How do investments earn you money?

Investors invest and buy shares in a company in the hopes of making a profit in the future by either growing their assets or earning an income.

People invest money to make gains from their investment
Investors may earn income through dividend payments from securities
Compounding generates long-term profits for investors
The value of assets increasing may also lead to earnings through investing
Generating income from multiple sources is the best way to make financial gains

In this lesson, you are going to learn everything about how investments can earn you money.

Now that you have learned that investing part of your income is an essential part of managing your money, it is time to take a closer look at how investments earn you money.

*Please note: Depending on where you live, income from investing is subject to national legislation and taxation. This article pertains to investing in European countries.

Earning money from dividends

One way investments generate income is by paying investors dividends. For example, if you have invested in a company by buying shares, the company pays a small proportion of its earnings to its shareholders in return. Like you have learned in lesson 14, such a payment is called a dividend. In addition, shares from a publicly-traded company will likely rise in value in line with the positive performance of the company.

Dividends from individual stocks

If you want to earn dividends from individual company stocks in your portfolio, there are several things you need to consider before you buy shares.

If you only buy shares in a small number of companies, this strategy may not offer enough diversification. By not spreading your investments over different assets, you may be increasing your risk - similar to putting “all your eggs in one basket”.

Further, if you are investing your money in stocks of just a few companies, you also need to take the time on a daily basis to closely monitor the companies that you have invested in. For instance, if you are investing in a company that produces goods that depend on resources from other markets, such as steel, you should also be keeping an eye on how global steel prices are developing, etc.

By not spreading your investments over different assets, you may be increasing your risk - similar to putting “all your eggs in one basket”.

Also, there are broker fees and conditions, as well as taxation issues to consider that may be more complex when dealing with individual shares. Finally, you’ll want to educate yourself on the taxation of your assets which depends on taxation laws in the country where you live.

Dividends from distributing ETFs

On the other hand, investing in funds such as an exchange-traded fund (ETF), which is made up of multiple stocks or other assets at once, instead of individual stocks may significantly reduce investment risk thanks to diversification. Diversification means that you spread your investments - and thus the risk - across a range of different asset types.

Like you learned in our previous lesson, investors can choose between “distributing ETFs” which regularly distribute dividends, and “accumulating ETFs” that reinvest dividends. So if you are looking for your assets to generate regular income, then you should look into investing in distributing ETFs that regularly pay out dividend income.

Earning money from compounding

Like you already learned in lesson 9 of the Bitpanda Academy, compound interest is the money that investors earn on the interest generated by their investments, and compounding means that the interest generated by an asset will generate further income over the course of time if reinvested continually.

The rule of 72

One way to calculate how long it is going to take you to double your investment with compounding is applying the “rule of 72”. Let’s say the fixed annual interest for an investment is 3%. You divide 72 by 3 and the result is 24, meaning that it will take 24 years to double the capital you invested if you leave your returns to compound.

This calculation shows you how low interest rates - along with the threat of inflation - may adversely affect your funds, such as in a savings account. When interest rates are low, your investment will only generate very little income at a very slow pace.

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Earning with cost averaging

To ensure steady gains from your assets, investing your money in a range of different investment vehicles may help you to reach your financial goals. It does not matter how small the amount is that you want to invest - on Bitpanda you can start investing for as little as €1.

A great way to get started in investing, like you learned in lesson 6 of the Bitpanda Academy, is to take advantage of cost averaging by making investments in an asset of your choice with a sum of your choice at regular intervals, like you can with Bitpanda Savings.

Earning through asset appreciation

Another reason to invest in an asset would be that your investment increases in value over time - and you realise capital gain when you sell this asset after it has increased in value.

Earning with real estate

A very basic example of asset appreciation would be buying property if you have a larger sum of money to invest at your disposal. If you buy property in an area that is just beginning to grow and to flourish, you can profit from selling it after its value goes up. If you set up a business on your property, you may also generate income from the business. Finally, if you buy an apartment, you don’t only profit from it increasing in value over time, you can also generate additional earnings by renting the apartment out to tenants.

Another reason to invest in an asset would be that your investment increases in value over time - and you realise capital gains when you sell it after it has increased in value.

As you see, there is a broad range of ways investments may earn you money. In our next lesson, we are going to talk about what it means to diversify your portfolio for the optimal spread of risk and profit.