What is an Investment?
Through an investment, an individual or organization spends resources to acquire assets (think stocks, real estate, etc) in an attempt to gain future benefits — Including profits or a new revenue stream.
When you make an investment, you trade resources (like money or credit) for assets (like stocks or real estate) in an attempt to gain future benefits. For example, an investor might purchase stocks believing that they’ll appreciate in value or to collect dividend payments. A student might invest in a college degree with the hope of starting a fulfilling career. Investments are often thought of in terms of money, but you can also invest other resources, like time and labor (like a business might do). An investment can produce losses if the acquired asset’s value decreases or if other realized benefits (think of rent payments for a rental property) don’t meet expectations. Where there’s a potential for reward, there’s also risk.
Imagine that a few years ago, as the 2014 holiday season approached, you noticed that most of your friends and family were buying gifts online. You became convinced that e-commerce was the future, so on Jan. 6, 2015, you bought 10 shares of Amazon at $300 per share. Fast forward to Feb. 11, 2020; Amazon stock is selling at a much higher price of $2,150 per share. You decide to sell yours. The 10 shares you invested in are now worth $21,150 — Netting you a profit of $18,500 before taxes, trading fees, and other costs are deducted. Of course, hindsight is 20/20; many investments don’t always pan out. If you had bought J.C. Penny stocks on Jan. 6, 2015 at $7.90, each share would have been worth only about 73 cents on February 11, 2020.
An investment is like planting a seed in a garden...
If you plant a seed in the right spot at the right time, and maintain it in the right conditions, someday that seed may grow into something that keeps giving back. Think of a lemon tree, a strawberry vine, or a fragrant flower. Similarly, an investment has the potential to grow into something with more value than what you paid to acquire it. But just as a plant may wither, an investment carries the risk of losing money.
When you invest, you trade current resources (such as time or money) to acquire an asset that will hopefully generate future benefits. Ideally, if you invest an asset at the right time and place, your investment may potentially gain value. For example, when you invest in the stock market, you typically trade money (an asset) for stocks. There are many different types of assets a person might invest in — Stocks, bonds, commodities, mutual funds, and real estate are just a few common examples. Generally speaking, the idea of an investment is that it can benefit the investor over time.
Think of someone buying a house with the hope that it will appreciate and later sell at a higher price. For many people, an investment offers an opportunity to grow their overall wealth or provide a source of income. It’s also important to keep in mind that all investments come with some level of risk. For example, a stock or property’s value can decline after you buy it.
The meaning of an investment can vary depending on the context. In macroeconomics, an investment refers to goods that are acquired and used in the future to create wealth. A company or individual in one country might invest in business interests in another country, such as setting up a factory (aka foreign direct investments).
Just as you can grow many different types of plants in a garden, you can put your money and other assets into a variety of securities. Depending on the investment, there may be different potential for returns, risks, and other characteristics, such as management fees and tax ramifications. Here’s a look at some examples of investments in the financial world:
When you invest in a stock, you’re essentially buying a small piece of ownership in a company. Stocks are kind of like the movie stars of investment instruments — They’re always in the news, and everyone’s talking about them. When people invest in stocks, they tend to do so with the hope that the stock’s price will have increased by the time they decide to sell. Selling a stock at a higher price often means that you’ll profit from the sale (assuming the increase in price was more than enough to cover any trading fees and transaction costs). Some companies distribute profits to shareholders through quarterly dividend payments to owners of common stock.
When you buy a bond, you’re lending your money to a government, company, or other borrowing entity. In exchange, your debtor (aka the bond issuer) is generally obligated to repay the debt, plus interest. Companies and occasionally countries are sometimes unable to make their bond payments, however, and default — They don’t make payments to the bond holders. Organizations usually default as a last resort because doing so can scare away investors, making it hard to raise funds. Traditionally, a bond is a fixed-income instrument, meaning it provides payments on a fixed schedule. Bonds typically have an end date (aka maturity date), on which the final interest payment is made and the original amount loaned is paid back.
All investments require an upfront outlay, usually in the form of money, time, or labor. Ideally, the upfront investment can then grow and later produce a return in the form of higher monetary value or another benefit, but not all investments will result in profits. Typically, investing in a financial product (like stocks or bonds) involves setting up an investment account with a broker or through a financial professional, such as a money manager.
Many people choose to invest in real estate. Let’s say you decide to buy a house not only because you need a place to live, but also because you hope it can later serve as a source of income. After seeing the home’s value appreciate over time, you decide to sell it at a higher price. Or maybe you might decide to rent out the house to another tenant. Either way, the home you invested in may offer value at a later point in time.
Many investments involve business operations. Business investments are often associated with stocks, capital goods, and physical capital. But many companies also invest in human resources. For example, a business might invest in training employees to increase their productivity.
Before investing, keep in mind that all investments come with potential risks. It’s important to do your research first — Whether you’re deciding what to invest in or whether to hire a professional to help. It can also help to understand what your investment goals are and your ability to handle risk. Historically, markets have experienced both upswings and declines — And in the past, generally speaking, the stock market has gained over longer periods of time (20+ years). That said, keep in mind that a market’s past performance doesn’t say much about its future performance. And equally important, most investors have not been able to beat the market.
Typically, getting started as an investor in the market involves opening an investment account that allows you to buy and sell shares. Some investors may hire a broker who can execute trades on behalf of their clients by bidding on stocks and other assets. Others may hire a portfolio manager to oversee their investments. It’s always a good idea to do your homework and understand as much as you can about the markets and opportunities you are considering investing in.
Investments may help an investor grow their money, and in turn, their money may help grow a company and the broader economy. For example, a capital market allows a company to raise funds through stock sales and issuing corporate bonds. With that funding, a company could expand their business operations — Like build a new factory, hire more employees, or develop a new product line. All of this can play a role in economic growth, through factors like creating jobs and consumer demand.
Like a company, a government also tries to raise funds by seeking investment, often in the form of bonds. The money raised typically goes toward public projects like paving a new highway or supporting social programs. This helps to stimulate demand. And when people invest in their own education, real estate, or even personal skills and talents, it can help drive consumption. Many individuals use their investments to fund financial goals like retirement.
When people have more income, they may be more likely to spend their money on goods and services, which can help the economy grow. Likewise, when an economy contracts, it’s often correlated with a drop in investments. However, a decline in investments will not always result in an economic contraction. A contracting economy might even spur investment. In fact, public investments often increase during economic contractions as the government tries to stimulate aggregate demand.
Investment banking is a particular kind of banking that deals with large, complicated financial transactions. For example, an investment bank can help a company launch an Initial Public Offering (IPO), manage mergers and acquisitions, and sell securities (like bonds and stocks), among other services. Many large banks, including Goldman Sachs and JP Morgan Chase, offer investment banking services. Investment banks typically serve companies and governments who need to raise capital — Think of assets, including cash, that companies can use to make money. A typical individual investor probably wouldn’t turn to an investment bank to help manage your investments. Instead, individual investors are more likely to seek out a financial advisor or money manager.
What is the Dow Jones Industrial Average (DJIA)?
The Dow Jones Industrial Average is a group of stocks, called an index, that tracks in 30 shares in some of the largest companies in the United States.
What is Purchasing Power Parity (PPP)?
Purchasing power parity (PPP) is an economic metric that compares the standard of living between two countries by weighing the amount of each currency needed to buy similar goods.
What is Annual Percentage Yield (APY)?
Annual percentage yield (APY) tells you how much you stand to earn or owe on an account in one year — including interest applied to your previous interest (compound interest).
What is Tax Exempt?
Being tax-exempt means something or someone is not subject to taxes –- Like donations received by a charitable organization or interest earned on a municipal bond.
What is the European Union (EU)?
The European Union is a group of 27 countries that share a standard set of economic and political policies.
What is a Stock Split
A stock split cuts the price of the stock to make it more affordable by proportionally increasing the number of shares available — All without changing the overall value of the company (and a “reverse stock split” is the opposite, increasing the price by reducing the number of shares).