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The first time you start looking for investments, you often hear the phrase: “Make your money work for you.” This old financial saying refers to the fact that successful investments increase in value, earning a lot of money the way you earn a salary. There are many different types of investments, each of which is more or less appropriate for the needs of people in different situations.
How investments work
When you invest money, you put your money in an investment vehicle that is expected to appreciate in value over time. With some investments, you lend the money to an individual or organization that pays you interest on that loan. With others, you buy all or part of an asset that can grow in value as a commodity becomes more expensive or as a company succeeds. However, the individual or company may fail, which means that your investment loses money or disappears completely. As a general rule, the riskier an investment is, the faster you can expect your investment to grow if the investment is made correctly.
Low-risk investments
Low-risk investments increase in value little by little, but rarely lose value and find virtually no risk of losing your initial investment. Some examples of low-risk investments include savings accounts, money market accounts, certificates of deposit, savings bonds from the United States and other economically stable countries and the actions of established frontline companies. Low-risk investments rarely appreciate more than 5% a year and many earn less than 2%.
Medium risk investments
Medium-risk investment options are typically appreciated faster than low-risk options, but they also have the opportunity to earn little or even lose value. Most securities, commodities and currency trading fall into this category, as do the investment funds in charge of successful financial groups. A medium-risk investment often earns between 5 and 10% annually, if it is successfully executed in a moderate to a successful market.
High-risk investments
A high-risk investment balances the potential for rapid gains against the probability of failure. New stocks, real estate and venture capitalism fall under this category, as do hedge funds and investments in emerging markets. When they are doing well, high-risk investments can pay with growth well above 10% a year. However, “high risk” means that they go wrong more often than they do well.
Diversification
It is a good idea to divide your investments between a mixture of low, medium and high-risk vehicles in order to balance the growth potential with the risk of failure. Some advisors recommend doing this at the same time, keeping a portfolio with all three types at once. Others recommend a lifestyle approach, where you favour high-risk investments while you are young and can afford the loss, then make a transition through medium and low-risk vehicles when you approach retirement.