What Sort Of Investing Will We Be Dealing With In This Section?
Investing is defined most broadly as the committing of a resource in order to obtain future value. This value may or may not be monetary, for instance one may invest one’s time in a hobby, for personal satisfaction or entertainment, or one may do so in order to seek financial gain.
It is investing for financial gain that we will be discussing in this section. So the gain that is sought is one where one is better off financially should the investment succeed, although not all financial investments succeed of course.
Not all investing involves allocations of financial resources, for instance we may invest our time to make money, or we may invest money or other things of monetary value to do so. We’ll be speaking here of investing money for financial gain, to make more money, and what will be invested in is instruments that can later be sold or redeemed for money, in other words, have liquidity.
Having money on deposit is in a sense investing as well, for instance putting money in an interest bearing account. In this section though we’re looking at purchasing financial instruments to be sold at some time in the future, and defining investing for the purposes of this section as the investment in financial instruments, and we’ll cover things like deposit accounts in the section under banking.
Let us further define the financial instruments we’ll be dealing with here as ones with a variable future value, as opposed to ones with a fixed future value like a certificate of deposit. We’ll also cover this under the banking section, as they are just really deposit accounts with a guaranteed rate of interest over a set period.
So now we’ve set the stage here, and to sum up, in the investing section we’ll be looking at the purchase of financial instruments of undetermined future value, in which one commits a certain amount of money to the investment in the hope that its future value will be greater, and that it can be sold later at a profit.
Investing in Stocks
So what sort of instruments does this leave us? When people think of investing, they usually think first of purchasing shares in companies on stock markets, and this is indeed a popular form of financial investing.
There is certainly a lot to know about buying and selling stocks, and people think about this too much in terms of ownership of a company, and don’t pay enough attention to the other market factors that influence share prices. This is not something that you just want to jump into without a good understanding, although many people don’t know what they don’t know.
Selecting and trading individual stocks can be done successfully over time, and one’s results over time are indeed tied pretty closely to one’s skill and knowledge, and in order to give yourself a good opportunity to succeed here, there is a commitment of time required.
Those of significant financial resources to devote to trading stocks and other instruments and who do not have the time, the skill, or the inclination to put together and trade their own portfolios may instead hire someone to do it for them.
Generally, stocks are purchased from previous shareholders, shares that have already been issued, but there are also opportunities to purchase initial public offerings, or IPOs. IPOs can be more lucrative, but also involve more risk, and these are the two main considerations in any stock play, the potential for profit and the potential for loss.
Investing in Mutual Funds and ETFs
More casual investors who do not have the means for this or just wish to manage their own resources in a much simpler manner may purchase units of mutual funds instead. Mutual funds are a pooling of resources from many investors which are actively managed by the fund’s operator.
So one simply buys into a fund and the fund managers do the rest, for a fee of course. There are many different mutual funds offered of various types and strategies, and one still needs to choose among them. Each has particular goals, not only in terms of the components of the fund, but also how aggressive or conservative they are, and one must first make sure that the goals of the fund fit their own, prior to deciding which one looks best in their own individual category.
People will often think of mutual funds as being stock portfolios, and some are, but often they are a mix of assets, stocks and bonds for instance, or some other mix. The reason why different assets are held is to reduce the risk of the investments, where for instance the stock market may go down and the bond market may rise in turn, and this helps prevent larger swings, and larger swings downward in particular.
Some funds may be set up to deliver income from dividends primarily, called income funds, and others may be set up to offset market risk, called hedge funds.
Individual investors may also choose to trade in ETFs, exchange traded funds, which combine the benefits of a mutual fund with the individual control of personal trading. Like mutual funds, ETFs may track a variety of financial instruments.
Investing in Bonds
Buying shares in a public company involves a fractional ownership of it. When one purchases a bond, this is like lending money to a company or institution. Similar to stocks, bonds which are traded are generally already purchased, so it’s not like you lent money to the company or institution directly, but someone did originally, and you purchase this loan so to speak to be either traded or redeemed later.
There are several types of bonds, but the idea behind them is the same, to buy bonds at a certain price, and sell them or redeem them at a profit later, which may include an interest payment.
Bonds are more stable than stocks, less speculative, and therefore less risky, and a lot of this has to do with a lot of their intrinsic value being derived from the underlying debt obligation of the bond issuer, the repayment of the principal amount, where with stocks its price for trading purposes depends more fundamentally on the market.
Investing In Commodities and Futures
Certain commodities are traded on exchanges, and this is used by various businesses who are looking to purchase various commodities at a future date at a certain price. This is used to hedge against future price increases of the commodity.
While a commodity contract is designed to be cashed in upon expiration, actually taking physical possession of the commodity in question, a lot of investors speculate in this market, and will buy and sell the commodity contracts for investment purposes, intending to sell the contract prior to expiration, hopefully at a profit.
Commodity contracts are just one form of futures contracts, and there are also financial instruments that have their own futures contract and markets, and these work the same way. One purchases a contract to take delivery of a certain item at a certain price at some point in the future, and these contracts are bought and sold and one may speculate on them with no intention of ever taking delivery, like with commodities.
Like stocks, one may take either a long position, purchasing a contract, or a short position, selling a contract. When you sell something short, you are selling it without having it in your possession, with the idea of purchasing it to fulfil your obligation at a later date and at a lower price. So you are betting something will decline in value in other words when you go short, as opposed to betting it will increase in value when you go long.
Somewhat related to futures is the options market, which is like a future contract that you don’t have to take delivery of, you have an option to, but we will deal with these investments in a separate section called options.
Investing Always Involves Risk Versus Reward
Investing in financial instruments always involves placing a bet of some sort, and in a sense all investing, all allocation of resources for a potential return, involves placing a bet. For instance when you watch a movie you are betting that the time invested will be worth it in terms of the entertainment you receive.
Investing in financial instruments though involve placing bets with money, which makes the betting part more lucid, although not everyone understands this properly. What is most helpful is being clear on what we are betting on, for instance betting that the price we can receive for holding a stock for a certain period of time will be higher, meaning that people will be betting bigger on it in the future than they are now.
The probability of the bet working is what we term the reward, the profit, and this includes both the probability of the bet winning and the magnitude of the win. The same is true with risk, the probability of the bet losing and the probable magnitude of the loss.
Everyone loves to win, and win big, so what needs to be decided is the risk part, making sure that the risk involved fits your appetite for risk, your risk tolerance. As you can see, there are a large variety of different types of financial instruments you can invest in. The main idea is to match your goals and your risk tolerance with the potential rewards and risks, and to the extent that you can do this effectively, you will find what is most suited for you, and this all has to be worked out even prior to your deciding which ones to trade.