What is an Investment?
- You make an investment when you purchase an asset, with hopes of receiving recurring income, or selling it in the future for a higher value - “reaping monetary benefits in the future” as they say in the textbooks.
- Investing involves risk with the potential loss of the initial capitalinvestment
- When it comes to public markets, the most common investments include stocks like Tesla, bonds like the US Treasury bond, commodities like Gold and most recently cryptocurrencies like Bitcoin
- There are many other investments categories - like art, collectibles, etc
What is an investment?
Let’s start from the very beginning. An investment is the purchase of an asset today with hopes of reaping monetary benefits in the future. An asset is a resource, which comes in a variety of forms, and has an economic value that an individual (aka the investor, aka YOU) or an organization (aka an institution) controls. Monetary benefit can be in the form of providing income in the future or appreciation in the economic value and then sale of the asset at a higher price.
Example: Jan buys a pair of limited edition sneakers for $100 today. Over the next few weeks, more people want to buy the sneakers and its price rises to $1,000. Jan can either hold the asset, in hopes of the asset’s value increasing more (but risk it no longer being the hot new shoe), or he can sell the asset now and take $900 profit.
So, why do people invest?
People invest in hopes of growing their wealth.
Whether it’s to achieve a fast return on a trendy stock or to save long-term for retirement, people invest to make their savings grow over some amount of time.
What are some types of investments?
An investment can be any resource with the ability to generate future income. This can be in the form of bonds, stocks, real estate, and many other examples. Yes, even sneakers. Investing in a child’s college could even be considered an investment, with hope for the child to get a good education, job and income in the future.
Is it risky?
Yes, investing inherently entails risk. An investment requires an initial allocation of capital, and its value can fluctuate in your favour or against you. Some investments may not generate any future income or could lose all economic value.
For example, investing in a company that goes bankrupt would result in the loss of some or all of your initial investment. Or placing a bet on a volatile cryptocurrency might increase its value ten-fold, or lose 90% of it.
One must carefully analyze an investment before choosing to invest. Think of an investment as something that has the potential to get more value than for what you originally paid to acquire it.
What are the main types of investments?
Focusing on investments available via public listed markets, there are six main classes of investments available to investors - both private and institutional. These are called asset classes, and include:
- Equities (like Amazon stock )
- Bonds (like corporate debt)
- Currencies (like the US dollar )
- Commodities (like copper )
- Cryptocurrencies (like Bitcoin )
How is investment different from speculation?
The line between speculation and investment can be fuzzy at times, but certain differences are accepted by a large consensus:
Investing has a longer horizon
In general, it’s assumed investing has longer time horizons, whereas speculation is shorter-lived and aims to “turn a quick buck”. In reality, what constitutes a long horizon for an investor might appear speculative for another.
A Hedge Fund manager might consider 6 months a very long holding period, whereas a Pension Fund might consider it too short
Investing focuses on broader research
Investment is generally associated with a broader research effort aimed at assessing all aspects of an investment, whereas speculation tends to focus on a narrower set of drivers.
A Private Equity Fund might conduct 6 months of due diligence on a company they seek to purchase, and study its revenues and costs and future prospects. Conversely, a day trader might buy a stock simply because it has reached the intraday low again.
Pop Quiz (no cheating!)
What qualifies as an investment?
- Putting $50 on black at a roulette table in Vegas
- Buying your friend breakfast
- Purchasing a one of a kind watch
Answer: by purchasing a one of a kind watch, you are making an investment. As the price of the watch changes in the future (because of its limited supply), the owner will have the chance to hold or sell the watch later. Roulette is just gambling, and buying your friend breakfast is just nice.