Investment generally means committing resources to gain benefits in the future. If money is involved, it means putting money in with the hope of making more money later. More broadly, investment can be seen as managing the spending and receiving of resources to optimize these flows. When discussing money, the term “cash flow” refers to the net amount received during a certain period, while “cash flow stream” refers to money received over several periods.
In finance, the goal of investing is to generate a return. This return can be from a profit or loss when selling the investment, or from periodic income like dividends, interest, or rent. It may also include gains or losses from currency exchange rate changes.
Investors usually expect higher returns from riskier investments. Lower-risk investments tend to offer lower returns, while higher-risk ones might lead to higher losses. To manage risk, investors, especially beginners, are often advised to diversify their investments, which can reduce overall risk.
Types of Financial Investments
In modern economies, traditional investments include:
- Stocks: Ownership shares in publicly traded companies.
- Bonds: Loans to governments or businesses traded publicly.
- Cash: Holding currency to use or to hedge against exchange rate changes.
- Real Estate: Property that can be rented for income or resold if its value increases.
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Alternative investments include:
- Private Equity: Investments in non-publicly traded businesses, often through venture capital or crowdfunding.
- Other Loans: Including mortgages.
- Commodities: Such as gold, agricultural products, and energy resources.
- Collectibles: Items like art, coins, vintage cars, and stamps.
- Carbon Offsets and Credits.
- Digital Assets: Like cryptocurrencies and NFTs.
- Hedge Funds: Using complex strategies like derivatives, leveraged investing, and short selling.
Investment and Risk
Investors may risk losing some or all of their invested capital. Unlike arbitrage, which profits without investment or risk, investments carry various risks. Savings also have some risk, such as the potential default of the financial provider or foreign exchange risk if the savings are in a different currency.
Even tangible assets like real estate come with risks. Buyers can mitigate these risks through strategies like taking out a mortgage. Investments generally carry more risk compared to savings, with varying risk levels across different industries.
History
In medieval Islamic finance, the qirad was a key financial tool where investors provided capital to an agent who traded with it, sharing profits but not bearing losses. This system is similar to the commenda used later in Europe.
In the early 1900s, investors were called speculators. After the 1929 Wall Street crash, “investment” became associated with more conservative approaches, while “speculation” referred to higher-risk securities.
Investment Strategies
- Value Investing: Investors buy undervalued assets and sell overvalued ones, using financial analysis to find bargains. Notable value investors include Warren Buffett and Benjamin Graham.
- Growth Investing: Investors seek stocks expected to grow significantly in value. This strategy often involves evaluating current value and future performance.
- Momentum Investing: Investors buy stocks showing a short-term uptrend and sell when the trend slows. In a bear market, they may short-sell stocks in a downtrend.
- Dollar Cost Averaging: Investing a fixed amount regularly, regardless of market conditions, to reduce short-term volatility and average the cost per share.
- Micro-Investing: Making small, regular investments to make investing accessible, especially for those with limited funds.
Intermediaries and Collective Investments
Investments are often made through intermediaries like pension funds, banks, and insurance companies. These institutions pool money from many investors into larger funds, with each investor holding a share of the assets.
Investment Valuation
Free cash flow measures the cash a company generates available for investors after reinvestments. High and rising free cash flow makes a company more attractive. The debt-to-equity ratio shows the proportion of debt compared to equity. A high ratio can make a company’s returns riskier. Investors compare this ratio across companies and track changes over time.
