6 ways to become financially independent. Part 2: Become a trader and investor

6 ways to become financially independent. Part 2: Become a trader and investor

In this 6-part series of articles we describe 6 ways that can contribute to achieving financial independence:

  • Starting a business
  • Become a trader and investor
  • Develop the right financial behaviour
  • Stop consuming and start producing
  • Read the right books
  • Meet helpful people

Part 2: Become a trader and investor

Becoming financially independent is a process that can take many years. The past has shown that trading and investing are proven methods of asset accumulation. The way you handle your money and how you invest it will also determine the risk your capital runs. It is therefore logical to want to possess the necessary knowledge and skills to build up capital on the one hand and protect our assets on the other.

Reasons to trade and invest

The most important reason why people trade and invest is because they want to make a profit and build up capital. Traders and investors accept the risk associated with trading and investing and expect this to yield more in the long term than, for example, a savings account.

Capital preservation and the protection of assets can also be reasons for trading and investing. Think, for example, of the diversification that investors make in their investment portfolios or investment products that can be used to hedge the risk of falling stock markets (options, CFDs, gold).

Investors like to respond to (economic) events. Recognising and putting into perspective everything that happens in the world will certainly contribute in a positive way to achieving financial independence. Of course there are also traders and investors who are looking for excitement, and see the financial markets as an ideal playground.

Ways to trade and invest

There are many ways to trade and invest, each with their own characteristics and properties.In general, we distinguish between trading, also known as day trading, and investing.

Daytrading or investing?

What is day trading?

Trading (or day trading) generally refers to trading financial products for a very short period of time (usually within one trading day). The financial product in question can be anything, but it usually involves shares, indices or currencies (forex). Transactions are normally closed before the end of each trading day, but this may not always be the case. Positions that are open for more than a day or a few days are also called swing transactions. Day trading and swing trading are both a form of speculation. Day traders are generally well educated and informed and use short-term trading strategies to take advantage of small price movements.

Daytrading was once an exclusive activity of banks and professional traders. The rise of the internet has made day trading available to retail traders. Successful day trading is not easy and carries a high risk of losing money. Day trading requires discipline, good risk management and a number of “rules of the game” apply. In this article you can read how to make money with forex and CFD trading.

For day trading in for example CFD’s or forex you’ll need a trading account with a broker. Make sure you only open an account with a reliable regulated broker. A well-known regulated forex and CFD broker is Avatrade. Opening an account with Avatrade is free of charge and uncomplicated.

Investing

There are many ways to invest. The difference between investing and speculating often lies in the risk taken and the duration of the hold of an investment.

What is investing?

Investing is allocating resources, usually money, with the expectation of profit. The expectation of return is therefore the most important point when investing. The return on investment can consist of interest, dividend, rental income, but also, for example, an increase in the value of the underlying asset.

Types of investments

There’s really no limit to the kind of investment you could come up with. Below is a brief overview of the most common types of investments.

Shares

When you buy shares, you become part owner of the company from which you buy shares. As a shareholder, you share in the success of the company and you can benefit from increases in the price of the share concerned and from dividend payments on profits made.

Bonds

A bond is a negotiable debt instrument for a loan taken out by a company, government or other entity. When you buy a bond, you receive a portion of the debt contracted by that party. As a result, you are periodically entitled to interest payments and a repayment of the nominal value of the bond.

Funds

Investing in funds allows an investor to invest in a mix or set of underlying assets such as shares, bonds, commodities and the like. A distinction is often made here between investment funds and ETFs (exchange traded funds). Investment funds are not listed on a stock exchange. However, ETFs are quoted on a stock exchange and are therefore, like shares, tradable during the opening hours of the exchange. There is also a difference between active and passive funds. For example, passive funds follow the movements of an index, such as the German DAX. Active funds are managed by fund managers and are therefore actively managed.

Direct investments

Direct investment is defined as all investment in goods or services made with a view to returns or an increase in value. Some examples of direct investments are: a holiday home for rent, holdings in companies, an oldtimer car, art, vintage watches and real estate intended for renting out.

Beginning to invest yourself

When you want to start investing yourself, you first have to ask yourself what kind of investor you really are. Are you a saver, a trader or an investor? Do you want to invest yourself or do you want to have this done for you?

What risk are you willing to take and how much time do you have to reach your investment goals? In general investing with diversification, at minimal costs with a long term objective, works best. Always try to avoid investments you don’t understand.

Risk and return are always directly related when investing. A lower risk generally results in a lower expected return, while a higher risk generally results in a higher expected return. The type of return can differ per investment. In the case of shares, there may be a development in the value of the share and dividend, while in the case of real estate there may be rental income. The development of the value of the underlying assets in question can form a large part of the return over many years.

There may be a difference in risk within the same type of investment. You can imagine that a share of a large listed company such as Allianz (quoted on the German DAX) will be less risky than a micro-cap which has just been quoted on a small stock exchange. In addition to the relationship between the risk and the expected return, there are more things to take into account such as taxes, your investment horizon and the available market risk.

Investing successfully does not have to be difficult. When you invest in products that offer a recurring return, your assets will grow over time. Open an online trading account with a broker so that you can learn how to invest more easily. Invest only with amounts that are within your capabilities and expand your portfolio by making periodic or monthly deposits and investments.

Conclusion

Trading and investing are proven methods of asset accumulation. Trading appeals very much to the imagination, but is a form of speculation in which the risk of losing money is always present. We have seen that even when investing, risk and return are directly related. This means that risk management and capital protection are essential for achieving good investment results in the long term.

Each type of investment has its own characteristics, type of return and type of risk. Make sure that you are well aware of this.

Periodic ups and downs are normal when investing and will occur from time to time. Capital growth with trading and investing is a long term game, where unfortunately no short-cuts are possible.

To become a successful trader or investor you need certain knowledge and skills. In the further parts of this series you can read more about this.

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