Question

Finance is exciting! In this course, we learned how money can grow through the use of compounding and interest rates and your growth strategies may now be different. What are your new financial goals? Would you like to become more liquid, to save more for your retirement, or to start a new business? Whatever your goals, finance is right at the core. Think about what you learned in this course regarding investing to complete this assignment. Write a two to three-page paper in which you: Describe three ways you will invest in your future based on the principles of finance discussed in this course. Include terminology from the course and use citations as necessary to support your explanation of the terminology. Discuss one of the three ways you feel most confident as a way to invest in your future. Explain your level of confidence. Of the three ways that you will invest in your future, discuss the one that you perceive might be the most challenging. Then, discuss how you might overcome some of those challenges?

Answer 1

The study of finance helps an individual to manage their funds by investing into different securities so that he/she can achieve their financial objectives. The process of investment is mainly dependent upon the risk-taking ability of a person. We will try to discuss every aspect of investing under this section.

Explanation:

Before investing into any security, one should identify the purpose of investing. Objective can be in the form of getting steady returns, accumulating savings for the future events, or yielding capital returns from the investment. Age and earnings of an investor are the major factor that defines the purpose of investing. A young individual will invest more in those securities which involves higher risk. Whereas, a person, who is in his retirement period, will invest more in those securities which provides him/her regular income. Also, an affluent investor can absorb higher amount of risk present in an investment when compared to the investors who are not that financially strong. Therefore, objectives, age, and earning level are the most important factor that assist a person in the process of investment.

There are many ways through which one can plan for their future by way of investing.

1. Investing should be done with a view of increasing wealth over time. The effect of compounding can turn a smaller amount into a very huge amount of fund. But this could take longer duration. Regular income can be earned over time if a person invests in debt instruments or in dividend paying stocks. Investment in stocks is the most common example of investment. Stocks provide greater return than any other instrument, but the risk involved in it is also high. The rule of investing into stocks says that; one should deduct their age from 100 to find out the percentage of investment that should be allocated to equities. For example, if the age of a person is 25, then the percentage of total investment that should be allocated to stocks should be 75% (100 - 25). The balance between debt and equity should be maintained. One should not invest all their fund into equities.
2. The second way of investing is by determining the risk-taking capability of the individual. A person who wants to earn higher returns and who has the capacity to take higher level of risk should invest more in risky instruments like equities. Risk-averse investors should put their money in those securities which has lower level of risk like government bonds, debentures, or blue-chip stocks. Therefore, it is always wise to determine the risk involved in a security before investing.
3. Diversification is the most important concept in the process of investing. Diversification means putting your money into many different securities. By way of this process, the total risk of the portfolio can be reduced. Generally, those securities are included in the portfolio which have negative correlation between them. This will help to protect the downside movement risk of a security. Some amount of your income should be invested into gold also because in the situation of recession, the prices of gold rises. The reason is that, during recession, people lose confidence in the stock market and they shift their funds into safest instrument like gold. Therefore, it is necessary to diversify your portfolio so that non-systematic risk (Industry-specific risk) can be eliminated.

Diversification is considered as the best way of investing because the total risk of the portfolio can be brought down to some extent. Beginners should invest small amounts of their income into different instruments. In this way, they would reduce the chances of losing their wealth.

One of the biggest challenges in the process of diversification is that it reduces only non-systematic risk of the portfolio. Systematic risk (market risk or economy risk) cannot be eliminated or minimized through the process of diversification. Hedging and the study of fundamental analysis are the only ways of dealing with the systematic risk.