Investing
What Is Investing?
Investing, comprehensively, is putting money to work for a while in some kind of project or undertaking to generate positive returns (i.e., profits that exceed the amount of the initial investment). It is the act of dispensing resources, generally capital (i.e., money), with the expectation of generating an income, profit, or gains.
One can invest in many types of endeavors (either directly or indirectly) like utilizing money to start a business, or in assets, for example, purchasing real estate in hopes of generating rental income or potentially reselling it later at a higher price.
Investing differs from saving in that the money used is put to work, meaning that there is some implicit risk that the related project(s) may fail, resulting in a loss of money. Investing likewise differs from speculation in that with the latter, the money isn't put to work per-se, yet is betting on the short-term price variances.
Understanding Investing
Investing is to develop one's money over time. The expectation of a positive return as income or price appreciation with statistical significance is the core premise of investing. The spectrum of assets wherein one can invest and earn a return is a very wide one.
Risk and return remain closely connected in investing; low risk generally means low expected returns, while higher returns are typically accompanied by higher risk. At the low-risk end of the spectrum are fundamental investments like Certificates of Deposit (CDs); bonds or fixed-income instruments are higher up on the risk scale, while stocks or equities are regarded as riskier. Commodities and derivatives are generally considered to be among the riskiest investments. One can likewise invest in something practical, like land or real estate, or delicate items, like fine art and antiques.
Risk and return expectations can change widely within the same asset class. For example, a blue chip that trades on the New York Stock Exchange will have a very different risk-return profile from a micro-cap that trades on a small exchange.
The returns generated by an asset depend on the type of asset. For instance, many stocks pay quarterly dividends, whereas bonds generally pay interest every quarter. In numerous locales, different types of income are taxed at different rates.
In addition to regular income, for example, a dividend or interest, price appreciation is an important component of return. Total return from an investment can in this manner be regarded as the sum of income and capital appreciation. Standard and Poor's estimates that since 1926, dividends have contributed nearly 33% of total equity return while capital gains have contributed 66%. Capital gains are therefore an important piece of investing.
Economists view investing and saving to be two of a kind. This is because when you save money by depositing in a bank, the bank then lends that money to people or companies that need to borrow that money to put it to great use. Therefore your savings is often someone else's investment.
Types of Investments
Today, investment is for the most part associated with financial instruments that allow people or businesses to raise and deploy capital to firms. These firms then rake that capital and use it for growth or profit-generating activities.
While the universe of investments is an immense one, here are the most common types of investments:
Stocks
A buyer of a company's stock becomes a fractional owner of that company. Owners of a company's stock are known as its shareholders and can participate in its growth and success through appreciation in the stock price and regular dividends paid out of the company's profits.
Bonds
Bonds are debt obligations of entities, like governments, municipalities, and corporations. Buying a bond implies that you hold a share of an entity's debt and are entitled to receive periodic interest payments and the return of the bond's face value when it matures.
Funds
Funds are pooled instruments managed by investment managers that enable investors to invest in stocks, bonds, preferred shares, commodities, etc. The two most common types of funds are mutual funds and exchange-traded funds or ETFs. Mutual funds do not trade on an exchange and are valued toward the end of the trading day; ETFs trade on stock exchanges and, like stocks, are valued continually all through the trading day. Mutual funds and ETFs can either passively follow indices, like the S&P 500 or the Dow Jones Industrial Average, or can be actively managed by fund managers.
Investment Trusts
Trusts are another type of pooled investment, with Real Estate Investment Trusts (REITs) the most popular in this category. REITs invest in commercial or residential properties and pay regular distributions to their investors from the rental income received from these properties. REITs trade on stock exchanges and consequently offer their investors the advantage of instant liquidity.
Alternative Investments
Alternative investments is a trick all category that includes hedge funds and private equity. Hedge funds are purported because they can hedge their investment bets by going long and short on stocks and other investments. Private equity enables companies to raise capital without opening up to the world. Hedge funds and private equity were typically simply available to affluent investors deemed "accredited investors" who met certain income and net worth requirements. However, in recent years, alternative investments have been introduced in fund formats that are accessible to retail investors.
Options and Other Derivatives
Derivatives are financial instruments that derive their value from another instrument, like a stock or index. Options contracts are a popular derivative that gives the buyer the right however not the obligation to buy or sell a security at a fixed price within a specific time period. Derivatives typically employ leverage, making them a high-risk, high-reward proposition.
Commodities
Commodities include metals, oil, grain, and animal products, as well as financial instruments and currencies. They can either be traded through commodity futures — which are agreements to buy or sell a specific quantity of a commodity at a specified price on a particular future date — or ETFs. Commodities can be used for hedging risk or for speculative purposes.
Comparing Investing Styles
Let's compare a couple of the most common investing styles:
- Active versus passive investing: The goal of active investing is to "beat the index" by actively dealing with the investment portfolio. Passive investing, then again, advocates a passive approach, for example, buying an index fund, in tacit recognition of the fact that it is hard to consistently beat the market. While there are pros and cons to the two approaches, in reality, few fund managers beat their benchmarks consistently enough to legitimize the higher costs of active management.
- Growth versus value: Growth investors prefer to invest in high-growth companies, which typically have higher valuation ratios like Price-Earnings (P/E) than value companies. Value investors search for companies that have fundamentally lower PE's and higher dividend yields than growth companies because they might be undesirable with investors, either temporarily or for a prolonged period of time.
Step by step instructions to Invest
Do-It-Yourself Investing
The question of "how to invest" boils down to whether you are a Do-It-Yourself (DIY) sort of investor or would prefer to have your money managed by a professional. Numerous investors who prefer to manage their money themselves have accounts at discount or online brokerages because of their low commissions and the ease of executing trades on their platforms.
DIY investing is sometimes called self-directed investing, and requires a fair amount of education, expertise, time commitment, and the ability to control one's emotions. In the event that these attributes do not describe you well, it might be smarter to let a professional help manage your investments.
Professionally-Managed Investing
Investors who prefer professional money management generally have wealth managers taking care of their investments. Wealth managers as a rule charge their clients a percentage of assets under management (AUM) as their fees. While professional money management is more expensive than overseeing money without anyone else, such investors wouldn't fret paying for the convenience of delegating the research, investment decision-production, and trading to an expert.
The SEC's Office of Investor Education and Advocacy urges investors to confirm that their investment professional is licensed and registered.
Roboadvisor Investing
Some investors opt to invest based on suggestions from automated financial advisors. Powered by algorithms and artificial intelligence, roboadvisors gather critical information about the investor and their risk profile to make suitable recommendations. With little to no human interference, roboadvisors offer a savvy approach to investing with services like what a human investment advisor offers. With advancements in technology, roboadvisors are capable of more than selecting investments. They can likewise help people develop retirement plans and manage trusts and other retirement accounts, for example, 401(k)s.
A Brief History of Investing
While the concept of investing has been around for millennia, investing in its present form can track down its foundations in the period between the seventeenth and eighteenth centuries, when the development of the principal public markets connected investors with investment opportunities. The Amsterdam Stock Exchange was established in 1787, followed by the New York Stock Exchange (NYSE) in 1792.
Industrial Revolution Investing
The Industrial Revolutions of 1760-1840 and 1860-1914 resulted in greater prosperity as a result of which people amassed savings that could be invested, fostering the development of an advanced banking system. The majority of the established banks that dominate the investing world began during the 1800s, including Goldman Sachs and J.P. Morgan.
twentieth Century Investing
The twentieth century saw new ground being broken in investment theory, with the development of new concepts in asset pricing, portfolio theory, and risk management. In the second half of the twentieth century, numerous new investment vehicles were introduced, including hedge funds, private equity, venture capital, REITs, and ETFs.
In the1990s, the rapid spread of the Internet made online trading and research capabilities accessible to the general public, completing the democratization of investing that had commenced more than a century prior.
21st Century Investing
The blasting of the dot.com bubble — a bubble that created a new generation of millionaires from investments in technology-driven and online business stocks — ushered in the 21st century and perhaps set the scene for what was to come. In 2001, the collapse of Enron became the dominant focal point, with its full display of fraud that bankrupted the company and its accounting firm, Arthur Andersen, as well as large numbers of its investors.
One of the most notable events in the 21st century, or history for that matter, is the Great Recession (2007-2009) when an overwhelming number of failed investments in mortgage-backed securities crippled economies around the world. Well-known banks and investment firms went under, foreclosures surmounted, and the wealth gap widened.
The 21st century additionally opened up the world of investing to newcomers and unconventional investors by immersing the market with discount online investment companies and free-trading apps, like Robinhood.
Investing versus Speculation
Whether buying a security qualifies as investing or speculation depends on three factors:
- The amount of risk taken on: Investing normally involves a lower amount of risk compared with speculation.
- The holding period of the investment: Investing typically involves a longer holding period, measured quite frequently in years; speculation involves a lot shorter holding periods.
- Source of returns: Price appreciation might be a relatively less important part of returns from investing, while dividends or distributions might be a major part. In speculation, price appreciation is generally the fundamental source of returns.
As price volatility is a common measure of risk, it makes sense that a grave blue-chip is significantly less risky than a cryptocurrency. In this way, buying a dividend-paying blue chip with the expectation of holding it for a long time would qualify as investing. Then again, a trader who buys a cryptocurrency to flip it for a quick profit in a couple of days is clearly speculating.
Example of Return From Investing
Assume you purchased 100 shares of XYZ stock for $310 and sold it exactly a year later for $460.20. What was your approximate total return, disregarding commissions? Keep as a main priority, XYZ does not issue stock dividends. The resulting capital gain would be (($460.20 - $310)/$310) x 100% = 48.5%.
Presently, imagine that XYZ had issued dividends during your holding period, and you received $5 in dividends per share. Your approximate total return would then be 50.11% (Capital gains: 48.5% + Dividends: (500/$31,000) x 100% = 1.61%).
The Bottom Line
Investing is the act of distributing resources into something to generate income or gain profits. The type of investment you choose could likely depend on you what you seek to gain and that you are so sensitive to risk. Assuming little risk generally yields lower returns and vice versa for assuming high risk. Investments can be made in stocks, bonds, real estate, precious metals, and the sky is the limit from there. Investing can be made with money, assets, cryptocurrency, or other mediums of exchange.
There are different types of investment vehicles, like stocks, bonds, mutual funds, and real estate, each carrying different levels of risks and rewards.
Investors can independently invest without the help of an investment professional or enlist the services of a licensed and registered investment advisor. Technology has additionally afforded investors the option of receiving automated investment arrangements via roboadvisors.
The amount of consideration, or money, needed to invest depends largely on the type of investment and the investor's financial position, needs, and goals. However, numerous vehicles have lowered their base investment requirements, allowing more people to participate.
Despite how you choose to invest or what you choose to invest in, research your target, as well as your investment manager or platform. Possibly one of the best nuggets of wisdom is from veteran and accomplished investor Warren Buffet, "Never invest in a business you can't understand."
Highlights
- Investing involves deploying capital (money) toward projects or activities that are expected to generate a positive return over time.
- The type of returns generated depends on the type of project or asset; real estate can produce the two rents and capital gains; many stocks pay quarterly dividends; bonds tend to pay regular interest.
- In investing, risk and return are cut out of the same cloth; low risk generally means low expected returns, while higher returns are typically accompanied by higher risk.
- Investors can take the do-it-yourself approach or employ the services of a professional money manager.
- Whether buying a security qualifies as investing or speculation depends on three factors - the amount of risk taken, the holding period, and the source of returns.
FAQ
How Might Investing Grow My Money?
Investing isn't reserved for the wealthy. You can invest nominal amounts. For example, you can purchase low-priced stocks, deposit small amounts into an interest-bearing savings account, or save until you accumulate a target amount to invest. On the off chance that your employer offers a retirement plan, for example, a 401(k), allocate small amounts from your pay until you can increase your investment. Assuming your employer participates in matching, you might realize that your investment has doubled.You can begin investing in stocks, bonds, and mutual funds or even open an IRA. Starting with $1,000 isn't anything to sneeze at. A $1,000 investment in Amazon's IPO in 1997 would yield millions today. This was largely due to several stock splits, however it does not change the result: monumental returns. Savings accounts are available at most financial institutions and don't ordinarily require a large amount to invest. Savings accounts don't typically flaunt high-interest rates; thus, shop around to track down one with the best features and most competitive rates.Believe it or not, you can invest in that frame of mind with $1,000. You will be unable to buy an income-producing property, however you can invest in a company that does. A real estate investment trust (REIT) is a company that invests in and manages real estate to drive profits and produce income. With $1,000, you can invest in REIT stocks, mutual funds, or exchange-traded funds.
Is Investing the Same as Gambling?
No, gambling and investing differ greatly.. With investing you put your money to work in projects or activities that are expected to produce a positive return over time - they have positive expected returns. Gambling is to place bets on the outcomes of events or games. Your money isn't being put to work by any means. Often, gambling has a negative expected return. While an investment might lose money, it will do so because the project involved fails to deliver. The outcome of gambling, then again, is due purely to chance.
What Are Some Types of Investments?
There are many types of investments to choose from. Perhaps the most common are stocks, bonds, real estate, and ETFs/mutual funds. Other types of investments to consider are real estate, CDs, annuities, cryptocurrencies, commodities, collectibles, and precious metals.
How Might I Start Investing?
You can choose the do-it-yourself route, selecting investments based on your investing style, or enlist the help of an investment professional, like an advisor or broker. Before investing, it's important to determine what your preferences and risk tolerance are. If risk-averse, picking stocks and options, may not be the best choice. Develop a strategy, framing the amount to invest, how often to invest, and what to invest in based on goals and preferences. Before dispensing your resources, research the target investment to make sure it lines up with your strategy and can possibly deliver desired results. Remember, you don't need truckload of cash to begin, and you can adjust as your needs change.
