Investing has become an increasingly important part of many people's financial plans, as it offers the potential for greater returns than simply leaving money in a savings account. By investing your hard-earned money, you can potentially build wealth over time and secure a better future for yourself and your family.
But what exactly is investing? Put simply, investing involves putting your money into assets with the goal of making more money. There are various types of investments available to individuals, from stocks and bonds to mutual funds and real estate investments. Understanding how each type works is key to making smart investment decisions that will help you meet your financial goals.
Investing can also involve investing in time and labor, especially when it comes to business operations. These investments are similar in that one expects to see returns. While no investment carries a guarantee, understanding what they are and how they operate will assist you in making smart financial decisions.
What is an investment?
When you invest, you're essentially trading current resources (like time or money) for an asset that has the potential to grow in value. Ideally, if you choose to invest in the right asset at the right time, your investment could gain value. As an example, when you trade on the stock market, you are buying stock with capital in the hope that in time the asset will grow in value and sell for more money than the initial capital investment.
There are plenty of different types of investments one could use to grow their money, from stocks and bonds to commodities and cryptocurrencies, as well as mutual funds and real estate properties. The concept behind every investment is that it will make more money for the investor in the long term.
A smart investment allows an individual to not only make money but increase their total net worth. However, it's crucial to remember that every type of investment is speculative and there is always a possibility you will lose some or all the money you put in. For example, if you purchase stock shares or a piece of property, the value could decrease soon after you buy it. For this reason it is imperative that one assesses their risk tolerance before investing in something so as not to lose money.
The definition of an investment is not constant and can change depending on the situation. For instance, in macroeconomics, investing refers to purchasing items now that will be used later to generate income. While a company or individual from one nation might invest in business properties located in another country, such as building a factory which is known as foreign direct investments.
What are the different types of investments?
With a variety of options available, each investment type carries its own potential for returns, risks, and other factors such as tax implications and management fees. Below we highlight several options available to the everyday trader that can be used individually or together as part of an investment strategy to contribute to their financial goals.
By investing in stocks on the stock market, you are purchasing fractional ownership of a public listed company. People generally invest in stocks with the aspiration that their value will have gone up by the time they sell them. In order to make a profit from selling stock, the price will need to have grown enough to cover any trading costs and transaction fees associated with the trade.
Investing in certain stocks might also make you liable to dividend payouts, where a company distributes profits to shareholders (holders of stock) based on the company's performance.
Read more about investing in stocks in our What Are Stocks article.
Mutual funds are investment vehicles that pool the money of many investors and invest in a variety of different assets such as stocks, bonds, and other securities. A mutual fund is managed by an investment professional who makes all the decisions about where to put the money within the fund.
These professionals seek to maximize returns for investors while maintaining a certain level of risk. Mutual funds are a great way for investors to diversify their portfolios, as the fund’s holdings may include stocks from many different companies and sectors. Additionally, mutual funds reduce the amount of research required to make an informed investment decision since all decisions are made by the fund manager. Investing in a mutual fund may come with higher fees than other investments.
By purchasing a bond, you are essentially loaning money to a government, company, or other borrowing entity. In return for your loan, the debtor (the bond issuer) is required to repay both the debt and any associated interest payments.
However, it's worth noting that on occasion companies and countries default on their bonds, meaning that they can't make scheduled payments to the bondholders which will result in the investor losing money. This is almost always a last resort option as these establishments know that defaulting will scare off investors going forward.
A bond is a fixed-income instrument that pays periodic interest payments until the agreed-upon end date when the final payment is made and the loan's original amount is repaid.
Commodities are raw materials that can be traded for one another, such as gold, beef, and gas, expanding to foreign currencies and indexes. Funds that invest money in commodities will typically invest in resources such as precious metals (silver, gold), energy resources (natural gas, oil), and primary agricultural products (wheat).
Cryptocurrencies are digital assets that are operated on decentralized networks free from government or financial institutional control. While considered high-risk, several cryptocurrencies (such as Bitcoin) have shown incredible gains over the last decade. Various investment accounts in mainstream firms are starting to incorporate cryptocurrencies into their portfolio.
Other investment options (real estate investments, etc)
Other investment options include real estate, options, futures, and certificates of deposit.
Before investing in any of the asset classes mentioned above it is imperative that one understands the financial instruments and their own risk tolerance entirely, as well as the terms involved in the investment, the fees or transaction costs and the risks involved.
It is also important for savvy investors to understand the tax implications of their investments and the capital gains tax they might be required to pay on any investment returns.
How do investments work?
While each asset class might differ slightly, they all require an upfront investment of capital. The intention is that this will later create a return in a monetary form of higher value.
When investing in financial products such as bonds, stocks, or a mutual fund, investors will typically have to set up an investment account with a professional such as a brokerage firm or money manager. This person can then advise on which products to invest in and manage your portfolio.
Investing in real estate will involve buying a house, usually done by making a down payment or investing in real estate investment trusts. These properties can either be used to live in or rent out and generate future income. The intention here is that the house appreciates in value over a certain period of time and can later be sold at a higher price. Depending on the property and area these types of investments can range from high risk to low risk.
How investments drive economic growth
Investments are not just for personal or corporate benefits, they play a big role in driving the broader economy. Through factors like building consumer demand and job creation, investing can play a direct role in economic growth.
For instance, a company might decide to sell stocks and issue corporate bonds in order to raise capital. This capital can then be used to build a factory, create a new product line and hire new employees. This then drives the greater economy while also building the company's and investors' wealth.
In another example, governments might use the funds raised from corporate bonds to fund public projects, fix the roads, or build social programs in communities. Or individuals might use gains made from investments to further their education or save for retirement. With more income comes more consumerism, in turn contributing to economic growth.
How to start investing
If you're ready to start investing, you will first need to determine your risk tolerance and which asset class you wish to pursue. If you're just starting out, start small and grow instead of taking on too many things at once. Gaining an understanding of your risk tolerance will help you to navigate where start investing.
Before you begin, ensure that you have a thorough understanding of the market you wish to invest in, and understand all the associated risks. Always do your own research, and don't rely on one outlet or individual to be the sole source of information. If the option is available, consider hiring a professional to assist you.
Understand market movements
Another important aspect to understand before investing is that markets will always have fluctuations. Even if they grow over long periods of time, they will still go through periods of increases and declines. Don't rely on past performances to dictate future outcomes.
Open an account
To get started in investing you will need to open an investment account that allows you to both buy and sell the financial instrument. Looking at investing in stock, some investors will open a brokerage account that will execute trades on their behalf, while others might use a portfolio manager who oversees all their investments. Always do your research before parting ways with your money.
Have your financial affairs in order first
While investing is designed to create wealth, it is important to have a grasp on your personal finance beforehand, and ideally have an emergency fund set up for any unforeseen expences (so that you won't have to tap into your investment accounts).
An investment is the act of buying an asset with the intention that it appreciates in value over time. Before people invest it is imperative that one establishes their risk tolerance to establish how much risk one has to navigate.
Investments can be managed by professionals or individually, depending on the investors preference. It is also important to note that return on investments will typically be imposed by capital gains taxes, depending on the jurisdiction.
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