What is an Investment?
I’ve seen many things labeled as investments, including holidays, cars, diamonds, houses, a college degree, you name it.
But how can you tell if something is really an investment?
An investment is something that requires you to risk your money, has the potential to make you more money, and needs very little, or no effort at all from you to make it happen.
Let’s break this down step by step.
Risk your money
All investments have an amount of financial risk associated with them.
Some investments have a low risk (e.g. your savings account), because you can be very sure that you will make some money from it.
Some investments have a high risk (e.g. investing in a company that plans to offer space flights and trips to the moon, for normal people), because you cannot be sure that your investment will make you money, or indeed, that you will even get back the same amount of money you invested in the first place!
Potential to make you money
If something does not have the potential to make you money on its own (i.e. without you doing anything), it is not an investment.
Buying a new BMW is not an investment. Buying a pair of shoes is not an investment. Taking a holiday is not an investment.
Buying shares in a company listed on the stock exchange is an investment. Putting money in a savings account is an investment. Providing venture capital for your friend’s business is an investment (as long as you stand to gain something from it).
Requires very little, or no effort at all from you
An investment does not require you to actively do a lot of work.
It may require you to do a bit of initial work (e.g. transferring money, signing a contract or filling out forms), or even a little bit of monthly work of the same nature. But as a rule, an investment does not require you to actively do work.
Something that has the other two characteristics of an investment (requires you to take a financial risk, and has the potential to make you money), but also requires you to actively do work, is called a business.
August 1st, 2008 at 04:58 am
my grandmother was really into investing. there has been this guy from edward jones coming around our neighborhood looking for people to invest. i think it would be cool to invest alittle, but it sounds like gambling to me. right now we are just sticking with the 401k.
August 1st, 2008 at 10:42 pm
@Jamie
I don’t know Edward Jones (I’m South African, remember
). I briefly looked at the website, but not in enough detail to tell you anything.
I’ve got a follow-up post lined up on identifying good investments.
But here are some general tips I follow:
1. If you don’t understand something, don’t invest in it.
2. REALLY, if it doesn’t make sense to you, either figure it out until it does, or just don’t invest in it.
3. It’s a good idea to diversify, i.e. invest in several different things, so if one tanks, the others will save it. E.g. buy shares in some foreign companies, some local companies, invest in some property, some cash (read bonds or savings account), and then perhaps a few other things to play with.
4. Invest most of your money (my advice is at least 50%) for the long-term. Like seriously long-term, between 10 years and death-do-us-part long-term.
August 2nd, 2008 at 08:56 am
What a great post! It’s the first time it’s ever been properly explained to me. I’ve always equated investments with people have have big money. Do you mean 50% of monthly income? I’d love to get to the point to invest at least 50% of my money.
August 2nd, 2008 at 11:49 am
@Elize
Your comment makes me happy. My goal with this post was to show that investing is not difficult to understand, and that it is not only for financial-gurus and super-rich folk, but also for “normal people”.
To be able to invest half of your income is a very good goal!!
But when I said 50% I was not really talking about 50% of your income. I mean that at least half of the investments you make should be for the (very) long-term.
E.g. I’ve bought shares in about 10 different companies. About half of the shares I bought, I probably won’t ever sell, or I’ll only sell them many many years from now.
Needlessly to say, I picked those shares very carefully.
I tried to find companies that have been around for a long time, will still be around for a long time, have a good track record, pay consistently good dividends, and had a reasonable share price at the time when I bought.
One more thing. For people who have a lot of debt, my advice is to first focus on paying off most of your debt, before you focus on making investments.
It’s OK to have some debt and also make investments, but it’s best to first pay off your “bad debts”, before your start investing ( see http://liberta.co.za/blog/is-there-such-a-thing-as-good-debt/ ).
August 6th, 2008 at 01:51 am
Most of the marketing mumbo jumbo plays to the idea of hidden investments.
One such investment would be any training you might spend that increases your potential to earn money (e.g. taking a course at a reputable college which will open carreer opportunities or help your to understand and invest your money).
Another may be reading this blog.
It is a bit more difficult to see and weigh up benifits vs cost of hidden investments.
I think the marketing guys play to this idea, when trying to sell cars and vacations
As a side – I technically would call a holiday/vacation maintainence as apposed to an investment. This doesn’t mean it’s not important – a well oiled cog will do more work more easily.
With this in mind, I feel justified to spend on myself ‘from time to time’, but I’m not about to lie to myself about it either.