Investing 101 Part 2

By on March 11, 2013

Part 2: Compound interest, portfolio diversification and ROIs

If you are looking to establish or grow your wealth, pay for your children’s college tuition, build extra income for retirement or just don’t know how to understand and manage your current investments, then you need to brush up on the basics. Become familiar with the jargon and basic concepts of investing to achieve successful profit or income growth, and build a financial safety net for the future.

In Part 2: Compound Interest, Portfolio Diversification and ROIs, we will be examining the some tools for growing your income and personal wealth.

Compound Interest

Or, how your money is able to make more money. Albert Einstein supposedly referred to compounding interest as “The Eighth Wonder of the World” for its ability to generate more money. Compound interest is the investment tool which generates more earnings. The interest earned is added back into original investment (principle) and also begins earning interest – the additional interest is called compounding.

Here is an example:
If you invested $10,000 at a 5%, you will have $10,500 a year later ($10,000 x 1.05). If you do not remove the additional $500 earned from interest, that money will so earn interest. At the same rate of 5%, your investment will increase by $525 to $11, 025 by the following year.

That $25 extra dollars may seem meager in the first year, however, if you keep it invested with your principal, then the amount you earn each year – without lifting a finger – is increased. The additional interest and investment of that interest will continue to increase the growth rates of your earnings year after year. In order for you to benefit from the magic of compound interest, you MUST keep your hands off the extra money.

Portfolio Diversification

Don’t put all of your eggs in one basket – we’ve all heard this saying before, but it simply advocates that it can be dangerous to rely on one source of income or investment. If that one investment loses value, your entire income could be lost.

An investment portfolio is a complete file of all the different investment assets someone holds. This can include anything from someone’s personal real estate to money market savings accounts, equities, stock and bonds,etc.. It is important to have a diverse collection of assets with various levels of risk to encourage growth and protect the value of the portfolio from inflation and loss.
Some people need an aggressive portfolio to earn more money quickly. Typically, these portfolios included more investments with a higher risk of loss but larger payoff, and a minimum number of low risk investments to prevent a total loss of wealth. Other people may have the opposite with a moderate portfolio with a balance of high and low risk investments, and every
combination in between. It is important to diversify your assets by determining how much risk you can handle in comparison to the return on investment each asset offers.

Return on Investment

In order to compare the benefit each investment opportunity can bring to your portfolio, individuals must compare the efficiency of each asset to earn income according to the capital invested. This snapshot of profitability (an accounting for risk factors) will help you decide which opportunities are the best investments for your financial situation.

Here is a useful formula to help you along:

Continued in Part 3: Start Investing

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About Terri A. Kamoto

Senior writer for FSN - Terri is a former financial analyst dedicated to making personal finances, budgeting, investment and insurance advice accessible, up to date and easy to understand. It is hard to find professional advice written in a language someone without a financial background can understand. Terri helps companies synthesize industry lingo and expertise into clear and informative content which builds smarter, financially successful individuals. You can find Terri on !

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