INVESTMENT BASICS

LEARNING OBJECTIVES

1. Describe the objective of investment.

2. Identify the major types of investment alternatives.
3. Identify various sources of financial information that can reduce risks and increase investment
returns.

What Is an Investment?
An investment is an asset or item acquired with the goal of generating income
or appreciation. Appreciation refers to an increase in the value of an asset
over time. When an individual purchases a good as an investment, the intent
is not to consume the good but rather to use it in the future to create wealth.

An investment always concerns the outlay of some resource today—time,

effort, money, or an asset—in hopes of a greater payoff in the future than
what was originally put in. For example, an investor may purchase a monetary
asset now with the idea that the asset will provide income in the future or will
later be sold at a higher price for a profit.

How an Investment Works

The act of investing has the goal of generating income and increasing value
over time. An investment can refer to any mechanism used for generating
future income. This includes the purchase of bonds, stocks, or real estate
property, among other examples. Additionally, purchasing a property that can
be used to produce goods can be considered an investment.

An investment bank provides a variety of services to individuals and

businesses, including many services that are designed to assist individuals
and businesses in the process of increasing their wealth. Investment banking
may also refer to a specific division of banking related to the creation of capital
for other companies, governments, and other entities. Investment banks
underwrite new debt and equity securities for all types of corporations, aid in
the sale of securities, and help to facilitate mergers and acquisitions.

Types of Investments
There's arguably endless opportunities to invest; after all, upgrading the tires
on your vehicle could be seen as an investment that enhances the usefulness
and future value of the asset. Below are common types of investments in
which people use to appreciate their capital.

Stocks/Equities

A share of stock is a piece of ownership of a public or private company. By

owning stock, the investor may be entitled to dividend distributions generated
from the net profit of the company. As the company becomes more successful
and other investors seek to buy that company's stock, it's value can also
appreciate and be sold for capital gains.

The two primary types of stocks to invest in are common stock and preferred
stock. Common stock often includes voting right and participation eligibility in
certain matters. Preferred stock often have first claim to dividends and must
be paid before common shareholders.

In addition, stocks are often classified as being either growth or value

investments. Investments in growth stocks is the strategy of investing in a
company while it is small and before it achieves market success. Investment
in value stocks is the strategy of investing in a more established company
whose stock price may not appropriate value the company.

Bonds/Fixed-Income Securities

A bond is an investment that often demands an upfront investment, then pays

a reoccurring amount over the life of the bond. Then, when the bond matures,
the investor receives the capital invested into the bond back. Similar to debt,
bond investments are a mechanism for certain entities to raise money. Many
government entities and companies issue bonds; then, investors can
contribute capital to earn a yield.

The recurring payment awarded to bondholders is called a coupon payment.

Because the coupon payment on a bond investment is usually fixed, the price
of a bond will often fluctuate to change the bond's yield. For example, a bond
paying 5% will become cheaper to buy if there are market opportunities to
earn 6%; by falling in price, the bond will naturally earn a higher yield.

Index Funds and Mutual Funds

Instead of selecting each individual company to invest in, index funds, mutual
funds, and other types of funds often aggregate specific investments to craft
one investment vehicle. For example, an investor can buy shares of a single
mutual fund that holds ownership of small cap, emerging market companies
instead of having to research and select each company on its own.

Mutual funds are actively managed by a firm, while index funds are often
passively-managed. This means that the investment professionals overseeing
the mutual fund is trying to beat a specific benchmark, while index funds often
attempt to simply copy or imitate a benchmark. For this reason, mutual funds
may be a more expense fund to invest in compared to more passive-style
funds.

Real Estate

Real estate investments are often broadly defined as investments in physical,

tangible spaces that can be utilized. Land can be built on, office buildings can
be occupied, warehouses can store inventory, and residential properties can
house families. Real estate investments may encompass acquiring sites,
developing sites for specific uses, or purchasing ready-to-occupy operating
sites.

In some contexts, real estate may broadly encompass certain types of

investments that may yield commodities. For example, an investor can invest
in farmland; in addition to reaping the reward of land value appreciation, the
investment earns a return based on the crop yield and operating income.

Commodities

Commodities are often raw materials such as agriculture, energy, or metals.

Investors can choose to invest in actual tangible commodities (i.e. owning a
bar of gold) or can choose alternative investment products that represent
digital ownership (i.e. a gold ETF).

Commodities can be an investment because they are often used as inputs to

society. Consider oil, gas, or other forms of energy. During periods of
economic growth, companies often have greater energy needs to ship more
products or manufacture additional goods. In addition, consumers may have
greater demand for energy due to travel. In this example, the price of
commodities fluctuates and may yield a profit for an investor.
Cryptocurrency

Cryptocurrency is a blockchain-based currency used to transact or hold digital

value. Cryptocurrency companies can issue coins or tokens that may
appreciate in value. These tokens can be used to transact with or pay fees to
transact using specific networks.

In addition to capital appreciation, cryptocurrency can be staked on a

blockchain. This means that when investors agree to lock their tokens on a
network to help validate transactions, these investors will be rewarded with
additional tokens. In addition, cryptocurrency has given rise to decentralized
finance, a digital branch of finance that enables users to loan, leverage, or
alternatively utilize currency.

Collectibles

A less traditional form of investing, collecting or purchasing collectibles

involves acquiring rare items in anticipation of those items becoming in higher
demand. Ranging from sports memorabilia to comic books, these physical
items often require substantial physical preservation especially considering
that older items usually carry higher value.

The concept behind collectibles is no different than other forms of investing

such as equities. Both predict that the popularity of something will increase in
the future. For example, a current artist may not be popular but changes in
global trends, styles, and market interest. However, their art may become
more valuable in time should the general population take a stronger interest in
their work.

How To Start Investing

There are many different avenues one can take when learning how to invest
or where to start when putting money aside. Here are some tips for getting
started in investing:

● Do your own research. A common phrase used in the investing

industry, it is important for investors to understand the vehicles they are
putting their money into. Whether it is a single share of a well-
established company or a risky alternative investment endeavor,
 investors should do their homework in advance as opposed to relying
on third-party (and often biased) advice.
● Establish a personal spending plan. Before investing, individuals
should consider their ability to put money away. This includes ensuring
they have enough capital to pay monthly expenses and have already
built up an emergency fund. As enticing as investing can be, individuals
should be mindful to meet their daily life obligations first.
● Understand liquidity restrictions. Some investors may be less liquid
than others, meaning it may be more difficult to sell. In some cases, an
investment may be locked for a certain period and cannot be liquidated.
Though not necessary fine print, it's important to understand whether
certain investments can be bought or sold at any time.
● Research tax implications. On a similar note, though an investment
can be bought or sold at any time, it may be tax-adverse to do so. With
unfavorable short-term capital gains tax rates, investors should be
mindful of strategies that extend beyond what product they hold but
what tax vehicle they put that investment in.
● Gauge your risk preference. As mentioned earlier, investing incurs
risk. This means you may end up with less money than what you started
with. Investors uncomfortable with this idea can (1) reduce the amount
they invest to only what they are comfortable losing or (2) explore ways
to mitigate risk.
● Consult an adviser. Many financial professionals would be happy to
provide their guidance, let you know what they think about markets, and
give you access to online platforms where you can invest money.

Return on Investment
The primary way to gauge the success of an investment is to calculate the
return on investment (ROI). ROI is measured as:

ROI = (Current Value of Investment - Original Value of Investment) /

Original Value of Investment

ROI allows different investments across different industries to be appropriately

compared. For example, consider two investments: a $1,000 investment in
stock that increased to $1,100 over the past year, or a $150,000 investment in
real estate that is now worth $160,000.

Stock ROI = ($1,100 - $1,000) / $1,000 = $100 / $1,000 = 10%

Real Estate ROI = ($160,000 - $150,000) / $150,000 = $10,000 / $150,000 =
6.67%

Though the real estate investment has increased in value $10,000, many
would claim that the stock investment has outperformed the real estate
investment. This is because every dollar invested in the stock gained more
money than every dollar invested in real estate.

Investments and Risk

In its simplest form, investment return and risk should have a positive
correlation. If an investment carries high risk, it should be accompanied by
higher returns. If an investment is safer, it will often have lower returns.

When making investment decisions, investors must gauge their risk appetite.
Every investor will be different, as some may be willing to risk the loss of
principle in exchange for the chance at greater profits. Alternatively, extremely
risk-averse investors seek only the safest vehicles where their investment will
only consistently (but slowly) grow.

Investments and risk are often strongly related to prevailing conditions in the
investor's life. As an investor approaches retirement, they will no longer have
stable, ongoing income. For this reason, people usually choose safer
investments towards the end of their working career. On the other hand, a
young professional can often bear the burden of losing money as they have
their entire career to make that capital back. For this reason, younger
investors are often more likely to invest in riskier investments.

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