Investment 101 Cheat Sheet

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While an individual’s investment strategies should depend on several factors, including how much money they have to invest and at what age they begin investing, there are general investing tips that practically any person or organization should follow. This cheat sheet lists some of the most important features of successful investing strategies.

#1: Stocks Offer the Best Returns on Long-Term Investment

Stock values can skyrocket or plummet within minutes. That volatility can make them seem like bad investment options. When investors look at the stock market’s history, they might balk when they see that values fell by 24.4 percent on December 12, 1914. Stocks also lost 37 percent of their value during 2009.

Those short-term pitfalls might look bad, but the stock market still <a href=”http://money.cnn.com/magazines/moneymag/money101/lesson4/”>offers the best returns</a> on long-term investments. Historically, stock value has risen by nearly 10 percent whereas U.S. Treasury bonds have only risen by about five percent.

Anyone focused on the long-term should put most of their money in stocks. That’s where they’ll get the best performance.

#2: Stock Diversification Reduces Specific Risk

Modern portfolio theory states that investors should diversify investments to reduce risk. By purchasing a wider range of stocks, investors lower the specific risk of purchasing stock in one company.

Investors should spend money on stocks that have relatively high risk because those stocks often offer the largest returns, assuming, of course, that they don’t fail. The potential failure makes those companies risky.

Less-risky stocks rarely have the wealth potential of high-risk stocks. But they offer a balance that counters the potential losses inherent in purchasing stock in companies with higher risk. This type of diversification gives investors the opportunity to earn solid returns without worrying that a single investment will ruin their portfolios.

#3: Diversification Cannot Reduce Systematic Risk

While a diverse portfolio reduces the specific risk of purchasing a stock, it does not affect systematic risk. In fact, investors purchasing stocks have no way to control systematic risk.

With this type of risk, investors must admit that an entire market can gain or lose value. The value of a specific stock matters very little when the whole market falls. That’s why investors cannot adequately protect themselves from the negative effects of economic recessions and depressions.

If one looks at investing as a type of bet, systematic risk assumes the possibility that all bets will lose. This essentially creates a no-win situation where every investor loses money because the overall economy loses value.

#4: Behavioral Finance Theory Addresses Inconsistencies

Traditional investment theory says that all investors act rationally to invest wealth. This does not explain why stock and market values often perform erratically. Behavioral Finance Theory accounts for this by explaining the emotional aspect of investing.

Investors do not always behave rationally because they respond to emotions such as fear and optimism. Market volatility, therefore, does not always come from objective factors. Instead, it comes from the way that people perceive news about the economy, politics, and company performance.

Organizational and individual investing involves complex factors that are often difficult to explain until after events have happened. The kind of historical understanding that students get while pursuing an Online MBA degree from Ohio University, however, can help them compare current circumstances with those that have happened in the past.

The more one knows about investment history, theory, and planning, the better equipped that person is to help other people invest wisely.