What Is An Investment? Definition, Types, Importance, and Process

What is an Investment?

An investment is a sacrifice of present consumption with the expectation of the future will be better. In a general sense, it is an allocation of money in different assets with the expectation that in the future the value of these assets will be higher and generate some return.

In a more simple sense, investment is the use of money with an expectation to earn more money. There are lots of ways you can begin your investing such as just by depositing money in your bank saving account, buying stocks, buying bonds, renting your assets, and so forth.

Even you can make an investment in yourself by learning, educating, and delivering great ideas to yourself. A good investment starts from an understanding of what asset or where you are investing your money for future return.

In addition, investment is learning by doing. Which calls time, effort, knowledge, risk, and ultimately gives reward to the investor. It focuses on long-term returns after investing in some assets.

In any investment, money is committed today with certainty, but the benefits are derived over several periods in the future with certainty. If the investment is properly undertaken, the return will compensate investors for a given level of risk and vice versa.

Types of Investment

There are several types of investments available in the market for investors. The basic types or alternatives of investments one should understand are.

Real Investment

As there is a financial investment, there is a real investment as well. When an investment is made on real assets like land, buildings, etc., is a real investment.

In such types of investments, real assets are purchased today and of course, it is assumed that in the future the price of such real assets will be higher than that of the purchased price.

Financial Investment

The investments that are made on financial securities are known as financial investments.

Making a deposit of your money on a bank account, placing your money on corporate securities like stocks, bonds, or treasury securities like treasury notes, treasury bills, treasury bonds, investments in pension funds, etc. all are an example of financial investment.

Money Market

The money market is one type of financial investment. The money market is the place where short-term financial securities (instruments) are traded which life span is less than one year.

Though the money market instruments have less than a year maturity period, they are high-quality securities as such they have a very low risk of default and are highly liquid.

Examples of money market instruments are treasury bills, certificates of deposits, bankers’ acceptance, eurodollars, commercial papers, and the LIBOR market.

Capital Market

The capital market is also a type of financial investment. It is a market where long-term financial securities are sold out as well as purchased.

The instruments of the capital market have a life expectancy of more than one year and are generally issued to generate capital for long-term investments.

Some examples of capital market instruments are shares, bonds, debentures, treasury notes, treasury bonds, municipal securities, etc.

Primary Market

Now the capital market is further divided into the primary and secondary markets.

A primary market is a place where the first-hand transaction of financial security is made. The best example of a primary market is the issuance of IPO of companies.

Where we can only apply for the number of shares we want to have and can’t make the selling of such shares with anyone.

Secondary Market

The secondary market is where the buyers and sellers of financial securities are met and trade has occurred. In such a market, one can easily buy the securities and another party can easily sell.

Why Investment is Important?

Since we have discussed investment as the expectation of more return in the future from the allocation of money today. The objectives or reasons to start investing may be different for different people.

Some general reasons that explain the importance of investment are,

It Helps To Grow Money

The first reason one may start investing is that s/he wants to grow his money in amount. Investing is a great way to make grow your money. Which definitely get more money in the future.

One example, when you invest your $1000 at a 4% annual interest rate. The expected amount you will get in the next year will be $1040.

It Makes Money To Work

There is a saying If you put your money in your pocket you are letting your money do rest. But if you invest your money you are making your money do work to make more money.

It Will Helps To Reach Your Financial Goals

When you invest your money in higher return promising assets and securities, it will definitely help you to reach your financial goals. For the higher returns, you may opt your investment in good companies’ stocks, bonds, and other financial securities.

It May Make You Rich

You may be heard of many rich people who have become rich from their investments.

One example of Warren Buffett, who annually makes around $592 million from Coca-Cola just from his dividend income.

Investment Process

A logical investment usually goes through some steps. The steps are,

Determine Your Investment Objectives

The first step of the investment process is the determination of the objective or goal that you want to achieve from your investing.

Since every person is different, the objectives are also different. You should determine your objectives based on your budget, risk-taking capability, and knowledge.

The objective of someone may be earning more money, for someone to invest for retirement, and for others, there may be different objectives.

Develop A Plan

The next step is to develop an investment plan. Such a plan should be consistent with your above-determined objective.

In addition, the plan should specify your return preference, risk tolerance, along the period of investment.

Evaluate and Select An Alternative

There may be a number of investment alternatives available in the market. As an investor, you should analyze all the available alternatives based on the risk-return relationship.

While selecting an alternative, you should choose one which is the best fit for your investment objective, your budget, and risk tolerance.

Manage Portfolio

Managing a portfolio means investing money in different sectors to reduce the risk of uncertain loss. There is a proverb that is best in this context “Never put all eggs in one basket”.

Evaluate and Revise Portfolio

The last step in investing is again evaluating and revising the portfolio. This includes evaluating existing shares and selling & buying stocks to make a better portfolio.