Investing is the key to building wealth and creating a financially stable future for yourself and your loved ones. Unfortunately, building wealth requires a bit more strategy than simply saving all the money you make. Inflation eats away at the buying power of your money, which means you must invest and earn a return greater than the rate of inflation to build wealth.
Diversification is the Key to Minimizing Risk
In addition to inflation, there are other risks that can cause losses in nearly every investment possible. This is one of the reasons it’s so important to diversify your investments. Diversification spreads out the risk. Diversification offers protection for the rest of your investment portfolio if one part of the market, or a class of investments, experiences a loss.
The following is a brief overview of a few of the major classes of investments that are popular choices for investors seeking to build wealth and mitigate risk with diversification strategies.
One of the most popular investment classes is currency. Some currencies hold intrinsic value because they are made of a tangible material such as gold, silver and platinum. These “metallic” currencies often become popular investment vehicles during times of uncertainty. There is some risk in buying and holding these types of currencies however, as the buying power of a currency backed by a precious metal can lose value if the price of the metal backing the currency drops.
Currencies issued by central governments can also be traded on the open market, but just like currencies backed by precious metals, their price is highly volatile and can fluctuate wildly over the course of a few hours. Currencies backed by a central government are easily influenced by inflation, as the government itself oversees how much of the currency is in circulation at any one time, which can dilute value.
Crypto-currencies like Bitcoin are increasingly seen as a safer way to invest in currency without the volatility of traditional currency markets as the total number of bitcoins that can ever be mined is ultimately fixed, providing a more reliable hedge against inflation. These currencies are also encrypted meaning that payment is secure, and private, between the parties to the transaction. Companies like Genesis Mining allow investors to mine Bitcoins, as well offer options to reinvest all or a portion of the proceeds into additional alternative investments.
Buying and holding property is also a great way to diversify one’s investment portfolio. One popular way to invest in real estate is buying property and then leasing it. Investors also buy properties, make improvements that improve their value and then resell at a profit.
There is risk in real estate, however. Properties may decline in value, despite improvements. Other times, renters may damage the property and make expensive repairs necessary, or a weather event or other disaster can lead to property destruction and investment loss.
Small Business Ownership
If you are looking for something to invest in that will build wealth, why not invest in yourself? While there are many risks to starting your own business, if you have a great business idea, and access to capital, starting your own business may be one of the best ways to gain greater autonomy over the way you work, while also helping you to secure your financial future.
Since many startups fail within their first five years, would-be entrepreneurs should still diversify their investments to keep from losing it all should their business idea ultimately fail.
Stocks and Bonds
One of the easiest types of investment you can make is in the stock market. Buying stocks allows you to invest and acquire ownership in companies over time.
Investors with stocks can make money in two ways. First, they can buy a stock and hold it for a period of time and sell it later at profit, if the share price increases. Many stocks also pay dividends periodically. While the amount paid for each share of stock is typically small, these amounts can add up to a significant sum.
Of course, there is no guarantee that any stock will grow in value. Some may decline, or even lose all their value.
Stop Losses and Diversification; Two Important Risk Management Tools for Stocks
There are several ways to go about risk management in the stock market. One of the most common is placing automated buy and stop orders on your trading account so that you only acquire shares of a specific stock when it is trading within a specific price range. This helps protect against losses that can occur when trading volume and volatility in pricing is extremely high.
While stop orders can help protect against volatility in a specific stock trade, diversification is still necessary to protect your investment should the entire stock market experience losses. Investors should invest in different segments of the market, rather than investing in only one company or market.
A prime example of how disastrous it can be to place too much of your investment portfolio in only one investment class, or company is the widely reported Enron scandal. This stock lost over 94% of its value in a short time and led to the loss of retirement pensions for Enron employees who had invested heavily in the company.
Mutual funds are an easy way for individual investors with little investment capital to achieve diversification. Mutual funds are often comprised of investments in multiple companies, across multiple markets, industries and sizes.
Investors can also further reduce their risk of loss by diversifying so their portfolios include some of the other investment types discussed above that are outside of the stock market.