Investment

This article is about investment in finance. For investment in macroeconomics, seeInvestment (macroeconomics).For other uses, seeInvestment (disambiguation).

"Invest" redirects here. For other uses, seeInvest (disambiguation).

Investmentis traditionally defined as the "commitment of resources to achieve later benefits". If an investment involves money, then it can be defined as a "commitment of money to receive more money later". From a broader viewpoint, an investment can be defined as "to tailor the pattern of expenditure and receipt of resources to optimise the desirable patterns of these flows". When expenditures and receipts are defined in terms of money, then the net monetary receipt in a time period is termedcash flow,while money received in a series of several time periods is termed cash flow stream.

Infinance,the purpose of investing is to generate areturnon the investedasset.The return may consist of a capital gain (profit) or loss, realised if the investment is sold, unrealisedcapital appreciation(or depreciation) if yet unsold. It may also consist of periodic income such asdividends,interest,or rental income. The return may also include currency gains or losses due to changes in foreign currencyexchange rates.

Investorsgenerally expect higherreturnsfromriskierinvestments. When a low-risk investment is made, the return is also generally low. Similarly, high risk comes with a chance of high losses. Investors, particularly novices, are often advised todiversifytheirportfolio.Diversification has thestatisticaleffect of reducing overall risk.

Types of financial investments

In modern economies,traditional investmentsinclude:

• Stocks-Businessownership, known asequity,inpublicly traded companies
• Bonds-loansto governments and businesses traded on public markets
• Cash- holding a particularcurrency,whether in anticipation of spending or to take advantage of or hedge against changes in acurrency exchange rate
• Real estate,which can be rented to provide ongoing income or resold if it increases in value

Alternative investmentsinclude:

• Private equityin businesses that are not publicly traded on astock exchange,often involvingventure capitalfunds,angel investors,orequity crowdfunding
• Otherloans,includingmortgages
• Commodities,such asprecious metalslikegold,agriculturalproducts likepotatoes,andenergydeliveries likenatural gas
• Collectables,includingart,coins,vintage cars,postage stamps,andwine
• Carbon offsets and credits
• Digital entities likecryptocurrencyandnon-fungible tokens
• Hedge fundsthat use sophisticated techniques like:
  • Derivatives,the value of which is determined by a contract and is derived by calculation from the performance of some other sort of underlying investment; these includeforwards,futures,options,swaps,collateralized debt obligations,credit default swaps,andTax Receivable Agreements
  • Leveraged investing,which is the investment of borrowed money
  • Short selling,which typically uses leverage and derivatives to bet that the value of a stock will decline

Investment and risk

An investor may bear ariskof loss of some or all of theircapitalinvested. Investment differs fromarbitrage,in whichprofitis generated without investing capital or bearing risk.

Savingsbear the (normally remote) risk that the financial provider may default.

Foreign currencysavings also bearforeign exchange risk:if the currency of a savings account differs from the account holder's home currency, then there is the risk that the exchange rate between the two currencies will move unfavourably so that the value of the savings account decreases, measured in the account holder's home currency.

Even investing in tangible assets like property has its risk. And similar to most risks, property buyers can seek to mitigate any potential risk by taking out mortgage and by borrowing at a lower loan to security ratio.

In contrast with savings, investments tend to carry more risk, in the form of both a wider variety of risk factors and a greater level of uncertainty.

Industry to industry volatility is more or less of a risk depending. Inbiotechnology,for example, investors look for big profits on companies that have small market capitalizations but can be worth hundreds of millions quite quickly.The risk is high because approximately 90% of biotechnology products researched do not make it to market due to regulations and the complex demands within pharmacology as the average prescription drug takes 10 years and US$2.5 billion worth of capital.

History

In themedieval Islamic world,theqiradwas a major financial instrument. This was an arrangement between one or more investors and an agent where the investors entrusted capital to an agent who then traded with it in hopes of making a profit. Both parties then received a previously settled portion of the profit, though the agent was not liable for any losses. Many will notice that theqiradis similar to the institution of thecommendalater used in western Europe, though whether the qirad transformed into the commenda or the two institutions evolved independently cannot be stated with certainty.

In the early 1900s, purchasers of stocks, bonds, and other securities were described in media, academia, and commerce as speculators. Since theWall Street crash of 1929,and particularly by the 1950s, the term "investment" had come to denote the more conservative end of the securities spectrum, while "speculation"was applied by financial brokers and their advertising agencies to higher risk securities much in vogue at that time.Since the last half of the 20th century, the terms "speculation" and "speculator" have specifically referred to higher risk ventures.

Investment strategies

Value investing

Main article:Value investing

A value investor buys assets that they believe to be undervalued (and sells overvalued ones). To identify undervalued securities, a value investor uses analysis of the financial reports of the issuer to evaluate the security. Value investors employ accounting ratios, such asearnings per shareand sales growth, to identify securities trading at prices below their worth.

Warren BuffettandBenjamin Grahamare notable examples of value investors. Graham andDodd'sseminal work,Security Analysis,was written in the wake of theWall Street Crash of 1929.

Theprice to earnings ratio(P/E), or earnings multiple, is a particularly significant and recognized fundamental ratio, with a function of dividing the share price of the stock, by its earnings per share. This will provide the value representing the sum investors are prepared to expend for each dollar of company earnings. This ratio is an important aspect, due to its capacity as measurement for the comparison of valuations of various companies. A stock with a lower P/E ratio will cost less per share than one with a higher P/E, taking into account the same level offinancialperformance; therefore, it essentially means a low P/E is the preferred option.

An instance in which the price to earnings ratio has a lesser significance is when companies in different industries are compared. For example, although it is reasonable for a telecommunications stock to show a P/E in the low teens, in the case of hi-tech stock, a P/E in the 40s range is not unusual. When making comparisons, the P/E ratio can give you a refined view of a particular stock valuation.

For investors paying for each dollar of a company's earnings, the P/E ratio is a significant indicator, but theprice-to-book ratio(P/B) is also a reliable indication of how much investors are willing to spend on each dollar of company assets. In the process of the P/B ratio, the share price of a stock is divided by its net assets; any intangibles, such as goodwill, are not taken into account. It is a crucial factor of the price-to-book ratio, due to it indicating the actual payment for tangible assets and not the more difficult valuation of intangibles. Accordingly, the P/B could be considered a comparatively conservative metric.

Growth investing

Growth investorsseek investments they believe are likely to have higher earnings or greater value in the future. To identify suchstocks,growth investors often evaluate measures of current stock value as well as predictions of future financial performance.Growth investors seek profits throughcapital appreciation– the gains earned when a stock is sold at a higher price than what it was purchased for. Theprice-to-earnings (P/E)multiple is also used for this type of investment; growth stock are likely to have a P/E higher than others in its industry.According to Investopedia author Troy Segal and U.S. Department of State Fulbright fintech research awardee Julius Mansa, growth investing is best suited for investors who prefer relatively shorter investment horizons, higher risks, and are not seeking immediate cash flow through dividends.

Some investors attribute the introduction of the growth investing strategy to investment banker Thomas Rowe Price Jr., who tested and popularized the method in 1950 by introducing hismutual fund,the T. Rowe Price Growth Stock Fund. Price asserted that investors could reap high returns by "investing in companies that are well-managed in fertile fields."

A new form of investing that seems to have caught the attention of investors is Venture Capital. Venture Capital is independently managed dedicated pools of capital that focus on equity or equity-linked investments in privately held, high growth companies.

Momentum investing

Momentum investors generally seek to buy stocks that are currently experiencing a short-term uptrend, and they usually sell them once this momentum starts to decrease. Stocks orsecuritiespurchased for momentum investing are often characterized by demonstrating consistently high returns for the past three to twelve months.However, in abear market,momentum investing also involves short-selling securities of stocks that are experiencing a downward trend, because it is believed that these stocks will continue to decrease in value. Essentially, momentum investing generally relies on the principle that a consistently up-trending stock will continue to grow, while a consistently down-trending stock will continue to fall.

Economists and financial analysts have not reached a consensus on the effectiveness of using the momentum investing strategy. Rather than evaluating a company's operational performance, momentum investors instead utilize trend lines, moving averages, and theAverage Directional Index (ADX)to determine the existence and strength of trends.

Dollar cost averaging

Dollar cost averaging: If an individual invested $500 per month into the stock market for 40 years at a 10% annual return rate, they would have an ending balance of over $2.5 million.

Dollar cost averaging(DCA), also known in the UK as pound-cost averaging, is the process of consistently investing a certain amount of money across regular increments of time, and the method can be used in conjunction with value investing, growth investing, momentum investing, or other strategies. For example, an investor who practices dollar-cost averaging could choose to invest $200 a month for the next 3 years, regardless of the share price of their preferred stock(s),mutual funds,orexchange-traded funds.

Many investors believe that dollar-cost averaging helps minimize short-term volatility by spreading risk out across time intervals and avoiding market timing.Research also shows that DCA can help reduce the total average cost per share in an investment because the method enables the purchase of more shares when their price is lower, and less shares when the price is higher.However, dollar-cost averaging is also generally characterized by more brokerage fees, which could decrease an investor's overall returns.

The term "dollar-cost averaging" is believed to have first been coined in 1949 by economist and author Benjamin Graham in his book,The Intelligent Investor.Graham asserted that investors that use DCA are "likely to end up with a satisfactory overall price for all [their] holdings."

Micro-investing

Micro-investingis a type of investment strategy that is designed to make investing regular, accessible and affordable, especially for those who may not have a lot of money to invest or who are new to investing.

Intermediaries and collective investments

Investments are often made indirectly throughintermediaryfinancial institutions. These intermediaries includepension funds,banks,andinsurancecompanies. They may pool money received from a number of individual end investors into funds such asinvestment trusts,unit trusts,andSICAVsto make large-scale investments. Each individual investor holds an indirect or direct claim on the assets purchased, subject to charges levied by the intermediary, which may be large and varied.

Approaches to investment sometimes referred to in marketing of collective investments includedollar cost averagingandmarket timing.

Investment valuation

Further information:Valuation (finance)andBusiness valuation

See also:Valuation using discounted cash flowsandValuation using multiples

Free cash flowmeasures the cash a company generates which is available to its debt and equity investors, after allowing for reinvestment inworking capitalandcapital expenditure.High and rising free cash flow, therefore, tend to make a company more attractive to investors.

Thedebt-to-equity ratiois an indicator ofcapital structure.A high proportion ofdebt,reflected in a high debt-to-equity ratio, tends to make a company'searnings,free cash flow, and ultimately the returns to its investors, riskier orvolatile.Investors compare a company's debt-to-equity ratio with those of other companies in the same industry, and examine trends in debt-to-equity ratios and free cashflow.

See also

• Capital accumulation
• Capital gains tax
• Climate-related asset stranding
• Diversification (finance)
• Divestment
• EBITDA
• Foreign direct investment
• Fundamental analysis
• Legal Alpha
• List of countries by gross fixed investment as percentage of GDP
• List of economics topics
• Market sentiment
• Mortgage investment corporation
• Rate of return
• Socially responsible investing
• Specialized investment fund
• Time value of money
• Time-weighted return