Investment is the investment of money in order to generate income or preserve capital. A distinction is made between financial investments (purchase of securities) and real investments (investments in industry, construction, etc.)
The Big Encyclopedic Dictionary in the edition of 2002 defines the word “investment” as a long-term investment of capital in sectors of the economy at home and abroad.
People who make investments are called investors. Anyone can become a private investor – a mid-level manager, financier, doctor, teacher, student, or pensioner, it does not require special education. It is a way for them to get additional income.
Traders are the opposite of investors; they constantly conduct short-term transactions, this type of activity is the main source of income for them.
While investments are aimed at making a profit for the investor, they are not a guaranteed way to make a profit. Different ways of investing provide different guarantees of income, but in all cases, there is a risk that instead of profit, the investor will receive a loss.
Ways to invest privately
There are many ways to invest money in the stock market. Some do not require deep knowledge of how financial markets work, while others are only for professionals.
The most common subjects for investment on the stock exchange can be included:
- Investing in stocks.
- Investing in bonds (government or corporate).
- Investments in precious metals (gold, silver, platinum).
- Investing in ETFs or mutual funds.
- Purchase of foreign exchange.
- Investing in derivative financial instruments (futures, options, swaps, etc.).
For convenience, private investments are divided into groups according to their timing. There are three groups:
- short-term (period of up to a year);
- medium-term (from 1 to 3 years);
- long-term (from three years and up).
Nowadays, there are two main styles of investing. The first is passive investing. It is characterized by investing for the long term. This style of investing presupposes that a person invests money, for example, in shares of a company and keeps them for several years without selling them. As a rule, passive investments are made in large commodity, technological and financial companies, they have a lower risk of sharp quotation drop, such companies often pay dividends.
The second style is aggressive investing. Here, it is implied that an investor invests money in more risky instruments. For example, not in shares of industry leaders, but in shares of smaller companies – when markets fluctuate such securities rise and fall (i.e., have high volatility), but due to the same quality one can earn more. This kind of investment requires a deep understanding of the market and a willingness to lose the money invested.
How to invest for a private person
A private person cannot trade at the exchange on their own. Brokers do this, and they also act as intermediaries between the exchange and the investor. You need to open a brokerage account, and then the account holder can buy/sell securities.
Brokers also offer the services of a professional asset manager. Together with specialists you choose an investment strategy, agree on the conditions of what shares to buy/sell, and further on the manager makes decisions about your portfolio.
Profitability and risks
Investments have two key qualities that have a direct correlation. They are profitability and risk. The higher the risk associated with an investment, the higher the potential return can be. And vice versa – relatively reliable investments never allow counting on a high return.
For example, a bank deposit, which can also be considered an investment, or the purchase of government bonds are low-risk investments. Bank deposits are insured, and in the case of government bonds, the government is the guarantor of the refund. But the return on such investments is also lower than the potential return on stocks, which can be affected for a variety of reasons, from market to corporate.
To illustrate the connection between risk and return, another example can be given. Bonds with a 10-year maturity bring the buyer a higher return than, for example, a three-year bond. The following principle applies here: the higher the term of the bond, the greater the risk is taken by the investor (after all, a lot can happen in 10 years even with government bonds), and therefore the greater the risk must be compensated for.
Portfolio of investments and its diversification
The totality of all investments made by an investor is called an investment portfolio.
An investment portfolio may consist of shares of one single company, but analysts and experienced investors recommend not spending all of your capital on one security. To reduce risks and increase the profitability of investments, the investment portfolio should be diversified, i.e. investments should be divided between different securities.
Even developed economies and large companies inevitably face periods of decline and stagnation. To protect yourself from such situations, your investment portfolio should include not only shares, but also bonds, deposits, and exchange-traded funds. Professional investors add commodity delivery contracts – futures – to their portfolios.
Shares are considered the riskiest, but the most profitable, part of a portfolio. Exchange-traded funds are the golden mean, associated with relatively low-risk and high returns. The protective part of a portfolio is bonds and deposits that stabilize a portfolio in case of strong volatility, it is the most reliable part of a portfolio.
In addition to asset diversification, it is also important to allocate the portfolio to sectors or industries. The importance of this principle is readily apparent in a careful study of any economic crisis. During such periods, when some stocks go down, others go up. This creates balance and keeps losses to a minimum.
What kind of investments there are
The notion of investment is not limited to private investments in securities or derivative financial instruments. Broadly speaking, the term “investment” can be extended to any investment by an individual or a company, whether in cash, tangible assets, or intangible assets.
The main classes of investments:
- Real investments. These include, for example, the purchase of a ready-made business; the purchase of intangible assets, such as patents, copyrights, trademarks, and others; construction, renovation, major repairs.
- Financial investments. This includes the purchase of securities or financial derivatives.
- Speculative investments. In this case, the main feature of investment is a bet on income at the expense of the change in the price of the asset. The principle “buy cheaper, sell dearer” is applied. The subject of speculative investments can be shared, in addition to them – currency, precious metals, bonds.
- Venture capital investments. These are investments in young companies for the long term. Venture capital investments are associated with a high risk of losing the investment altogether, but they can also bring investors super-profits. An example of successful venture investment is SoftBank’s investment in a young company, Alibaba, in 2000. After Alibaba’s IPO in 2014, SoftBank’s stake grew from $20 million to $74 billion. An example of a failed venture capital investment is the bankruptcy of the medical project Theranos, which attracted at least $500 million from venture capitalists before its collapse.
- Portfolio investments. These are investments not in one type of asset (for example, a share of a particular company), but in several, which are formed as a portfolio of several securities.
Intellectual investments. These are investments in an intellectual product. This may be the training of specialists, scientific development, intellectual property, or the creative potential of a group of people.
The opposite of investment is divestment. This is the economic term for the reduction of an asset. Divestment can be defined as the sale of part of an existing business, which companies do when they want to focus on their core business.
Divestment can also be done for moral and ethical reasons. In recent years, environmental activists have called for the divestment of oil-related assets.
Sometimes divestment is the result of antitrust policy. One such case took place in 1984 when the US authorities obliged the telecommunications corporation AT&T to split up and sell one of its divisions.