An investment is a financial or physical asset purchased with the goal of generating income or gaining value.
For individuals, investments can include a wide range of assets and activities. People might invest money to enroll in school and earn a degree or certification that can increase their earning potential. Or they might buy securities such as shares of a publicly traded company, which could generate income in the form of dividends, or potentially appreciate in value.
All investments inherently come with risk. Whether an investor is investing in themselves or purchasing financial instruments, there’s a chance of losing rather than making money.
Objectives of investing
While all investments have the broad objective of making money, investors often have more specific financial goals:
- Fund retirement. One common investment goal is to save for retirement. Tax-deferred retirement accounts, such as a 401(k) or individual retirement account (IRA), are designed specifically for this purpose.
- Pay for higher education. Some people save up to spend on tuition, a form of investment, while parents often set aside and invest money in a college fund for their children.
- Afford a large purchase. Investors may have a specific large purchase in mind and invest their money to save up for a down payment on a new home, vacation home, vehicle, or business.
- Create income streams. Some invest with the objective of increasing their income. Stocks that pay dividends and a rental property is a good example of an investment that can generate monthly income.
- Support personal values. Some investors want to use their money to drive social change while also making money. This is known as impact investing or SRI (socially responsible investing). An investor passionate about climate change might invest in alternative energy, or an investor who cares about diversity and inclusion may invest in companies with diverse leadership.
- Offset inflation. Some investments are intended to preserve rather than increase wealth. These are low-risk investments, such as government bonds, whose goal is to earn enough to offset inflation.
Evaluating and understanding investments
Setting objectives can be an important first step when investing. Additionally, savvy investors research their options, understand the potential risk and reward of each, and choose investments that align with their values and goals.
Some considerations include:
- Objectives or goals. These might include buying a home, funding retirement, paying off debt, or sending a child to college.
- Risk tolerance. An investor’s tolerance for risk is the degree to which you can absorb financial outcomes that are different from what you expect.
- Time horizon. Time horizon is how long you plan to hold an investment before selling. It can be connected to risk tolerance. Investors with a shorter time horizon may have a lower risk tolerance, whereas those with a longer time horizon might be willing to tolerate price fluctuations in the short-term in exchange for the chance of higher future gains.
- Types of investment accounts. Investors may be able to use a regular brokerage account or a tax-advantaged account, depending on what they plan on using their invested capital and gains for. Understanding the tax implications of different accounts and investments can be important for maximizing gains.
- Fees. Investing fees can eat into returns. These could include fees for managers who make decisions on behalf of investors or manage a pooled investment vehicle like a mutual fund or exchange-traded fund (ETF). Some investment accounts also charge fees for buying or selling securities.
Additionally, investors can choose from a variety of investment types.
Types of investments
Here are some of the most common financial investment categories, or asset types:
- Stocks. Buying stock makes someone a partial owner of a publicly traded company. The value of the stock may increase or decrease depending (in part) on how well the company does and the demand for its stock. Shareholders may also earn income if the company distributes dividends.
- Bonds. This instrument represents a loan from an investor to a borrower, typically a corporation or government. A bond investor acts as the lender and receives interest payments, which are called coupon payments.
- Mutual funds. A mutual fund pools investors’ money together to purchase a bundle of assets. Mutual funds can have different focuses, such as growth, income, or social responsibility. Investors can buy mutual funds from a mutual fund company or through a brokerage firm.
- ETFs. An ETF is a pooled form of investment that is designed to track an index, sector, or commodity. These trade just like stocks.
- Commodities. Commodities are physical goods, such as oil, gold, and grains. People can invest in commodities in different ways, such as buying mutual funds or ETFs that track commodity prices.
- Real estate. Investors can buy residential or commercial property or purchase in the shares of real estate investment trusts (REITs), a type of company that owns and manages real estate.
- Other. Other types of investments can include lending money through a peer-to-peer lending platform, buying annuities, or purchasing cryptocurrencies.
4 different investing styles
Investors may favor different investment styles or types of investments based on their goals. The preferred style may also change over time as the investor accomplishes one goal and moves on to the next. Four common investments styles include:
- Passive. Passive investing or index investing tries to track an existing index. For example, many mutual funds or ETFs passively track the S&P 500—an index of the 500 largest publicly traded companies in the US.
- Active. Active investors pick investments in an attempt to outperform a benchmark index, such as the S&P 500. Investors also can buy an actively managed mutual fund or ETF, and the fund managers will make decisions based on their research.
- Growth. Growth investors focus on companies they believe will grow faster than the overall market. These businesses often don’t pay dividends because they invest as much money as possible in the company.
- Value. Value investors look for companies that may be worth more than their stocks’ current price indicates. Investors try to make money by buying these (relatively) cheap investments and benefiting from their dividend payments or long-term increase in value.
Investors and fund managers can use different financial metrics to evaluate investment options. There can also be overlap between these styles, such as an actively managed mutual fund that focuses on either growth or value investments.
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