The investing landscape can be extremely volatile and change year after year, but there is a lot to be said for investing in what you really know and understand. Considering the enormous number of products on offer, as well as the nature of the industry, it is not that simple to be simple, but it can certainly be done. First, we will take a look at the potential difficulties of understanding investments, and then we'll look at how new investors can invest safely, suitably and sensibly.

SEE: Investing 101

How Much Do We Really Understand?
One could argue that the only asset that is fully understandable is cash in the bank, or some form of fixed deposit. Here, you know exactly how much you will earn and that you will get your capital back. The problem is that you will be lucky to beat inflation, and simply leaving your money in cash is not the answer; it is just not a productive investment.

Moving a bit up the risk ladder, we get to bonds. Given the variety of bonds and bond funds, understanding what you get is also not necessarily that simple. Government bonds are fairly straightforward, but, again, they don't pay much. Municipal bonds pay a little more and are usually tax-exempt, but are not going to satisfy the average investor's retirement needs. So to really earn anything, you need a variety of bonds, both corporate ones and, arguably, foreign. Yet these start to become complex and more risky, depending on various factors relating to the issuing company or country. Likewise, bond funds may depend on a number of managerial and financial issues.

SEE: Bond Basics Tutorial

The same applies to stocks, mutual funds and so on. Even real estate funds have proved to be less reliable and straightforward than many people might think. Direct real estate purchases are more understandable in one sense - what you see is what you get. But then again, there can be unknowns relating to the market, taxation, the location, disclosure by the seller and so on.

Similarly, alternative investments, such as hedge funds, can be extremely complex. Infrastructure, too, is without doubt a great idea in principle, but the nitty-gritty of investing in it is not such a sure thing. No matter how sound the principle of a particular investment, there is almost always someone or something out there that can make it go wrong. And as for certificates of deposit (CD), they are probably the hardest type of investment to understand. Given yield curves, expectations and potential early withdraw penalties, they may be the easiest to missell.

SEE: Hedge Fund Due Diligence

Tracker funds, on the other hand, are relatively simple to understand - you are indeed just "buying the market," but the markets themselves are not so easy to deal with and understand. Furthermore, the tracker market is becoming more sophisticated and complex. This all sounds very daunting. But in fact, one can still invest simply and understandably, at low cost and with a good, diversified portfolio that is likely to perform well over time.

How Can We Invest Sensibly, Suitably and Simply?
The above section certainly implies that we really know very little about a lot of asset classes and investments. Nonetheless, there are many ways of ensuring that you are investing in what you know. One can really invest in a straightforward manner, and understand what one is doing.

Many veteran investors have simple diversified portfolios, and look more at asset allocation. Spending hours performing regression analysis is not an option for many part-time investors. For example, Steven Goldberg, of Kiplinger, has said in his "Value Added Web Column" that: "Most people wish they didn't have to be investors," and that they "lead busy enough lives without having to worry about stocks, bonds and mutual funds." Goldberg therefore recommends sticking with index funds that simply mirror the market and only attempt to be average. He even argues that one only needs three index funds: one covering the U.S. equity market, another with international equities and the third tracking a bond index.

SEE: The 10 Commandments Of Investing

Trackers are sometimes better than actively managed funds. Lower fees, low turnover and a combination of available investor education makes index investing extremely attractive. So, a really straightforward mix of these funds is transparent, cheap and does as good (or better) a job as more complex and expensive vehicles. Despite the above, to be fair, there are a lot of good managed funds out there. With a bit of effort, you can find reliable and understandable equity and bond funds with which you can relax.

A good piece of advice is to search through's tutorial section, to start with simple investments and then expand and extend as you learn more. Specifically, mutual funds or exchange-traded funds are a good way to get going, and one can then move on to individual stocks, real estate and further down the line, even a sensible amount into resources or hedge funds.

It is interesting to note the book title, "How Buffett Does It: 24 Simple Investing Strategies from the World's Greatest Value Investor" (James Pardoe, McGraw-Hill, 2005), about the world's greatest pro. Buffett himself comments that Wall Street dislikes too much simplicity. The reason is that brokers make money out of complexity. But one does not have to fall for this.

The Bottom Line
The more you learn, the better. But above and beyond this, you can (and probably should) avoid investments that you do not even understand in principle. A small number of index funds seems a very good solution.

Also, go on sound recommendations. If your parents-in-law have been investing for 20 years in some mixed fund which has served them well, there is a good chance that it will continue to do so. On the other hand, if you get a phone call from someone you met in a pub last week who wants to give you a hot tip as a "big favor," be more skeptical.

Likewise, there are many independent financial advisors around who get paid only for their time and not on commission. Their job is to understand what they recommend, without the pressure of having to sell to earn a commission. And make sure you diversify, not only into asset classes, but possibly into different banks and fund providers. Then, if something goes wrong that neither you nor anyone else seemed to understand after all, the losses are not so disastrous. Always bear in mind that too many bits and pieces also create complexity which can lead to errors.

Related Articles
  1. Investing

    2 Common Ways to Misuse Target Date Funds

    The world of asset classes is just as complicated as taking vitamins. How much should you take of small caps? Intermediate bonds? Emerging market stocks?
  2. Mutual Funds & ETFs

    What Target-Date Funds Can Teach About Investing

    Target-date funds are a popular way to invest for retirement. Here's what they can teach the novice investor.
  3. Mutual Funds & ETFs

    4 Mutual Funds Warren Buffet Would Buy

    Learn about four mutual funds Warren Buffett would invest and recommend to his trustee, and discover detailed analysis of these mutual funds.
  4. Investing News

    4 Value Stocks Worth Your Immediate Attention

    Here are four stocks that offer good value and will likely outperform the majority of stocks throughout the broader market over the next several years.
  5. Mutual Funds & ETFs

    The 4 Best Buy-and-Hold ETFs

    Explore detailed analyses of the top buy-and-hold exchange traded funds, and learn about their characteristics, statistics and suitability.
  6. Investing

    How ETFs May Save You Thousands

    Being vigilant about the amount you pay and what you get for is important, but adding ETFs into the investment mix fits well with a value-seeking nature.
  7. Bonds & Fixed Income

    High Yield Bond Investing 101

    Taking on high-yield bond investments requires a thorough investigation. Here are looking the fundamentals.
  8. Retirement

    How Robo-Advisors Can Help You and Your Portfolio

    Robo-advisors can add a layer of affordable help and insight to most people's portfolio management efforts, especially as the market continues to mature.
  9. Mutual Funds & ETFs

    Top 3 Muni California Mutual Funds

    Discover analyses of the top three California municipal bond mutual funds, and learn about their characteristics, historical performance and suitability.
  10. Professionals

    How to Sell Mutual Funds to Your Clients

    Learn about the various talking points you should cover when discussing mutual funds with clients and how explaining their benefits can help you close the sale.
  1. What licenses does a hedge fund manager need to have?

    A hedge fund manager does not necessarily need any specific license to operate a fund, but depending on the type of investments ... Read Full Answer >>
  2. Can mutual funds invest in hedge funds?

    Mutual funds are legally allowed to invest in hedge funds. However, hedge funds and mutual funds have striking differences ... Read Full Answer >>
  3. When are mutual funds considered a bad investment?

    Mutual funds are considered a bad investment when investors consider certain negative factors to be important, such as high ... Read Full Answer >>
  4. What fees do financial advisors charge?

    Financial advisors who operate as fee-only planners charge a percentage, usually 1 to 2%, of a client's net assets. For a ... Read Full Answer >>
  5. Can mutual funds invest in IPOs?

    Mutual funds can invest in initial public offerings (IPOS). However, most mutual funds have bylaws that prevent them from ... Read Full Answer >>
  6. Are stocks real assets?

    Stocks are financial assets, not real assets. Financial assets are paper assets that can be easily converted to cash. Real ... Read Full Answer >>

You May Also Like

Hot Definitions
  1. Real Estate Investment Trust - REIT

    A REIT is a type of security that invests in real estate through property or mortgages and often trades on major exchanges ...
  2. Section 1231 Property

    A tax term relating to depreciable business property that has been held for over a year. Section 1231 property includes buildings, ...
  3. Term Deposit

    A deposit held at a financial institution that has a fixed term, and guarantees return of principal.
  4. Zero-Sum Game

    A situation in which one person’s gain is equivalent to another’s loss, so that the net change in wealth or benefit is zero. ...
  5. Capitalization Rate

    The rate of return on a real estate investment property based on the income that the property is expected to generate.
  6. Gross Profit

    A company's total revenue (equivalent to total sales) minus the cost of goods sold. Gross profit is the profit a company ...
Trading Center
You are using adblocking software

Want access to all of Investopedia? Add us to your “whitelist”
so you'll never miss a feature!