What is a Financial Investment?
Definition of a Financial Investment:
Have you ever heard someone talking about stocks,bonds, or mutual funds and were a little confused? Does the mention of investments or financial topics seem overwhelming Understanding some basic information about financial investments can be a great first step in learning how to invest, knowing your path to retirement, or maximizing the rate of return on your money.
A financial investment is an asset that you put money into with the hope that it will grow or appreciate into a larger sum of money. The idea is that you can later sell it at a higher price or earn money on it while you own it. You may be looking to grow something over the next year, such as saving up for a car, or over the next 30 years, such as saving for retirement.
How you invest these dollars can be very different. How much time you have on your side is often a key thing to consider when making a financial investment. The more time you have, the more risk you can usually take. The more risk you take, the more potential for making more money! It is important to note that there is also an economic definition of financial investments that deals with how businesses invest in products, equipment, factories, employees, and inventories. This lesson will focus on the finance definition of financial investment. Let's look at a few key terms worth knowing when it comes to financial investments.
Appreciation:
is the amount an investment grows in value. For example, you buy a share of stock for $10, and a year later it is worth $15; the stock has appreciated $5.
Dividends:
are usually cash payments that are paid out on financial investments based on the success and earnings of a company. For example, you invest in Microsoft stock, and it may pay you a dividend of $5 a share. If you owned 500 shares you would get paid 500 * $5 which is $2,500!
Interest:
is the fee a bank, institution, or government pays you for loaning them money through the purchase of a CD or bond. You can also earn small amounts of interest on a checking or savings account. For example, you may have $10,000 in government savings bonds that pays 5% interest annually; that adds up to $500 a year!
Types of Financial Investments
CDs stand for certificates of deposit and are certificates that earn interest over a set amount of time. They usually range from 30 days to 5 years and are issued most often by banks. These are extremely low risk.
Next, we'll cover bonds. When you purchase a bond, you are lending out your money to a company or government entity. They pay you interest on your money and eventually pay you back the amount you lent out. In general, these are slightly more risky than CDs but provide a better return or interest rate.
Stocks:
are ownership interests in part of a company. When you buy stock in Walmart, Google, or Starbucks, you are becoming part owner of the business. This allows you to potentially receive profits that the company allocates to its owners. Those profits are dividends. A stock can also appreciate in value, based on the success of the company. These are higher risk but have good long term potential to make bigger profits.
Mutual funds:
are often a pooled collection of stocks and bonds that are overseen by a professional manager. Mutual funds often usually focus on a specific type of investment, such as small companies, large companies, bonds, or real estate Mutual funds can appreciate in value and can pay dividends, as well. These can have high and low risk, depending on the type of fund you invest in.
Gold:
is a precious metal that you can invest in. It is often a small part of a portfolio that appreciates over time. It is thought to be a form of financial protection, in lieu of cash. You can also invest in silver, copper, and other metals. Over the long-term, precious metals are fairly low risk; in the short-term, they can be very volatile in value.
Exchange Traded Funds (ETFs):
Exchange traded funds (ETFs) have become quite popular since their introduction back in the mid-1990s. ETFs are similar to mutual funds, but they trade throughout the day, on a stock exchange. In this way, they mirror the buy-and-sell behavior of stocks. This also means their value can change drastically during the course of a trading day.
ETFs can track an underlying index such as the S&P 500 or any other "basket" of stocks the issuer of the ETF wants to underline a specific ETF with. This can include anything from emerging markets, commodities, individual business sectors such as biotechnology or agriculture, and more. Due to the ease of trading and broad
coverage, ETFs are extremely popular with
investors.
• Real estate:
Investors can acquire real estate by directly buying commercial or residential properties. Alternatively, they can purchase shares in real estate investment trusts (REITS). REITs act like mutual funds wherein a group of investors pool their money together to purchase properties. They trade like. stocks on the same exchange.
Stocks:
Shares of stock let investors participate in the company's success via increases in the stock's price and through dividends. Shareholders have a claim on the company's assets in the event of liquidation (that is, the company going bankrupt) but do not own the assets.
Holders of common stock enjoy voting
rights at shareholders' meetings. Holders
of preferred stock don't have voting rights
but do receive preference over common
shareholders in terms of the dividend
payments.
Hedge funds and private equity funds:
Hedge funds, which may invest in a spectrum of assets designed to deliver beyond market returns, called "alpha." However, performance is not guaranteed, and hedge funds can see incredible shifts in returns, sometimes underperforming the market by a significant margin. Typically only available to accredited investors, these vehicles often require high initial investments of $1 million or more. They also tend to impose net worth requirements. Both investment types may tie up an investor's money for substantial time periods.
Commodities:
Commodities refer to tangible resources such as gold, silver, crude oil, as well as agricultural products.
Cash:
A cash bank deposit is the simplest, most easily understandable investment asset and the safest. Not only does it give investors precise knowledge of the interest they'll earn, but it also guarantees they'll get their capital Bank.
On the downside, the interest earned from
cash socked away in a savings account
seldom beats inflation. Certificates of
deposit (CDs) are less liquid instruments,
but typically provide higher interest rates
than those in savings accounts. However,
the money put into a CD is locked up for a
period of time (months to years) and there
are potentially early withdrawal penalties
involved.