What is an Investment?

An asset that is obtained in order to generate wealth or financial stability at a juncture in future is known as an investment. It is an act of safe-keeping money in a bank, any business, or property. 

Who is an Investor?

An investor is a person who puts in capital in a particular venture or project of an organization within an intention of making profits out of it. An investing is a way of capital utilization in an expectation for a handsome rate of return.  

Types of securities.

• Stocks
• Bonds
• Mutual funds
• Money market funds
• Exchange-traded funds

Types of Investments

There are various ways of investment that one should be aware of. They are

Stocks

Also referred to as “securities”, representing a part of a company owned by an individual. According to the definition, the shareholder receives dividends based on the company’s performance and earnings in the form of monetary compensation.

Bonds

A type of an invest done by an individual in security that contains less risk than others. It is a fixed income mechanism which allows a company to borrow money from people. The money is then returned at equal intervals at a fixed rate of return. This investing strategy is used by companies, municipalities, states, and sovereign governments to finance projects and operations. They generally have maturity dates at which the principal amount is paid back in full or is accounted as default. In case of bond, its prices are inversely correlated with interest rates, i.e., when rates go up bond prices fall and vice-versa.

Mutual Funds

A combination of capital of various people who are keen to invest in securities. A mutual fund investing consists of bonds, securities, money market funds, and so on. It covers every aspect of the market related to bonds and stocks. It provides a good management of portfolios at a lower rate to small-scale investors. A mutual fund’s value depends on the performance of securities bought by it. Mutual funds charge a fee called expense ratios, typically known as commission.

Equity Stock

The stock that represents ownership of a company. When an individual owns interest in a company, it means they have been holding an equity stock. It is also known as a shareholder’s equity and is traded in the stock market.

Real Estate Investments

Means investing in any tangible property in order to generate a return or to meet an individual’s financial goals, rather than using it merely for residing.

Money Market Funds

Money market funds are safer than other investing options. Only specific categories of stocks are traded in money market funds issued by the U.S state, federal, or local governments. It includes short-term investments as well as high-quality investment portfolios.

Income Funds

 Income fundsincludes treasury stocks, bonds, and other securities. This form of investing has capacity to pay back good returns, specifically, interests or dividends. Similar to mutual funds, it is mostly focused on current returns rather than future returns.

Balanced Funds

A mixture of bonds and stocks that help in generating a moderate return. It happens so because of the combination and balance between bond interest and dividend shares.

Growth Funds

It usually includes investing of shares by companies that have the capacity to increase the share price rather than the income. More emphasis is given to an increase in share price, however, returns from such stocks are not very high. It is a combination of domestic and foreign shares that is more volatile than income funds.

International Funds

International funds involve investing in foreign shares and bonds. The stock market is international and includes certain specific countries that invest. The risk is higher in international stock market funds, however, return on such funds is also higher in future.

Sector Funds

 It involves investing in a particular sector or industry of an economy. Risk is higher in sector funds and an appreciation of price is also present at a reasonable rate.

Hedge Funds

A type of alternative investing strategy. It is generally considered as more expensive compared to conventional investing of funds and is restricted to high net-worth or other sophisticated investors. These are most often set up as private limited partnership that are open to a limited number of high-net-worth investors and usually require large amount of initial investment.  It also requires investors to keep their money in the fund for at least one years’ time also known as the lock-up period. The withdrawals in hedge funds takes place quarterly or bi-annually.

Common Mistakes

• High Expectation: Most of the small-scale investors that do not have a lot of money to invest, always invest in small stocks or low-priced shares expecting a gain of a large amount in return. For example, these investors expect to earn $5,000 by investing in an $800 priced share that is considered impracticable.
• Unaffordable Risk: A person should only invest an amount that he/she is ready to put at stake. Investing in securities or bonds consists of numerous risks as well as opportunities. So, if one cannot afford to take risks, he/she mustn’t invest in any kind of asset or security. It will ultimately result in decisions that turn out to be inadequate in regard to buying or selling. This is an outcome of high stress levels.
• Impatient Investors: It requires a lot of time to gain profit in shares. New business plans are made by a company to increase the share price and return on such. As a result, it takes a long time and an investor should have the patience to gain a good return on his/her investment. Thus, the immediate expectation of an increase in share price is in vain.
• Investing on Stocks by Gaining Knowledge from Wrong Places: This is a very important point to consider as experts share their opinions and suggestions with people regarding the best places to invest. However, not all experts have the correct knowledge and expertise in terms of investment planning. Thus, choosing a correct investing portfolio is necessary.
• Mob Mentality: Many people invest in shares or bonds that are popular and have performed well in the past. Places where most investors invest and places that have growth in their pricing are always taken as a priority. Due to this mentality, a new company’s stock is not regarded as an important functional area. Even stock planners and guides suggest investing in popular stocks.
• Averaging Down: It is used by investors who have already made a mistake and are trying to recover their losses. For instance, if they bought a stock at $5.50, and it drops to $1.60, they make a mistake by purchasing the lower-priced shares or a bunch of those shares to reimburse their losses.
• Little due Diligence: Where the speculation is high and stocks are with lower prices, significant diligence is required and some work to have a proper investment portfolio. For better investing returns, due care and diligence are mandatory. For example, electric vehicles will be in great demand in the future, hence investment in an electric car company’s stock would be a fruitful plan that provides a high surplus in future.

Relationship Between Risk and Return

A positive correlation exists between risk and return: the greater is the risk, the higher is the potential for a greater return and in case where the risk is less, lower is the potential for profit or return. A potential investor should try to understand his individual tolerance for risk before constructing a portfolio of assets.

Formulas

Total Return

Calculation of total return includes dividends while figuring the return on stock. The formula for calculating the total return is written below.

(Value of investment at the end of the year — Value of investment at beginning of the year) + Dividends / Value of investment at beginning of the year.

Simple Return

A simple return is the same as a total return but is used to calculate the return only after selling it. The formula for calculating simple return is shown below.

(Net Proceeds + Dividends) / Cost Basis – 1

ROI = Current Value of Investment – Cost of Investment ÷ Cost of Investment

Return on Investment (ROI)

Return on investment is used to evaluate the performance and efficiency of an investment. It is used to compare its capability using different investing strategies. The formula for calculating return on investment is shown below.

Context and Applications

The topic is significant in the professional exams for both undergraduate and postgraduate courses, especially for

• B. Com (H) (Bachelor of Commerce (Honors)
• BA (Bachelor of Arts) in Finance/ Economics
• BBA (Bachelor of Business Administration) in Finance
• MBA (Master of Business Administration) in Finance
• CFA (Chartered Financial Analyst) Program 

Related Concepts

• Asset allocation
• Bond
• Exchange
• IRA
• Market Capitalization
• Stock
• Yield
• Benchmark
• Capital
• Custodian
• Diversification
• Growth investing
• Index
• Inflation
• Maturity
• Prospectus
• Valuation
• Value Investing
• Volatility