How Investing Makes Money

If you want to create wealth over time, you need to learn how to make your money grow. Investing is the best way to do that. 

At its most basic, investing involves putting money in an asset – things like stocks, bonds or property – and earning a financial return from it over time. This future return is what helps you achieve your financial goals, be it retirement, children’s education, or a dream wedding. 

How investing works

One way investing works is through the profits earned from capital gains and appreciation. Let’s break these concepts down.

When you buy a stock at a low price and sell it at a higher price, the return on your investment is called a capital gain. You make money when you realise your capital gains i.e. sell your investments for a profit.

When your asset gains in value after you’ve purchased it, that’s called appreciation. For instance, the price of a stock might appreciate when the company announces the launch of a new product. This raises the stock price as more investors buy the stock. A property might appreciate when certain upgrades are made, or when the location becomes more desirable. 

Investing also works when you buy and hold assets that generate income or dividends. Real estate investment trusts (REITs) and some stocks pay dividends. The goal is to hold these assets long-term and profit from the dividends received. Over time, you may even be able to live off your dividends and achieve financial independence. 

Investing isn’t as complicated as it seems. Now that you know how investing works, the next step is to understand what to invest in. 

The main investment types to know 

There are mainly four asset types you can invest in: stocks, bonds, real estate and commodities. You can also buy funds like exchange traded funds (ETFs) to invest in hundreds of these individual assets at once. 

Stocks

When you buy stocks (also known as equities), you get to own a small piece of that particular company and participate in its successes (or failures). Stocks have historically offered higher returns over the long term but they are not without risk. The company you’ve invested in could go out of business for example. This is why diversifying – owning multiple stocks instead of picking just one – is so important.

Bonds

Also known as fixed income, bonds are like a loan you give the bond issuer. You will receive interest payments at regular intervals and on the maturity date of your bond, get your principal back. Bond issuers can be companies (corporate bonds) or governments (government bonds). Generally, bonds hold lower risk but they also yield relatively low returns. Because their prices do not usually move in tandem with stock prices, they are usually added to a stock portfolio to enhance diversification.

Real estate

You can invest in real estate by buying a home, building or piece of land. You profit when your asset appreciates, or when you collect rental income on your property. However, buying a physical property involves a large initial capital outlay. This is why many investors turn to REITs. They get to earn steady income in the form of dividends but without the cost and hassle of maintaining a physical property.

Commodities

Commodities are energy products such as oil and natural gas, agricultural products such as wheat and cocoa, and metals such as gold and silver. Commodities are mostly traded using futures and options contracts – approaches more suited to highly experienced investors. However, the average investor can still invest in commodities via ETFs or by owning shares of commodity companies.

ETFs

ETFs are not an asset class per se. Rather, they are funds that trade on a stock exchange and seek to replicate the performance of a benchmark index. An example would be the Standard & Poor’s 500 index (S&P 500) which tracks the performance of 500 large-cap US stocks. Additionally, ETFs typically hold the same proportion of assets as its index. This diversification makes them less risky than individual investments. 

Things to consider before investing 

Before you actually start investing, you need to decide what investment types are most suitable for you and your financial goals. This mix of assets is known as your asset allocation. The asset allocation that works best for you will largely depend on your financial goals, time horizon and ability to tolerate risk.

Your time horizon is simply how long you will be investing to achieve your goals. If you are saving for your child’s education, your time horizon may be 10 to 15 years. The longer your time horizon, the more risk you can consider taking as you have time to ride out any market downturns. This could mean that a portfolio with more stocks and REITs may be ideal for you.

Your risk tolerance is your ability and willingness to lose some or all of your original investment in exchange for greater potential returns. If the thought of losing any money worries you, or if you think you’re likely to panic-sell your investments when the market drops, you’re likely an investor with a low risk tolerance. A portfolio that holds a greater percentage of bonds may be more suitable for you. 

Ultimately, all investments involve some form of risk. Basically, the goal of asset allocation is to help you determine the combination of assets that can give you the highest probability of meeting your investment goals, and at a level of risk you will be comfortable with. 

An easy way to get started

As with all things, if you want to be able to invest on your own successfully, you need to spend time and effort learning about the stock market and monitoring market trends. 

But if you want an easier way to invest, Syfe offers ready-made portfolios for your objectives and allows you to lean back and focus on the things you enjoy the most. Ready to get started? Explore our three portfolio types here or speak with our wealth experts to find out which portfolio best fits your goals.

Now that you’re covered on the basics, it’s time to make your money work for you.