Question

investing your savings is a crucial componentto becoming financial independent.how do we invest?

what are stocks and bonds?why is it important to understand these conepts?what is compound interest?

Answer 1

We do invest on how much return we are expecting. If we want to earn more return, we should be willing to take more risk.

We basically invest by checking the current market price of the instrument and what should be the price as per our estimation of the instrument. If our estimated price is more than the market price, then we won't invest in the instrument as it is already overpriced. On the other hand, if our estimated price is less than the current market price then we will buy that instrument as it is undervalued, as per our calculations.

Stocks and bonds are two ways by which a company raise funds. If company is raising funds via stocks, it means the company is selling its portion to raise fund, that is the buyer is the buying the proportion of the company. However, if the company is issuing bonds it means the company is raising debt and in return will pay interest and principal. Usually, company pays periodic coupon payments and at the maturity date the last coupon and the total principal. If the bond is not paying coupon payments, it is called zero coupon bond.

A stock offers ownership in the company and is more riskier than bonds. Bond holders are paid before than the stockholders, whereas stockholders demand more return as they are taking more risk.

It is important to understand these concepts to get a sense of how equity and bond markets work. This will help in making investment decisions based on the risk tolerance of an individual.

Compound interest is usually applicable on the financial investments. It calculated on both principal and previously accumulated interest i.e. interest on interest. For example if we borrowed $1,000 at 10% compounded annually

Then Interest in year 1 = 1000*0.1 = $100

If unpaid, After year 1, total amount would be 1000 + 100 = $1100

And the interest would be 1100*0.1 = 110

If we look at the above example, Now the interest is calculated to 1000 + 100 =1100 i.e. initial borrowed amount + interest accrued in year 1