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Introduction of Investment

Investment is an asset that is acquired with the anticipation of generating an income or profit or price appreciation. The benefit derived from the investment is called a return. Risk and returns are directly proportional (i.e.) the Higher the risk, the higher the returns.

Explanation

Investors actively invest intending to generate income, secure future benefits, experience capital appreciation, and create wealth. Investors always target future returns when making investments; hence it comes with some risk. Investments generate income in two ways. One invests in an asset that gives profit on the sale (i.e.) Capital appreciation, and the other is an income generation plan where a regular income can be earned from those assets (i.e.) Dividend, Interest, Rental income, etc. The capital appreciation investment type has more risk than the income-generating investment type. Investments can be in the nature of ownership, lending, and cash/liquid assets.

Low-risk investments are Certificates of deposits, Fixed deposits, Bonds, etc., that yield lower returns. They are an income-generating investment model. High-risk investments are stocks, Commodities, Derivatives, etc., that yield higher returns. They are the capital appreciation investment model. Risks and returns vary within the same investment class. E.g. Shares. Investment in blue-chip stocks is more secure than mid-cap and small-cap stocks.

Examples of Investment

There are various investment options available. Some of them are discussed below

1. Stocks

Stocks of publicly listed companies are traded in the secondary market, and any individual can buy the same. Investment in stocks can either be long-term or short-term. There are two types of returns that the stocks offer one is price appreciation in stocks, and the second is receipt of dividends. The risk of investment is higher in stocks as there is no guarantee of investments.

Example: X Corp is an e-commerce listed company in the US. The following are its stock trading price over 2 years.

Date

Open High Low

1-Jan-17 1940 1980 1920 1950

1-Jan-18 2250 2350 2200 2300

1-Jan-19 2500 2650 2450 2600

If Mr. Y purchased 10 X Corp shares on 1st Jan’17 @ $1940/share, the investment value is $19,400, the same share price on 1st Jan’ ’19trades @ $2600/share; the investment value increased to $26,000. The capital appreciation over 2 years is $6,600, which is 34%. The risk in this investment is high, so the returns are also high.

2. Bonds

Government entities and corporations actively issue bonds as debt instruments. This debt instrument offers periodic interest, and the bond’s face value will be returned on maturity. They are also known as fixed-income instruments.

Example: HS bank issues bonds. Mr. A purchases a 5-year $1 Million HS bond with a 10% coupon rate.

This investment plan makes HS bank pay Mr. A the interest of $100,000 every year for 5 years, and at the end of the 5th year, $1 Million will be paid back to Mr. A.

3. Fixed Deposit/Certificate of Deposit

Investors predominantly deposit fixed deposits with banks as investments. It actively generates fixed-interest income, and the deposit holder receives the original investment money upon maturity.

Example: Mr. B deposited $1 Million in XY bank, which pays 10% interest annually. This is a one-year deposit plan. Upon completing one year, Mr. B will be paid $100,000 as interest and $1 Million as the initial deposit value.

4. Options and Derivatives

Derivatives are financial instruments that derive their value from other instruments, such as stocks or indexes. Options are derivative instrument that gives the buyer the right but not the obligation to buy or sell a security at a fixed price within a specific time. Derivatives are high-risk and high-reward instruments.

5. Funds

Investment managers actively manage pooled investment plans known as funds. This fund invests investors’ money in stocks, bonds, commodities, etc. The common types of funds are mutual and exchange-traded (ETF). Mutual funds are not actively traded directly on an exchange, and their valuation is based on the net asset value at the end of each trading day. ETFs are traded on the stock exchange just like stocks.

6. Investment Trusts

Trusts also come under the pooled investment category. Real Estate Investment Trusts (REITs) are common in this category, where the pooled investment money is invested in commercial or residential properties, and the rental income generated from those properties is distributed to the investors.

7. Commodities

Commodities are products like financial instruments, currency, oil, metals, etc. They can be traded through commodity futures – which gives the buyer the right but not the obligation to buy or sell a specific quantity of the commodity at a specific price at a specific date, and through ETFs. Market participants actively use commodities for hedging risks or engaging in speculative trading.

8. Real estate

Real estate is land, buildings, property, etc. The return on this investment is the price appreciation of the real estate asset value, and rental income can also be generated from real estate built-in property. Real estate can be in the form of Residential property, Commercial property, Industrial property, and land.

Conclusion

Investments are important as they give financial security for the future and lead to wealth generation, as seen in the above section of Investment Examples. Investments can keep the money safe, and it is up to the investor to choose the right investment based on their risk appetite. It makes money grow (i.e.) capital appreciation of investment over time and generates a regular income source. It helps to achieve long-term and short-term financial goals. There are various sources of investments, and every investor will have their own strategy and goals.