10 Investing Concepts All Beginners Need to Know

The $0.12 you earned last year in your savings account isn't getting you any closer to your financial goals. So, you're ready to start investing. Smart move. Investing consistently over time is a proven way to build wealth and achieve financial security.

You're also smart to work on expanding your own knowledge from the start. The more you learn now, the more you can minimize early mistakes that can derail your investing plan.

Read on for 10 beginner investing concepts that'll help you make better decisions and keep you moving toward your wealth goals.

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Risk and reward are tied together. If a security can rise rapidly and turn a profit, it can also fall rapidly and create a loss.

You can see the risk-reward relationship by comparing the behavior of stocks to cash. Stocks usually appreciate over time, but they can lose value in the short term. The reward opportunity is high, but it comes with risk.

Cash does not lose value the way stocks can, but it doesn't appreciate, either. With cash, the reward opportunity is low and so is the risk.

Individual stocks offer different levels of risk and reward. For example, massive organizations like Walmart and Apple are lower risk, because they aren't likely to go out of business. But the reward can also be lower, because large companies often don't grow as quickly as smaller ones.

Keep the risk-reward trade-off in mind as you select investments. The bigger the growth opportunity, the greater the risk.

ALSO READ: How Much Money Do You Need to Start Investing?

If you plan to make a lot of money in the stock market over time, you'll do it by way of compound earnings. Your earnings compound when you reinvest them so they produce more earnings.

Imagine you have $10,000 invested. To keep things simple, let's assume the money is growing by 7% annually. In year one, your $10,000 makes $700. If you withdraw the $700, you still have your $10,000 and it will make another $700 in the following year.

Alternatively, you could reinvest the $700 so that it also grows by 7%. In that case, your earnings in the second year would be $749. In the third year, you'd earn $801.

Compounding creates earnings momentum. That's a powerful motivator to leave your money invested for the long term and to reinvest dividends and interest whenever possible.

Dollar-cost averaging, or DCA, is the practice of investing a set amount at regular intervals. You might invest $500 monthly, for example, as opposed to investing $6,000 once a year.

You are already practicing DCA if you are contributing to a 401(k). You can review the history of those 401(k) transactions to see DCA's big advantage. Investing a set amount regularly causes you to buy more shares when prices are lower and fewer shares when prices are higher.

If you are investing $100 at a time, for example, you'll buy five shares when the per-share price is $20, but only four shares when the price is $25. DCA holds your costs down, which creates more room for gains.

Volatility refers to how much a stock's price moves up or down over time. Riskier stocks have bigger share-price fluctuations, while safer stocks tend to be more stable.

Too much volatility is problematic for investors because share price declines cut deeper than the gains. Here's an example: You own a stock that's worth $100 and its share price falls by 50%. Now it's worth $50. If that stock then gains 50%, the share price only goes up to $75. After the 50% gain, you still need another 33% boost to get back to $100.

Beta is a common measure of volatility that you can look up for any publicly traded stock. The market has a beta value of 1. If a stock has a beta value greater than 1, it has been historically more volatile than the market. A beta value of less than 1 implies lower-than-market volatility.

ALSO READ: 5 Must-Know Investing Rules for Anyone New to Stocks

Market capitalization is the market value of a company. To calculate market value, multiply the company's current share price by the number of outstanding shares.

Public companies are categorized according to their market capitalization. Large caps have market capitalizations of $10 billion or more. Amazon, Apple, and Microsoft are examples. Large caps tend to show slow and steady growth.

Mid caps are valued between $2 billion and $10 billion. These midsize companies often grow faster, but with more volatility than large caps.

Companies with market capitalization of less than $2 billion are called small caps. As you can guess, small caps can be the most volatile of the three categories.

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We hear it over and over from investors, “I wish I had bought Amazon or Netflix when they were first recommended by the Motley Fool. I’d be sitting on a gold mine!” And it’s true. And while Amazon and Netflix have had a good run, we think these 5 other stocks are screaming buys. And you can buy them now for less than $49 a share! Simply click here to learn how to get your copy of “5 Growth Stocks Under $49” for FREE for a limited time only.

The buy-and-hold strategy is an investment approach that involves choosing stocks with the intention of keeping them for long periods of time. This is a safer approach than swing trading or day trading -- both of which rely on short-term price changes to earn profits. Many famous investors practice the buy-and-hold approach, including Warren Buffett and Vanguard founder Jack Bogle.

Buy-and-hold investing aims to take advantage of long-term stock market growth trends. Although the market can swing wildly up or down in a single year, the long-term trend is for share prices to rise -- at about 7% annually after inflation.

The best buy-and-hold investors can overlook whatever craziness might be happening in the stock market now, because they're focused on that longer-term picture. The approach eliminates the need to time the market, which is something even the best investors can't do consistently.

Diversification is a risk management strategy that involves holding various types of securities. The idea is to spread your wealth across positions that behave differently. That way, you don't live and die by the performance of one company, or even one type of company. Diversification is the investor's version of not putting all your eggs in one basket.

You can diversify within and across asset classes. For example, you'd diversify within the stock asset class by investing in companies of different sizes, companies that operate in different sectors, or even companies based in different countries. When you do that, most economic cycles will only affect some of your positions, rather than all of them at once.

You'd diversify across asset classes by investing in stocks, bonds, real estate, and cash.

ALSO READ: How Many Stocks Should You Own?

Asset allocation is closely related to diversification -- so much so that the two terms are sometimes used interchangeably.

Asset allocation is the practice of strategically investing in different asset classes to manage risk. Investors often rely on a specific formula for asset allocation, such as 65% U.S. stocks, 15% international stocks, and 20% bonds.

Generally, asset allocations with greater exposure to stocks (versus bonds) will be riskier. Within stocks, smaller companies and international companies carry more risk, while larger, domestic companies have less risk.

To maintain your targeted asset allocation over time, you must rebalance your portfolio periodically. This is because your stocks will gain value in a rising market, but your bonds won't. As a result, your exposure to stocks may increase -- say, to 83% when your target is 80%. To rebalance your stocks back to 80%, you'd sell some of them and use the proceeds to buy bonds.

As a new investor, you might kick off your activities by investing in index funds. Index funds are investment portfolios that replicate a market index, such as the S&P 500. It's a popular choice for index fund investors, because it includes the 500 largest publicly held companies in the U.S.

Also, the S&P 500 index is often used as a benchmark for the entire stock market. So, investing in an S&P 500 index fund gives you easy access to near-market-level performance. You won't beat the market this way, but you shouldn't be too far behind, either.

Any difference between the performance of the fund versus the index is largely a function of the fund's expense ratio. The expense ratio quantifies the fund's operating expenses that are charged to you. Lower expense ratios are better, because they allow you to receive a greater share of the index's investment returns.

Value and growth are two fundamental investing styles. Value investors look for stocks that are priced at less than they're worth, according to the investor's analysis. The thinking is that the share price will eventually rise to reflect that company's true value.

Growth investors prefer stocks that are poised to generate much higher revenues and profits. These companies normally are reinvesting most of their earnings to fund expansion plans. The growth might come from building out manufacturing capacity, creating product lines, moving into new markets, or making strategic acquisitions.

Of the two styles, value is less risky. Value stocks are usually established companies that pay dividends. The expected bump in share price may or may not materialize, but shareholders can often enjoy dividends and steady growth while they're waiting.

Growth stocks can deliver strong gains in short order, but only if their growth initiatives are successful.

5 Winning Stocks Under $49
We hear it over and over from investors, “I wish I had bought Amazon or Netflix when they were first recommended by the Motley Fool. I’d be sitting on a gold mine!” And it’s true. And while Amazon and Netflix have had a good run, we think these 5 other stocks are screaming buys. And you can buy them now for less than $49 a share! Simply click here to learn how to get your copy of “5 Growth Stocks Under $49” for FREE for a limited time only.

Investing can be as simple or as complex as you want it to be. To keep things simple, practice dollar-cost averaging and invest in S&P 500 index funds to start. Because an S&P 500 index fund is diversified across high-quality companies, it's a good fit for your buy-and-hold strategy.

You'll want to diversify outside of those by holding bonds, too. A safe choice would be an index fund with U.S. Treasury bonds.

As your confidence and expertise grow, you can move into value or growth funds, depending on your wealth goals, and more complex asset allocations. That’s the fun of investing -- there’s always something new to learn and try.

John Mackey, CEO of Whole Foods Market, an Amazon subsidiary, is a member of The Motley Fool’s board of directors. Teresa Kersten, an employee of LinkedIn, a Microsoft subsidiary, is a member of The Motley Fool’s board of directors. Catherine Brock owns shares of Microsoft. The Motley Fool owns shares of and recommends Amazon, Apple, and Microsoft. The Motley Fool recommends the following options: long January 2022 $1,920 calls on Amazon, long March 2023 $120 calls on Apple, short January 2022 $1,940 calls on Amazon, and short March 2023 $130 calls on Apple. The Motley Fool has a disclosure policy.