What is an investment?
When someone makes an investment two things will happen. Firstly they are supplying money for capitalism to take place. This may be in the form of a loan from a bank in which they have deposited their capital in return for some interest.
It may be in the form of a loan directly to a company or by purchasing shares in a company – both of which will provide additional cash to the company concerned. It might be via a property purchase that is subsequently leased to a company in order to provide them with a base for their operation.
Secondly, in return for supplying the capital for the business to use, the investor expects to be paid a return. This return is to compensate the investor for taking the risk of investing, for tying up their capital and missing any subsequent opportunities.
The higher the risk to the investor’s capital, the higher return will need to be offered to attract the investor’s capital. This is a basic tenet of investing: there is no investment return without investment risk.
So what types of investments are there? Investment assets are generally grouped into four broad classes: cash, fixed income, shares & property. These asset classes are considered investments because they each have a mechanism for paying income.
When you deposit money with a bank or building society you are investing into the cash asset class. These accounts usually pay a rate of interest.
The fixed income asset class is characterised by holdings that pay a regular income for a set period of time and then return the original investment.
The shares (or equities) asset class is perhaps the most well known. Share owners may, at the discretion of the directors, receive a distribution of the company’s profit.
Property as an asset class is perhaps easiest for the residents of the UK to understand. A landlord renting a building (to an individual or company) would expect to be paid a rent for the use of the property.
Any asset that has no inherent mechanism for the distribution of income is not an investment. It’s a speculation, a gamble. The return from these speculations is solely determined by changes to its price.
Examples are numerous but gold, precious & other metals are topical at the moment. Owning these assets is a speculation – a bet that their price will rise – and that the asset can be sold (at a profit) before the price falls.
Investors should avoid speculating and concentrate instead on investing.