An investment is an asset or item that is purchased with the hope that it will generate income or will appreciate in the future. In an economic sense, an investment is the purchase of goods that are not consumed today but are used in the future to create wealth. In finance, an investment is a monetary asset purchased with the idea that the asset will provide income in the future or will be sold at a higher price for a profit.
The term "investment" can be used to refer to any mechanism used for the purpose of generating future income. In the financial sense, this includes the purchase of bonds, stocks or real estate property. Additionally, the constructed building or other facility used to produce goods can be seen as an investment. The production of goods required to produce other goods may also be seen as investing.
The income that results from investing can come in many forms, including profit, interest earnings, or appreciation. Investing refers to long-term commitment, as opposed to trading or speculating, which are short-term and often deal with heavy turnover and, consequently, a higher amount of risk.
Investing is the key to building wealth, but investing in and of itself is not enough. You have to invest wisely! Investing is risky, as the business you invest in could go down in value or even close down completely. It is important to research the business and analyze the risk of investing before putting money down.
There are two major kinds of investment: fixed income and variable income. Fixed income investment refers to an investment that brings in a set amount of interest income on a regular basis, such as bonds or fixed deposits. Variable income investment refers to business or property ownership.
An investment product is a product purchased with the expectation of earning a favorable return. Investment products can be income-producing, as with fixed-interest earning products, or more speculative in nature, as with stocks and options. A wide variety of investment products exist, including, but not limited to, stocks, options, futures, bonds, mutual funds, certificates of deposit, money market investments, ETFs and annuities.
Investment products are available for individual and institutional investors, and are purchased in an attempt to generate a profit. Some investment products, such as certain types of bonds, provide a fixed interest payment in addition to a return of the initial investment at the time of maturity. Other types of investment products, such as stocks, entail greater risk and while earnings (and profits) are anticipated, they are not guaranteed. An investor who diversifies will have a variety of investment products in his or her portfolio to manage risk.
An investment bank provides a variety of services designed to assist an individual or business in increasing associated wealth. This does not include traditional consumer banking. Instead, the institution focuses on investment vehicles such as trading and asset management. Financing options may also be provided for the purpose of assisting with these services.
Speculation is a separate activity from making an investment. 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 higher risk than traditional investing, though this can vary depending on the type of investment involved.
The New York Stock Exchange (NYSE) first opened in 1792, and it remains today one of the world's leading exchanges. Most of the established banks that dominate the investing world began in the 1800s, including Goldman Sachs and J.P. Morgan. In the early 1900s, the term investing was highly intertwined with trading, speculating, and other terms that are now seen to be more risky and refer to short-term endeavors. Around the 1950s, investing was distanced from these other terms and became known as a longer-term, more reliable way to purchase securities.
Also labelled fixed-income securities, the term bond is commonly used to refer to any securities that are founded on debt. When you purchase a bond, you are lending out your money to a firm or government. In return, they agree to give you interest on your money and eventually pay you back the amount you lent out.
The main attraction of bonds is their relative safety. If you are buying bonds from a stable government, your investment is virtually guaranteed, or risk-free. The safety and stability, however, come at a cost. Because there is little risk, there is little potential return. As a result, the rate of return on bonds is generally lower than other securities.
When you purchase stocks, or equities, as your advisor might put it, you become a part owner of the business. This entitles you to vote at the shareholders' meeting and allows you to receive any profits that the company allocates to its owners. These profits are referred to as dividends.
While bonds provide a steady stream of income, stocks are volatile. That is, they fluctuate in value on a daily basis. When you buy a stock, you aren't guaranteed anything. Many stocks don't even pay dividends, in which case, the only way that you can make money is if the stock increases in value - which might not happen.
Compared to bonds, stocks provide relatively high potential returns. Of course, there is a price for this potential: you must assume the risk of losing some or all of your investment.
A mutual fund is a collection of stocks and bonds. When you buy a mutual fund, you are pooling your money with a number of other investors, which enables you (as part of a group) to pay a professional manager to select specific securities for you. Mutual funds are all set up with a specific strategy in mind, and their distinct focus can be nearly anything: large stocks, small stocks, bonds from governments, bonds from companies, stocks and bonds, stocks in certain industries, or stocks in certain countries
The primary advantage of a mutual fund is that you can invest your money without the time or the experience that are often needed to choose a sound investment. Theoretically, you should get a better return by giving your money to a professional than you would if you were to choose investments yourself. In reality, there are some aspects about mutual funds that you should be aware of before choosing them, but we won't discuss them here.
While many (if not most) investments fall into two categories: stocks or bonds, there are numerous alternative vehicles, which represent the most complicated types of securities and investing strategies.
The good news is that you probably don't need to worry about alternative investments at the start of your investing career. They are generally high-risk/high-reward securities that are much more speculative than plain old stocks and bonds. Yes, there is the opportunity for big profits, but they require some specialized knowledge. So if you don't know what you are doing, you could get yourself into a lot of trouble. Experts and professionals generally agree that new investors should focus on building a financial foundation before speculating.
How to buy Investment Products
Buying and owning investment products and financial instruments is Investing. You can buy financial instruments and all kind of investment products at a bank, broker, or insurance company. In many cases, these organizations pool the investment money they receive to make more large-scale investments, and each individual investor has a claim on a portion of the larger investment. You can also buy financial instruments directly through a broker, who will handle the order in exchange for a fee or commission.
It's actually pretty simple: investing means putting your money to work for you. Essentially, it's a different way to think about how to make money. Growing up, most of us were taught that you can earn an income only by getting a job and working. And that's exactly what most of us do. There's one big problem with this: if you want more money, you have to work more hours. However, there is a limit to how many hours a day we can work, not to mention the fact that having a bunch of money is no fun if we don't have the leisure time to enjoy it.
You can't create a duplicate of yourself to increase your working time; so instead, you need to send an extension of yourself - your money - to work. That way, while you are putting in hours for your employer, or even mowing your lawn, sleeping, reading the paper or socializing with friends, you can also be earning money elsewhere. Quite simply, making your money work for you maximizes your earning potential whether or not you receive a raise, decide to work overtime or look for a higher-paying job.
There are many different ways you can go about making an investment. This includes putting money into stocks, bonds, mutual funds, or real estate (among many other things), or starting your own business. Sometimes people refer to these options as "investment vehicles," which is just another way of saying "a way to invest." Each of these vehicles has positives and negatives and the point is that it doesn't matter which method you choose for investing your money, the goal is always to put your money to work so it earns you an additional profit. Even though this is a simple idea, it's the most important concept for you to understand.
Investing is not gambling. Gambling is putting money at risk by betting on an uncertain outcome with the hope that you might win money. Part of the confusion between investing and gambling, however, may come from the way some people use investment vehicles. For example, it could be argued that buying a stock based on a "hot tip" you heard at the water cooler is essentially the same as placing a bet at a casino.
True investing doesn't happen without some action on your part. A "real" investor does not simply throw his or her money at any random investment; he or she performs thorough analysis and commits capital only when there is a reasonable expectation of profit. Yes, there still is risk, and there are no guarantees, but investing is more than simply hoping Lady Luck is on your side.
Obviously, everybody wants more money. It's pretty easy to understand that people invest because they want to increase their personal freedom, sense of security and ability to afford the things they want in life.
However, investing is becoming more of a necessity. The days when everyone worked the same job for 30 years and then retired to a nice fat pension are gone. For average people, investing is not so much a helpful tool as the only way they can retire and maintain their present lifestyle.
Whether you live in the U.S., Canada, or pretty much any other country in the industrialized Western world, governments are tightening their belts. Almost without exception, the responsibility of planning for retirement is shifting away from the state and towards the individual. There is much debate over how safe our old-age pension programs will be over the next 20, 30 and 50 years. But why leave it to chance? By planning ahead you can ensure financial stability during your retirement.
Even though all investors are trying to make money, each one comes from a diverse background and has different needs. It follows that specific investing vehicles and methods are suitable for certain types of investors. Although there are many factors that determine which path is optimal for an investor, we'll look at two main categories: investment objectives and investing personality.
Generally speaking, investors have a few factors to consider when looking for the right place to park their money. Safety of capital, current income and capital appreciation are factors that should influence an investment decision and will depend on a person's age, stage/position in life and personal circumstances. A 75-year-old widow living off of her retirement portfolio is far more interested in preserving the value of investments than a 30-year-old business executive would be. Because the widow needs income from her investments to survive, she cannot risk losing her investment. The young executive, on the other hand, has time on his or her side. As investment income isn't currently paying the bills, the executive can afford to be more aggressive in his or her investing strategies.
An investor's financial position will also affect his or her objectives. A multi-millionaire is obviously going to have much different goals than a newly married couple just starting out. For example, the millionaire, in an effort to increase his profit for the year, might have no problem putting down $100,000 in a speculative real estate investment. To him, a hundred grand is a small percentage of his overall worth. Meanwhile, the couple is concentrating on saving up for a down payment on a house and can't afford to risk losing their money in a speculative venture. Regardless of the potential returns of a risky investment, speculation is just not appropriate for the young couple.
As a general rule, the shorter your time horizon, the more conservative you should be. For instance, if you are investing primarily for retirement and you are still in your 20s, you still have plenty of time to make up for any losses you might incur along the way. At the same time, if you start when you are young, you don't have to put huge chunks of your paycheck away every month because you have the power of compounding on your side.
On the other hand, if you are about to retire, it is very important that you either safeguard or increase the money you have accumulated. Because you will soon be accessing your investments, you don't want to expose all of your money to volatility - you don't want to risk losing your investment money in a market slump right before you need to start accessing your assets.
What's your style? Do you love fast cars, extreme sports and the thrill of a risk? Or do you prefer reading in your hammock while enjoying the calmness, stability and safety of your backyard?
Peter Lynch, one of the greatest investors of all time, has said that the "key organ for investing is the stomach, not the brain". In other words, you need to know how much volatility you can stand to see in your investments. Figuring this out for yourself is far from an exact science; but there is some truth to an old investing maxim: you've taken on too much risk when you can't sleep at night because you are worrying about your investments.
Another personality trait that will determine your investing path is your desire to research investments. Some people love nothing more than digging into financial statements and crunching numbers. To others, the terms balance sheet, income statement and stock analysis sound as exciting as watching paint dry. Others just might not have the time to plow through prospectuses and financial statements.
The main thing determining what works best for an investor is his or her capacity to take on risk.
While some core factors determine risk tolerance, it's important to remember that every individual's situation is different and that there is no comprehensive list of the ways in which investors differ from one another. The important point of this section is that an investment is not the same to all people.
If you are not sure about how you would react to market movements, we can suggest one good starting point: try starting up a mock portfolio in this free investing simulator, which gives you $100,000 of virtual money in an account that tracks the real stock market. The simulated experience of investing can really help you know your head, your habits and your stomach before you invest even one real dollar.
Diversify your Risk
A portfolio is a combination of different investment assets mixed and matched for the purpose of achieving risk diversification for an investor's financial goals. Items that are considered a part of your portfolio can include any asset you own - from real items such as art and real estate, to equities, fixed-income instruments and their cash and equivalents. For the purpose of this section, we will focus on the most liquid asset types: equities, fixed-income securities and cash and equivalents.
An easy way to think of a portfolio is to imagine a pie chart, whose portions each represent a type of vehicle to which you have allocated a certain portion of your whole investment. The asset mix you choose according to your aims and strategy will determine the risk and expected return of your portfolio.
In general, aggressive investment strategies - those that shoot for the highest possible return - are most appropriate for investors who, for the sake of this potential high return, have a high risk tolerance (can stomach wide fluctuations in value) and a longer time horizon. Aggressive portfolios generally have a higher investment in equities.
The conservative investment strategies, which put safety at a high priority, are most appropriate for investors who are risk averse and have a shorter time horizon. Conservative portfolios will generally consist mainly of cash and cash equivalents, or high-quality fixed-income instruments.
Note that the terms cash and the money market refer to any short-term, fixed-income investment. Money in a savings account and a certificate of deposit (CD), which pays a bit higher interest, are examples.
The main goal of a conservative portfolio strategy is to maintain the real value of the portfolio, or to protect the value of the portfolio against inflation. The portfolio you see here would yield a high amount of current income from the bonds and would also yield long-term capital growth potential from the investment in high quality equities.
A moderately aggressive portfolio is meant for individuals with a longer time horizon and an average risk tolerance. Investors who find these types of portfolios attractive are seeking to balance the amount of risk and return contained within the fund.
The portfolios would consist of approximately 50-55% equities, 35-40% bonds, 5-10% cash and equivalents.
You can further break down the above asset classes into subclasses, which also have different risks and potential returns. For example, an investor might divide the equity portion between large companies, small companies and international firms. The bond portion might be allocated between those that are short-term and long-term, government versus corporate debt, and so forth. More advanced investors might also have some of the alternative assets such as options and futures in the mix. As you can see, the number of possible asset allocations is practically unlimited.
It all centers on diversification. Different securities perform differently at any point in time, so with a mix of asset types, your entire portfolio does not suffer the impact of a decline of any one security. When your stocks go down, you may still have the stability of the bonds in your portfolio.
There have been all sorts of academic studies and formulas that demonstrate why diversification is important, but it's really just the simple practice of "not putting all your eggs in one basket." If you spread your investments across various types of assets and markets, you'll reduce the risk of catastrophic financial losses.
Your Key Take Aways
#1: Investing is about making your money work for you
#2: Reinvesting your earnings allows you to take advantage of compounding
#3: Each investor is different in his or her objectives and risk tolerance
#4: There isn't just one strategy that can be used to invest successfully
#5: Each investment vehicle has its own unique characteristics
#6: Diversifying investments in a portfolio helps to manage risk