Investing refers to the act of allocating resources (generally money) in the hope of making a profit and/or producing income. Ventures include investing in capital to start a business or buying assets such as real estate with the intent of selling it later at a higher price.
Investing Fundamentals
The fundamental concept behind investing is to expect a statistically significant return, either in the form income/price appreciation. There are many assets that one can invest in and make a profit from.
Investments are both risky and rewarding. A low risk investment usually means lower projected profits. However, higher returns often entail greater risk.
Risk and return expectations can differ between asset classes. For example, a blue chip on New York Stock Market will have a significantly different risk-return profile to a micro-cap on smaller exchanges.
The asset’s type determines the return it generates. For example, many equities pay quarterly dividends while bonds pay interest every quarter. Different income types are subject to different tax rates in various countries.
A significant component of return is price appreciation. This is in addition to regular income like dividends and interest. Capital appreciation and income together make up the total return on investment. Standard & Poor’s estimates that dividends have contributed roughly a third to total equity returns since 1926. Capital gains, however, have contributed two-thirds.
Various Investments
There are many ways to invest, but these are the most popular.
Stocks
You become a part owner of a company when you purchase a share of its stock. Stockholders can be part of the development and success of a company through stock price appreciation or monthly dividends.
Bonds
Bonds are debt obligations that are issued by governments, municipalities and businesses. You buy a bond to purchase a portion of the entity’s debt. When the bond matures, you will be entitled to periodic interest payments and the face value.
Fonds
Funds allow investors to diversify their investments by investing in stocks, bonds and preferred shares. ETFs and mutual funds are the most popular types of funds. ETFs trade on stock exchanges and their value is maintained throughout the day. Mutual funds are not traded on any exchange. They are only valued at the end of each trading day. ETFs and mutual funds can track indexes such as the Dow Jones Industrial Average or the S&P 500 in passive mode or can be actively managed by fund managers.
Investment trusts
Another type of pooled investment is the trust. Real Estate Investment Trusts are the most popular. REITs invest in residential or commercial properties and pay regular dividends to shareholders based upon the rental income generated. REITs trade on stock exchanges, providing liquidity for their investors.
Other investments
This broad category includes private equity and hedge funds. Hedge funds are named after the fact they can buy and sell stocks and other assets to hedge their financial risks. Private equity is a way for businesses to raise capital without going public. Private equity and hedge funds were traditionally only available to wealthy investors who met certain income and net worth criteria. These are known as accredited investors. In recent years, alternative investments have been made in fund structures that are available to individual investors.
Options and derivatives
Derivatives can be financial products that derive their value from an asset such as an index or stock. Common derivatives include options. They give the buyer the option to buy or sell assets at a specific price and within a specified time frame.
Commodities
Commodities include metals, oil and grain as well as financial instruments, currencies and financial instruments. There are two options for trading commodities: commodity futures (agreements to buy or sell a certain quantity of a commodity at a fixed price at a future date) and exchange-traded funds. You can use commodities for speculation or risk management.
Investing Styles Comparison
Let’s take a look at some of the most sought-after investment styles.
Active vs. passive investing:
Active investing is about “beat the index” through actively managing a portfolio. Passive investing promotes passive investment. This is because it recognizes that the market cannot consistently beat. Both have their advantages and disadvantages. However, very few fund managers consistently outperform their benchmarks to justify the higher expenses of active management.
Growth vs. value:
High-growth companies have higher price-earnings ratios (P/E), which is what growth investors are looking for. Value firms can be out of favor with investors for short or long periods. They have lower PEs, and higher dividend yields than growth businesses.
