What Is an Investment?
An investment is an asset or item acquired with the goal of
generating income or appreciation. 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 later be sold at a higher price for a profit.
Understanding Investment
Investing is putting money to work to start or expand a project - or to
purchase an asset or interest - where those funds are then put to work,
with the goal to income and increased value over time. The term
"investment" can refer to any mechanism used for generating future
income. In the financial sense, this includes the purchase of bonds,
stocks or real estate property among several others. Additionally, a
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.
Taking an action in the hopes of raising future revenue can also be
considered an investment. For example, when choosing to pursue
additional education, the goal is often to increase knowledge and
improve skills in the hopes of ultimately producing more income. This is
also the main goal of reading articles on Investopedia. Because
investing is oriented toward future growth or income, there is risk
associated with the investment in the case that it does not pan out or
falls short. For instance, investing in a company that ends up going
bankrupt or a project that fails. This is what separates investing from
saving - saving is accumulating money for future use that is not at
risk, while investment is putting money to work for future gain and
entails some risk.
How Do Investments Earn Money?
Most investments earn an investor money through appreciation, interest
payments or dividends. Appreciation means that the value of an asset has
increased. If you purchased a collectible item for $100 and five years
later it was worth $500, then the collectible appreciated in value.
Securities can do the same -- a stock issued by a company can increase
in value over a number of years.
You have likely paid interest payments on a loan you have taken out,
whether that was a student loan or mortgage. These interest payments you
paid the lender were how the lender earned money on that loan (or
investment). One type of security that issues interest payments to its
investors is a bond. When you buy a bond, you are lending money to the
government or a corporation, who promises to pay you back and make
interest payments on the amount you lent.
Dividends are also issued as a payment to investors, but they
are made by companies whose stock or equity that you own. Public
companies issue stock to raise money for business activities, letting
investors purchase these stocks. If you own a stock in a company, that
company may also issue dividend payments to you as a way to share its
profits with its investors. This is on top of any appreciation in the
value of the stock.
Risks with Investing
Even though investing can earn money for you, it is not without risks.
The biggest risk with investing is that you may lose the money you
invested. Unlike savings or checking accounts, whose value is guaranteed
by the Federal Deposit Insurance Corporation (FDIC), investments have
no such guarantee.
Certain investments are less risky than others, but all investments
carry some amount of risk. The amount of risk also affects the rate of
return of an investment, meaning for someone to take on a lot of risk,
there must also be the possibility of great reward. Think about it: you
would not take a big risk without the possibility a big payoff.
Conversely, investments with less risk typically have lower returns.
One way that investors reduce their overall risk is by investing in a
variety of different securities, such as stocks and bonds, or even in
different types of the same security, such as government bonds and
corporate bonds. This is known as diversification, and it isan important
concept for any investor to understand.
Another big risk in investing is your own emotions. Many investments are
volatile in the short term, meaning that their value may fluctuate a
lot over one to five years. During economic recessions, the value of
many investments may fall dramatically. As an investor, it is difficult
to watch your investments lose money. This can lead to investing
decisions based on fear or panic, such as selling stocks when the prices
fall too low for your comfort.
When you invest, you should be holding most of your investments for ten,
twenty or more years. It is over these longer time periods that the
value of investments has historically increased. The Standard and Poors
500 (S&P 500), a stock market index, averaged a 7%
inflation-adjusted return from 1950 to 2009. Keep this in mind when you
make investing decisions. You will perform better as an investor if your
investing decisions are based on logic and reason rather than emotions.
You may have heard investing compared to gambling, and if you invest in a
lackadaisical way, it may be the same. However, smart investors will
approach investing strategically to choose investments that have a good
expectation of return. Gambling, on the other hand, is usually based
purely on chance.
