Do You Have These 5 Financial Investment Basics Down?
Working with a trusted financial professional is important when it comes to strategizing and preparing to meet your financial goals. As most of us handle money on a daily basis, it’s important to have an in-depth understanding of the fundamentals of financial literacy, especially when it comes to investing. Below we’ve identified five financial basics everyone should know. Understanding these important concepts can serve as a basis for your financial standings.
Basics #1: Diversification
Diversification is something that is talked about quite a lot when it comes to investing. It is summed up in the old saying, "do not put all your eggs into one basket," however, when it comes to investing diversification, it is more than having different investments such as bonds, stocks, precious metals, real estate, and so on. These can be a good place to start, but if all of your investments are in different vehicles but not in different sectors, currencies, and even countries, the overall portfolio could be holding a higher amount of risk. Even having all your finances in one country could leave your wealth exposed to more risk than is needed.
Geographical diversification is a type of diversification for one's wealth structure that involves moving assets offshore to protect them against a falling domestic currency. In this case, it is literally moving your eggs into another basket. When doing so also allows investors to have a portion of their wealth take on a different emphasis when it comes to investing activities such as placing investments outside of their domestic economy adding an international diversification to their wealth structure.
Basics #2: Interest
There are two sides to interest that can make it a tricky concept to grasp - interest accrued on debt and interest accrued on savings.
When you take on debt (like credit card debt, an auto loan, or a mortgage), you’ll be responsible for paying back both the principal amount and the interest accrued on the loan. The interest is how a lender makes money on the loan and provides the borrower with an incentive to pay the loan back in full and on time.
When you have a savings account that accrues interest, the interest earned gets added to the principal. Then, interest is earned on the new, larger principal, and the cycle repeats. This is called compounding interest, and it can be an integral part of growing your retirement savings - as the longer the interest has to compound, the greater the savings will grow. Bonds also earn interest as the investor becomes the lender and will earn an interest payment on the bond held. These interest payments can be used as passive income to grow your wealth.
Basics #3: The Value of Time
As a general rule of thumb, it’s never too early to start saving - for retirement, homebuying, a child’s education, or whatever could be coming down the line. The earlier you start saving, the more you’ll be able to tuck away over time - especially with the power of compounding interest. This leverages the value of time to your advantage.
Basics #4: Inflation
Inflation has the potential to eat away the purchasing power of your money. That means, with inflation, the dollar you earn today may not be worth a dollar in the future. Below are two important concepts to remember regarding inflation.
Cash in a Mattress
Keeping all your cash under a mattress is not only unsafe, it literally costs you money. Assuming the annual rate of inflation is a hypothetical two percent, every dollar you keep under your mattress and not earning interest would shrink in value to $.98 next year. Investing can be used to preserve the wealth you have worked hard to earn overtime when using a capital preservation strategy. However, it is important to do your due diligence when investing and you should always consult a financial professional when investing as there is always risk involved.
Rate of Return
Because inflation erodes the purchasing power of your money, any returns you earn on your accounts may not be the “real” rate of return. If your account earned a hypothetical six percent rate of return over the last year, but inflation was 1.5 percent, your real rate of return was 4.5 percent.
Basics #5: Privacy & Safety
Especially as the world shifts to doing everything virtually, identity theft remains one of the biggest threats to financial and personal security. A cracked password or misplaced Social Security number can have big consequences on your current and future finances.
The common wisdom is to use a unique password for each site or service you use. One of the benefits that some offshore bank accounts are the extent of their privacy and online security aspects. Private Banks are hyper-aware of the security needs of their clients and they have security as a high priority, especially when it comes to their online banking portals.
As an example, in Switzerland, the client’s information is treated like medical or legal information meaning that banks are required to keep the information private like a doctor or a lawyer must. Further, the security of the banks is to the highest of standards to ensure the clients' assets remain protected. If an American was to open a Swiss Bank account due to the banking secrecy act only the IRS—as Americans are legally required to report their foreign accounts—and whomever you tell is privy to the funds held offshore.
While this is a brief overview of some important basics, it’s important to work with your trusted financial professional to explore these topics further. Remember to reach out if you have questions about any of these basics, and take this month to reevaluate your current financial investment knowledge as you identify potential areas for improvement.
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