Investment

Investment
An investment means spending money on something now, with the hopes that it will make you money in the future. Getting a college degree, buying stock, and buying a home are all considered investments.

What is an Investment?

An investment means spending money on an asset that you hope will earn money in the future.

People often associate the term investment with purchasing a stock, but an investment can be anything one pays for with the hope of getting a greater return. Bonds, some real estate, and starting a business are all considered investments.1

What differentiates a purchase from an investment is whether or not what you’re paying for has the potential for appreciation.

What is appreciation?

Appreciation is the amount your investment grows in value over time. For example, if you invest $1,000 and a year later your investment is worth $1,500—your investment has appreciated $500.2

What are the different kinds of Investments?

The three main kinds of investments are ownership investments, lending investments, and cash equivalents. People will often use the word investment to describe purchases that do not fall under one of these three categories. One common is example is a college degree, or other form of education. Although you could argue that you’re spending money on a degree in the hope that it will “earn” you money in the form of higher paying jobs, it isn’t actually a literal investment.3

What is an ownership Investment?

When you imagine an investment, you’re probably thinking of an ownership investment. Stocks are a common type of ownership investment. A stock is a piece of a company that you can purchase. If the company does well, demand for the stock might increase, allowing you to sell it for a higher price than you purchased it. Some stocks will also pay dividends, a portion of their profits, to investors. Others will reinvest their profits instead, meaning that selling the stock will be the only way to get an appreciation on your investment.4

Another common type of ownership investment is rental property. If you purchase an apartment or house with the intention of charging people to live there, you do so with the hope of earning more money in rent over time than you spent on the initial purchase. A house that you purchase to live in, however, is not an investment, unless you’re planning to improve it with the intention of selling it for a greater amount of money in the future.

Starting a business is also an ownership investment. If you open a bakery, the storefront, ingredients, and anyone you hire are considered investments, because they will ideally eventually earn you more money than you’ve spent. Unfortunately, starting a business could be considered one of the riskier investments. According to a study by the University of Tennessee, seven out of ten businesses fail within ten years.5

Finally, collector’s items or precious metals can be considered investments if you’re purchasing them with the intention to sell them for a profit in the future.

What is a lending Investment?

A lending investment has much less profit potential than some ownership investments, but it also comes with less risk. You might already have a lending investment and not even know it. A savings account is a common type of lending investment. You’re essentially giving a loan to the bank, which can use your money as they like in exchange for giving you interest on that money. It’s going to take a long time for you to have any significant appreciation on that money, but you don’t have to worry about losing your investment the way you might with a stock or business.

A bond is another kind lending investment. You can purchase a bond for a set amount of money with the knowledge that when it “matures” after a specific number of years, you will be paid back a greater amount than you purchased the bond for. Bonds can be purchased from both companies and governments.6

What is a cash equivalent Investment?

The final type of investments are cash equivalent investments. These investments are liquid, meaning that they can be spent at any time, just like cash. The most common type of cash equivalent investment is a money market fund, which is an investment with very little appreciation.7 They are similar to lending investments, except with much shorter maturities than bonds. The advantage is the ease of spending the invested money on short notice—if you worry you might need to.

References:

  1. “Investment.” Investopedia. Accessed February 26, 2016 from http://www.investopedia.com/terms/i/investment.asp.
  2. “What Is a Financial Investment?” Study.com. Accessed February 26, 2016 from https://study.com/academy/lesson/what-is-a-financial-investment-definition-types-examples.html.
  3. “Defining the Three Types of Investments.” Investopedia. Accessed February 26, 2016 from http://www.investopedia.com/articles/younginvestors/10/what-is-an-investment.asp.
  4. [iv] “Why Do Some Companies Not Pay Dividends?” Trendshare.org. Accessed February 2, 2017 from https://trendshare.org/how-to-invest/why-do-some-companies-not-pay-dividends.
  5. “Startup Business Failure By Industry.” Statisticbrain.com. Accessed February 2, 2017. http://www.statisticbrain.com/startup-failure-by-industry/.
  6. “U.S. Savings Bonds.” Investopedia. Accessed February 2, 2017 from http://www.investopedia.com/terms/u/ussavingsbonds.asp.
  7. “Money Market Fund.” Investopedia. Accessed February 2, 2017 from http://www.investopedia.com/terms/m/money-marketfund.asp.