Define Investments in Simple Terms
An investment refers to any asset that is obtained for cost on the grounds that it is expected to provide value in the future that will exceed its initial cost and time to value.
This happens due to an appreciation of the asset’s value. This could be because of:
- A change in market conditions (such as with stocks)
- A change in the overall supply (such as the works of a particular artist growing more expensive as collectors accumulate more of the overall supply)
- Because of a direct improvement being made (such as with buying real estate and renovating to increase the value).
An investment is an asset that will eventually provide value that exceeds the initial cost.
The term investment can apply to almost any asset, including intangible assets such as education.
In terms of the stock market, investing typically refers to the purchase of stocks or bonds.
These securities are designed to provide an investor with future value that will exceed their initial cost.
Investments can also be made in other assets. Investing in real estate, for example, could mean buying an inexpensive property, renovating to increase its value, and then selling or leasing for more than the original cost.
What Do Investments Mean in Finance?
Investments in finances are instruments that investors purchase in order to realize a greater return later. Most often, these instruments are stocks.
For example, an investor may purchase $1000 in stocks from a company. The company uses the money to fund and grow operations.
As the company develops, the value of the investor’s shares may grow to $1200. The investor will have realized a $200 profit from their investment.
Types of Investments
Below is a list of some common financial investments:
- Stock/Equity: Buying stock is like buying a small fraction of a company; it uses your money to fund the business and you get to enjoy a portion of the profits.
- Bonds/Debt Instruments: Buying bonds is like having a company take out a loan from you. It will pay you interest on the principal as well as the full amount later on.
- Mutual Funds: Mutual funds pool money from several investors and invest it in different asset classes. Each investor sees a return based on performance and the size of their initial contribution.
- Index Funds: Index funds track the performance of a particular market index, such as the S&P 500. They are not actively managed; their performance is based on the performance of the index.
- Exchange-Traded Funds (ETFs): ETFs are similar in function to index funds, but they are traded on the open market like stocks.
- Options: Options are a contract to buy or sell an asset (such as stocks) at a set date for a set price. Smart investors predict price changes in order to realize a profit.
A capital investment is a type of investment that involves putting down a sum of cash to finance a purchase that will provide long-term value.
It is also sometimes used to describe the purchase of things like long-term equipment.
Capital investments are often made by wealthy individuals, venture capital groups, or financial institutions.
In such a case, the investment in the business is expected to return value to the investor.
Fixed Income Investments
Bonds are among the most common fixed income investments. They offer a consistent return on principal over time.
Other fixed income investments include preferred stocks, which pay dividends, as well as CDs and money market funds.
High Risk vs Low Risk Investments
Risk is a term that is not unanimously defined by investors.
Generally, the probability that an investment will yield either a loss or underperformance can be thought of as the investment’s level of risk.
High risk investments are those that have a relatively high chance of ending up with a loss.
Junk bonds, for example, carry a greater than average risk that the issuing company will default.
Low risk investments are those with a relatively low risk of failure. Government bonds and stable indices like the S&P 500 are examples of fairly low risk investments.
What Is Investment Management?
Investment management refers to the service of managing a client’s investments, including allocation, buying and selling, and other forms of handling.
Investment managers can help ensure a well diversified portfolio, and can be beneficial when investing large amounts of money in different asset classes.
What Is an Investment Portfolio?
An investment portfolio is a basket of assets that may be comprised of stocks, bonds, real estate, cash, ETFs, mutual funds, and more.
Investors aim to have a well diversified portfolio. This means that their portfolio contains a variety of different assets (such as stocks, bonds, and real estate).
Assets are often chosen to intentionally react differently to market changes.
This is to offset any losses from a random market swing.
Return on Investment
Return on investment, or ROI, is a metric that evaluates approximately how much value has been gained from an investment relative to the cost.
For example, if you had purchased an asset for $100 and the value appreciates to $120, then you have gained $20 worth of value for an ROI of 20%.
Return on Investment Formula
Return on investment is calculated using the following formula:
Take the current value of the investment and subtract the cost of the investment.
Divide by the cost of the investment and you have the return on investment.
For example, say that you bought an asset currently worth $1000. You initially purchased the asset for $800.
The return on investment for that asset would be:
An investment bank is a financial institution that advises and makes investment transactions on behalf of clients.
These clients may be individuals, corporations, or governments.
Despite being called banks, investment banks do not accept deposits and usually don’t offer traditional banking services.
This is due to the Glass-Steagall Act of 1933 that enforces the separation of investment and commercial banks.
An investment company is a business that invests the pooled capital of investors.
Their goal is to make investments that grow the investor’s asset bases. Usually investment companies invest in mutual funds.
While the main purpose of an investment company is to hold and maintain investor’s accounts, they may offer services such as tax management, recordkeeping, and portfolio management.