Career & Finance Fridays

“If you aren't thinking about owning a stock for ten years, don't even think about owning it for ten minutes.” ― Warren Buffett

What Is an Investment?

An investment is an asset or property acquired to generate income or gain appreciation. Appreciation is the increase in the value of an asset over time. It requires the outlay of a resource today, like time, effort, and money, for a greater payoff in the future or for generating a profit.

Key Takeaways

• An investment involves using capital in the present to increase an asset's value over time.
• Investments may include bonds, stocks, real estate, or alternative investments.
• Investments can be diversified to reduce risk, though this may reduce the amount of earning potential.
• In business contexts, investments are financial; however, consider how some people spend time to make higher incomes in the future (i.e. invest in a college education).

Stocks, bonds, and mutual funds are the most common types of investments.

Investopedia / Nez Riaz

Where to Invest

• Stocks or Equities: A share of stock is a piece of ownership of a public or private company. The investor may be entitled to dividend distributions generated from the company's net profit. The stock's value can also grow and be sold for capital gains. The two primary types of stocks to invest in are common and preferred.
• Bonds or Fixed-Income Securities: An investment that often demands an upfront investment and pays recurring interest over time, called a coupon payment. At maturity, the investor receives the capital invested into the bond. Like debt, bond investments are a mechanism for governments and companies to raise money.
• Index Funds or Mutual Funds: Index and mutual funds aggregate specific investments to craft one investment vehicle. An investor can buy shares of a single mutual fund that owns shares of multiple companies. Mutual funds are actively managed while index funds are often passively managed. Actively-managed funds use investment professionals to outperform an index or try to beat a specific benchmark. In contrast, passively-managed funds attempt to imitate a benchmark by mirroring the stocks listed on the index.
• Real Estate: Real estate investments are 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.
• Commodities: Raw materials such as agriculture, energy, or metals are commodities. Investors can invest in tangible commodities, like owning a bar of gold, or choose alternative investment products that represent digital ownership, such as a gold ETF. Oil and gas are examples of commodities.
• Cryptocurrency: A blockchain-based currency used to transact or hold digital value. Cryptocurrency developers or companies can issue coins or tokens that may increase in value. These tokens can also be used in transactions. Cryptocurrency can be staked on a blockchain where investors agree to lock their tokens on a network to help validate transactions. These investors are rewarded with additional tokens.
• Collectibles: Collecting or purchasing collectibles involves acquiring rare items in anticipation of those items increasing in value and demand. From sports memorabilia to comic books, these physical items often require substantial physical preservation, considering that older items usually carry higher value.

How to Invest

Take the Next Step to Invest

• Research: Investors should understand the vehicles they are putting their money into. Whether it is a single share of a well-established company or a risky alternative investment endeavor, investors should do their homework.
• Establish a personal spending plan: Before investing, individuals should ensure they have enough capital to pay monthly expenses and have already built up an emergency fund.
• Understand liquidity restrictions: Some investments are less liquid than others and may be more difficult to sell. An investment, like a Certificate of Deposit (CD), may be locked for a certain period and not be easily liquidated.
• Tax implications: Investors should understand the cost of short-term and long-term capital gains tax rates.
• Determine Risk: Investing incurs risk. Investors may end up with less money than they started with. Investors uncomfortable with this idea can (1) reduce their investment only to amounts they are comfortable losing or (2) explore ways to mitigate risk through diversification.

• Consult an adviser: Many financial professionals provide guidance and help investors access financial instruments, accounts, and online platforms.

Fast Fact

Diversification mixes a variety of investments, such as stocks, bonds, or real estate, within a portfolio to reduce portfolio risk.

Calculating Return on Investment (ROI)

The primary way to gauge the success of an investment is to calculate the return on investment (ROI). ROI is measured as:

ROI = (Current Value of Investment - Original Value of Investment) / Original Value of Investment

ROI allows different investments across different industries to be compared. For example, consider two investments: a $1,000 investment in stock that increased to $1,100 over the past year, or a $150,000 investment in real estate now worth $160,000.

Stock ROI = ($1,100 - $1,000) / $1,000 = $100 / $1,000 = 10%

Real Estate ROI = ($160,000 - $150,000) / $150,000 = $10,000 / $150,000 = 6.67%

Though the real estate investment has increased by $10,000, many would claim that the stock investment has outperformed the real estate investment because every dollar invested in the stock gained more than that invested in real estate.

Investments and Risk

Investment return and risk commonly have a positive correlation. If an investment carries high risk, it should be accompanied by higher returns. When making investment decisions, investors must gauge their risk appetite. 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. Individuals closer to retirement commonly choose safe investments.

Because investing is oriented toward future growth or income, there is always a certain level of risk. An investment may lose value over time, a company may go bankrupt, or interest rate fluctuations may affect bonds or real estate investments. Investors can reduce portfolio risk with a broad range of investments. By holding different products or securities, an investor may not lose as much money as they are not fully exposed in any one way.

How Much Will I Make If I Invest $100 Per Month?

It depends on what you invest in and market conditions. If you expect (and get) a 5% return over 30 years of investing $100 per month, you'd end up with about $198,300.

How Do Investments Work?

There are many forms of investing, but in general, you use your money to purchase an asset (that you have educated yourself about) to provide income or grow in value.

What to Invest In As a Beginner?

Some of the simplest and most inexpensive ways to begin investing is in a retirement plan such as a 401(k) through your employer, an IRA, or an exchange traded fund (ETFs). ETFs generally have low starting amounts, such as $1, and have very low fees.

The Bottom Line

An investment is an asset purchased as part of a plan to put money to work today to obtain more money in the future. It is also the primary way people save for major purchases or retirement. Using stocks, bonds, real estate, or commodities, individuals can create a diversified portfolio.

Money & Finances

Where do you have the majority of your money invested?