p versus bitcoin p2p platforms
A step further in the search for innovative investment for beginners leads us to P2P platforms facilitated by bitcoin. From an investor’s perspectives, these types of bitcoin-based platforms share the benefits and risks that conventional P2P platforms have. The most important benefit is the higher returns on investment. On average, investors on P2P lending platforms receive a return of 8% link to source.
The significantly higher rate of return compared to traditional investment, is what has fueled the enormous growth of p2p’smarket size in the last years.
Another important advantage is the ability to diversify your investment portfolio globally.Because bitcoin works independently of the banking system, p2p bitcoin lending platforms like Bitbond can operate with significantly less overheads. The consequent savings are passed on to the borrowers and investors. Thus, investing on p2p lending platforms like Bitbond is absolutely free.
Bitcoin P2P lending has another significant edge over their conventional P2P counterparts when it comes to the benefits it affords to inexperienced investors. Investors of bitcoin P2P platforms have access to borrowers around the world. This extraordinary reach translates into higher interest rates.
The reason for this is that borrowers in many developing economies are willing to pay high interest rates compared to borrowers in western Europe or the US. That willingness to pay reflects their countries’ interest rates and their difficulty accessing loans. The real interest rate in Brazil, for instance, is almost 24%.
It makes sense for borrowers in Brazil to pay 15% elsewhere, a rate that would turn off most Americans or Europeans. Besides the higher ROI’s, investors can benefit from a globally diversified portfolio. This is beneficial because it enables you to minimise risk, by spreading your investments across geographical regions.
Recent economic collapses in Cyprus and Greece have shown the dangers of investing solely in one country. Bitcoin p2p lending allows you to minimise the effects of regional macroeconomic policy as well as gain access to significantly higher interest rates. Investing for beginners should focus on minimising risk, making p2p bitcoin lending platforms highly valuable.
On the other hand, like with any type of investment that promises attractive returns, there are risks. Some of those risks are unique to bitcoin lending platforms. First, the value of bitcoins is more volatile than conventional currencies. Because of this, investors might think that they stand to lose a lot if the value of bitcoins doesn’t change to their favour.
To mitigate this risk, most bitcoin platforms offer exchange rate pegged loans link to our definition. These use the US dollar as the underlying currency for loans. Therefore, bitcoin lending is not any more risky than conventional p2p lending, despite the significantly higher ROI’s.
Another factor to consider is the default rate which is naturally slightly higher than the default rates of bank loans. This is actually a factor which affects both regular and bitcoin P2P lending channels. Because no standard credit scoring system is used to indicate the riskiness of a specific borrower, lenders might feel they lack key information to distribute their investments in a smart way. Bitbond, for example, has addressed this issue and made investment for beginners a more transparent and less intimidating process.
Information is crucial when it comes to investing because it can help you reduce risk while maximizing rate of returns. The historical data that this platform makes available to investors facilitates the process of creating an investment strategy that fits your goals. You can download a CVS file in Excel or Google Sheets and apply filters to analyze the data.
Let’s take a look at one of the many ways the data can guide your investment choices. For example, default rates of loans and a borrower’s connectivity to social media are correlated. The average default rate of a borrower only connected to Facebook is 19.46% while it is 12.92% for those connected to LinkedIn.
Intriguingly borrowers who have connected their eBay accounts to their Bitbond account are the least likely to default There are many other hints the historical data can easily reveal by just using with the filters function. With this feature, investment for beginners has never been easier.
Conclusion
And of course, the information the borrower provides as part of the loan request could already tell you enough whether it is a good investment for you. For instance, a new investor might only be comfortable making investments in businesses she/he understands well. Or she might want to focus her investment in certain countries while avoiding others.
All of this information and more is made available by site. The takeaway of this point is that you don’t have to have a degree in finance, let alone pay a professional investor, to start investing and investing in ways that get you going on the path to financial freedom, whatever that freedom means to you.
Chris Grundy
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