investing definition: What, Where, and How

An investment is an activity that consists of dedicated resources with the aim of obtaining a profit of any kind.

In economics, resources are usually identified as the associated costs. The main resources are land, time, labor, and capital. Therefore, everything done to use any of these four resources to obtain a profit is an investment.

An investment entails an opportunity cost by giving up those resources in the present to obtain an uncertain future benefit. Therefore, when an investment is made, a certain risk is assumed. But in return, it is expected to obtain returns on that investment, earning more than what was invested.

To have money to invest, it is necessary to have had an income and previously saved part of it.

Many people think that investing is something that only the rich can do. But the rich are precisely the ones who can afford the most not to invest, since it is very likely that they will remain rich all their lives even if they do not invest. However, they are the ones who invest and reinvest the most, continually increasing their fortune even more.

Thanks to the internet and the reduction of commissions, nowadays anyone can invest in the stock market and earn money simply by getting a return on the money saved, whatever the amount. And precisely because we are not rich, we benefit a lot from the investment, especially in the long term.

If you want to invest but don’t know where to start, in the basic stock market investment course of the Economipedia Campus, you can learn in a practical and simple way.

Types of investment

The classification of investments can be done from different points of view. Thus, there is no single classification or one that is better. There are several, all valid and useful depending on the context.

According to the time horizon:

  • Short term: less than 1 year.
  • Medium-term: between 1 and 3 years.
  • Long term: more than three years.

Depending on the element in which it is invested:

  • Machinery: tractors, robots, packaging companies…
  • Raw materials: metals, food, fuel…
  • Transport elements: vans, trucks, cars…
  • Buildings: industrial buildings, offices, commercial basements, etc.
  • Investment in the shares of other companies
  • investment in research and development (R&D).

According to the area:

  • Business.
  • Personal.
  • Financial.

Depending on the nature of the subject:

  • Private.
  • Public.

According to the recipient’s adaptation:

  • personal or tailor-made.
  • Generalist or standard?

We could cite many more investment classifications, but the previous ones are essential. That is the most important.

How does investment work?

To know how an investment works, it is important to know the economic meaning of investment. Whatever its type, it is governed by four fundamental factors. Profitability, risk, liquidity, and term: what we gain, what we could lose, and the time

  • Profitability: The return on investment is what we get in exchange for making the investment. It is usually measured in terms of profit or profitability, although it doesn’t have to be that way.
  • Risk: Refers to uncertainty. In economics, nothing is one hundred percent safe. With which, we must always work with acceptable risks in case the investment does not go as we expected.
  • Liquidity: It is the ability to convert a certain investment into money with minimal losses with respect to its value.
  • Term: Time is the third fundamental variable. We can expect a certain return, but depending on the time it takes us to get it, will it compensate for the investment or not?

See the relationship between profitability, risk, and liquidity.

Addressing these four factors, although it may seem obvious, is not very common. Many investors usually focus on the first of the factors. Focusing on how much I will earn is not always a good idea. We must also pay close attention to the other two factors. and especially the risk.

How do you know if one investment is better than another?

Knowing if one investment is better than another or others is, frankly, something that is difficult. In essence, it will depend on the preferences of each investor. Some will consider that a return of 50% is very good, and others will settle for 10%.

More importantly, if possible, we must consider the investor’s risk aversion and his or her patience or impatience (deadline).

That said, considering that it is not black or white, several methods exist to compare different investments monetarily. For example:

  • Internal Rate of Return (TIR)
  • Pay-Back.
  • Net present value (VAN)
  • Discount on cash flows
  • Profit-risk ratios.
  • valuation ratios: ROCE, ROE, ROI, PER, or BPA.

There are other methods to compare, but these are the best known and most affordable. Using one or the other will depend, among other things, on the nature of our investments.

If you want to start investing, visit the guide with the best brokers to invest in Spain. This is a selection of our experts recommendations to help you decide which broker to choose. You can also invest through an automated manager, or robo-advisor, if you know how they work. In Economipedia, we have created a guide to the best robo-advisors of 2023.

On the one hand, we call savings the money we keep to dispose of it in the future. We give up spending it in the present, putting it in a safe and risk-free place, but that usually generates interest. We save when we keep our money in cash, in a bank account, or in a deposit, for example.

On the other hand, we call investment the money that we give up spending in the present so that it will give us extra money in the future. We associate investment with purchasing a good or a financial asset in the hope of making a profit. This extra profit that the investment brings us with respect to savings is due to the fact that with the investment we are risking our money, and for that we receive compensation. We can invest our money in many things, from something immaterial like education to financial assets such as e-actions, bonds, or investment funds.

Difference between savings and investment

Even if you are not an expert, you must rely on a financial advisor and understand his advice. To guide you and so that you can investigate in detail, consider the following investment options for beginners:

  • Investments in gold or silver Precious metals are considered safe investments because their value increases over time. However, the risk you run is your protection, and at the time of recovering your monetary value, you must have a correct valuation. It is at this point that you can lose money on the investment.
  • More for your retirement savings account The aforementioned individual account is an investment mechanism to increase your pension amount at the time of retirement. Even though there are set quotas that the government, the employer, and the worker themselves contribute to the account, it’s crucial to make an effort to make voluntary contributions that increase the amount of money to invest.
  • Invest in government instruments. The Bank of Mexico issues debt instruments called Treasury Certificates, or Cetes; in simple words, it is a loan of money that is given to the federal government for a certain period, and at the end, the total is returned plus interest.
  • Investments in real estate Whether to rent, resell, or consolidate a home, a property is considered a safe investment as long as the location, services, and appraisal are correctly analyzed.

A correct projection of its value in the future will, over time, allow you to have a higher-cost property, allowing you to sell it to form a larger inheritance.

We will be happy to hear your thoughts

Leave a reply