An investment is an asset or item acquired with the goal of generating income or appreciation.
Appreciation refers to an increase in the value of an asset over time.
When an individual purchase a good as an investment, the intent is not to consume the good but rather to use it in the future to create wealth.
Remember: Poor spends most of their money, middle class saves most of their money. But the rich invest most of their money. (Rich Dad Poor Dad)
An investment always concerns the outlay of some resource today—time, effort, money, or an asset—in hopes of a greater payoff in the future than what was originally put in.
For example, an investor may purchase a monetary asset now with the idea that the asset will provide income in the future or will later be sold at a higher price for a profit.
Flash Features:
- An investment involves putting capital to use today in order to increase its value over time.
- An investment requires putting capital to work, in the form of time, money, effort, etc., in hopes of a greater payoff in the future than what was originally put in.
- Investment can refer to any medium or mechanism used for generating future income, including bonds, stocks, real estate property, or alternative investments.
- Investments usually do not come with guarantees of appreciation; it is possible to end up with less money than with what you started.
- An Investments can be diversified to reduce risk, though this may reduce the amount of earning potential.
What are the Objectives of Investment?
Before you decide to invest your earnings in any one of the many investment plans, it’s essential to understand the reasons behind it and the investment’s meaning.
While the individual objectives of the investment may vary from one investor to another, the overall goals of investing money may be any one of the following reasons..
1. To Keep Money Safe
Capital preservation is one of the primary objectives of investment for people. Some investments help keep hard-earned money safe from being eroded with time.
By parking your funds in these instruments or schemes, you can ensure that you do not outlive your savings.
Fixed deposits, government bonds, and even an ordinary savings account can help keep your money safe. Although the return on investment may be lower here, the objective of capital preservation is easily met.
2. To Help Money Grow
Another one of the common objectives of investing money is to ensure that it grows into a sizable corpus over time.
Capital appreciation is generally a long-term goal that helps people secure their financial future. To make the money you earn grow into wealth, you need to consider investment objectives and options that offer a significant return on the initial amount invested.
Some of the best investments to achieve growth include real estate, mutual funds, commodities, and equity.
The risk associated with these options may be high, but the return is also generally significant.
3. To Earn a Steady Stream of Income
Investments can also help you earn a steady source of secondary (or primary) income.
Examples of such investments include fixed deposits that pay out regular interest or stocks of companies that pay investors dividends consistently.
Income-generating investments can help you pay for your everyday expenses after you have retired.
Alternatively, they can also act as excellent sources of supplementary income during your working years by providing you with additional money to meet outlays like college expenses or EMIs.
4. To Minimize the Burden of Tax
Aside from capital growth or preservation, investors also have other compelling objectives for investment.
This motivation comes in the form of tax benefits offered by the Income Tax Act, 1961. Investing in options such as Unit Linked Insurance Plans (ULIPs),
Public Provident Fund (PPF), and Equity Linked Savings Schemes (ELSS) can be deducted from your total income.
This has the effect of reducing your taxable income, thereby bringing down your tax liability.
5. To Save up for Retirement
Saving up for retirement is a necessity. It is essential to have a retirement fund you can fall back on in your golden years, because you may not be able to continue working forever.
By investing the money you earn during your working years in the right investment options, you can allow your funds to grow enough to sustain you after you’ve retired.
6. To Meet your Financial Goals
Investing can also help you achieve your short-term and long-term financial goals without too much stress or trouble.
Some investment options, for instance, come with short lock-in periods and high liquidity.
These investments are ideal instruments to park your funds in if you wish to save up for short-term targets like funding home improvements or creating an emergency fund.
Other investment options that come with a longer lock-in period are perfect for saving up for long-term goals.
How an Investment Works?
The act of investing has the goal of generating income and increasing value over time. An investment can refer to any mechanism used for generating future income.
This includes the purchase of bonds, stocks, or real estate property, among other examples. Additionally, purchasing a property that can be used to produce goods can be considered an investment.
In general, any action that is taken in the hopes of raising future revenue can also be considered an investment.
For example, when choosing to pursue additional education, the goal is often to increase knowledge and improve skills.
The upfront investment of time attending class and money to pay for tuition will hopefully result in increased earnings over the student’s career.
Because investing is oriented toward the potential for future growth or income, there is always a certain level of risk associated with an investment.
An investment may not generate any income, or may actually lose value over time. For example, a company you invest in may go bankrupt.
Alternatively, the degree you investing time and money to obtain may not result in a strong job market in that field.
Types of Investments
There are arguably endless opportunities to invest; after all, upgrading the tires on your car could be seen as an investment that enhances the usefulness and future value of the asset.
Below are common types of investments in which people use to appreciate their capital.
Stocks/Equities
A share of stock is a piece of ownership of a public or private company. By owning stock, the investor may be entitled to dividend distributions generated from the net profit of the company.
As the company becomes more successful and other investors seek to buy that company’s stock, it’s value can also appreciate and be sold for capital gains.
The two primary types of stocks to invest in; are common stock and preferred stock.
Common stock often includes voting rights and participation eligibility in certain matters.
Preferred stock often has first claim to dividends and must be paid before common shareholders.
In addition, stocks are often classified as being either growth or value investments.
Investments in growth stocks is the strategy of investing in a company while it is small and before it achieves market success.
Investment in value stocks is the strategy of investing in a more established company whose stock price may not appropriate value the company.
Bonds/Fixed-Income Securities
A bond is an investment that often demands an upfront investment, then pays a reoccurring amount over the life of the bond.
Then, when the bond matures, the investor receives the capital invested into the bond back. Similar to debt, bond investments are a mechanism for certain entities to raise money.
Many government entities and companies issue bonds; then, investors can contribute capital to earn a yield.
The recurring payment awarded to bondholders is called a coupon payment.
Because the coupon payment on a bond investment is usually fixed, the price of a bond will often fluctuate to change the bond’s yield.
For example, a bond paying 5% will become cheaper to buy if there are market opportunities to earn 6%; by falling in price, the bond will naturally earn a higher yield.
Many investments can be leveraged for higher returns (or higher losses) through derivative products.
It’s often recommended that investors not handle derivatives unless they are aware of the high risk involved.
Index Funds and Mutual Funds
Instead of selecting each individual company to invest in, index funds, mutual funds, and other types of funds often aggregate specific investments to craft one investment vehicle.
For example, an investor can buy shares of a single mutual fund that holds ownership of small-cap, emerging market companies instead of having to research and select each company on its own.
Mutual funds are actively managed by a firm, while index funds are often passively-managed.
This means that the investment professionals overseeing the mutual fund are trying to beat a specific benchmark, while index funds often attempt to simply copy or imitate a benchmark.
For this reason, mutual funds may be a more expense fund to invest in compared to more passive-style funds.
Real Estate
Real estate investments are often broadly defined as investments in physical, tangible spaces that can be utilized.
Land can be built on, office buildings can be occupied, warehouses can store inventory, and residential properties can house families.
Real estate investments may encompass acquiring sites, developing sites for specific uses, or purchasing ready-to-occupy operating sites.
In some contexts, real estate may broadly encompass certain types of investments that may yield commodities.
For example, an investor can invest in farmland; in addition to reaping the reward of land value appreciation, the investment earns a return based on the crop yield and operating income.
Commodities
Commodities are often raw materials such as agriculture, energy, or metals.
Investors can choose to invest in actual tangible commodities (i.e. owning a bar of gold) or can choose alternative investment products that represent digital ownership (i.e. a gold ETF).
Commodities can be an investment because they are often used as inputs to society. Consider oil, gas, or other forms of energy.
During periods of economic growth, companies often have greater energy needs to ship more products or manufacture additional goods.
In addition, consumers may have greater demand for energy due to travel. In this example, the price of commodities fluctuates and may yield a profit for an investor.
Cryptocurrency
Cryptocurrency is a blockchain-based currency used to transact or hold digital value. Cryptocurrency companies can issue coins or tokens that may appreciate in value.
These tokens can be used to transact with or pay fees to transact using specific networks.
In addition to capital appreciation, cryptocurrency can be staked on a blockchain.
This means that when investors agree to lock their tokens on a network to help validate transactions, these investors will be rewarded with additional tokens.
In addition, cryptocurrency has given rise to decentralized finance, a digital branch of finance that enables users to loan, leverage, or alternatively utilize currency.
Collectibles
A less traditional form of investing, collecting, or purchasing collectibles involves acquiring rare items in anticipation of those items becoming in higher demand.
Ranging from sports memorabilia to comic books, these physical items often require substantial physical preservation, especially considering that older items usually carry a higher value.
Categories of Investments
1. Ownership Investments
Ownership investments, as the name clearly suggests, are assets that are purchased and owned by the investor.
Examples of this kind of investment include stocks, real estate properties, and bullion, among others. Funding a business is also a kind of ownership investment.
2. Lending Investments
When you invest in lending instruments, you’re essentially behaving like the bank.
Corporate bonds, government bonds, and even savings accounts are all examples of lending investments.
The money you park in a savings account is basically a loan that you give the bank. This money is used by the bank to fund the loans it gives out to its customers.
3. Cash Equivalents
These are investments that are highly liquid and can easily be converted into cash.
Money market instruments, for instance, are excellent examples of cash equivalents. Cash equivalents generally offer low returns, but correspondingly, the risk associated with them is also negligible.
Investments and Risk
In its simplest form, investment return and risk should have a positive correlation.
If an investment carries high risk, it should be accompanied by higher returns. If an investment is safer, it will often have lower returns.
Read: Systematic risk VS Unsystematic risk
When making investment decisions, investors must gauge their risk appetite. Every investor will be different, as some may be willing to risk the loss of principle in exchange for the chance at greater profits.
Alternatively, extremely risk-averse investors seek only the safest vehicles where their investment will only consistently (but slowly) grow.
Investments and risk are often strongly related to prevailing conditions in the investor’s life. As an investor approaches retirement, they will no longer have stable, ongoing income.
For this reason, people usually choose safer investments towards the end of their working career. On the other hand, young professionals can often bear the burden of losing money as they have their entire career to make that capital back.
For this reason, younger investors are often more likely to invest in riskier investments.
Investing vs. Speculation
Speculation is a distinct activity from investing.
Investing involves the purchase of assets with the intent of holding them for the long term, while speculation involves attempting to capitalize on market inefficiencies for short-term profit.
Ownership is generally not a goal of speculators, while investors often look to build the number of assets in their portfolios over time.
Although speculators are often making informed decisions, speculation cannot usually be categorized as traditional investing.
Speculation is generally considered a higher risk activity than traditional investing (although this can vary depending on the type of investment involved).
Some experts compare speculation to gambling, but the veracity of this analogy may be a matter of personal opinion.
Investing vs. Saving
Saving is accumulating money for future use and entails no risk, whereas investment is the act of leveraging money for a potential future gain and it entails some risk.
Though both have the intention of having more capital available in the future, each go about growing in a very different way.
Conclusion
An investment is a plan to put money to work today in hopes of obtaining a greater amount of money in the future.
Though that plan may not always work out and investments can lose money, it is also the primary way people save for major purchases or retirement.
Ranging from stocks, bonds, real estate, commodities, and modern alternative investments, the digital age has brought about easy, transparent, and fast methods of investing money.
Reference:
https://www.investopedia.com/
https://www.commsec.com.au/
https://www.williamsassetmanagement.com/
