To invest is to allocate money in the expectation of some benefit in the future.
In finance, the benefit from an investment is called a return. The return may consist of a gain (or loss) realised from the sale of property or an investment, unrealised capital appreciation (or depreciation), or investment income such as dividends, interest, rental income etc., or a combination of capital gain and income. The return may also include currency gains or losses due to changes in foreign currency exchange rates.
Investments are like modes of transportation - a bicycle, a car, a bus, a plane, etc. — what you take depends on where you’re going.
Terminology and risk
Savings bear the (normally remote) risk that the financial provider may default.
Foreign currency savings also bear foreign 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 unfavorably, so that the value of the savings account decreases, measured in the account holder's home currency.
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.
The Code of Hammurabi (around 1700 BC) provided a legal framework for investment, establishing a means for the pledge of collateral by codifying debtor and creditor rights in regard to pledged land. Punishments for breaking financial obligations were not as severe as those for crimes involving injury or death.
In the early 1900s, purchasers of stocks, bonds, and other securities were described in media, academia, and commerce as speculators.
Types of investments
A value investor buys assets that they believe to be undervalued (and sells overvalued ones).
The price 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 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 of financial performance; 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 investors paying for each dollar of a company's earnings, the P/E ratio is a significant indicator, but the price-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.
Intermediaries and collective investments
Investments are often made indirectly through intermediary financial institutions. These intermediaries include pension funds, banks, and insurance companies. They may pool money received from a number of individual end investors into funds such as investment trusts, unit trusts, SICAVs, etc. to 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.
Investors famous for their success include Warren Buffett. In the March 2013 edition of Forbes magazine, Warren Buffett ranked number 2 in their Forbes 400 list. Buffett has advised in numerous articles and interviews that a good investment strategy is long-term and due diligence is the key to investing in the right assets.
The investment principles of both of these investors have points in common with the Kelly criterion for money management. Numerous interactive calculators which use the Kelly criterion can be found online.
Free cash flow measures the cash a company generates which is available to its debt and equity investors, after allowing for reinvestment in working capital and capital expenditure. High and rising free cash flow therefore tend to make a company more attractive to investors.
The debt-to-equity ratio is an indicator of capital structure. A high proportion of debt, reflected in a high debt-to-equity ratio, tends to make a company's earnings, free cash flow, and ultimately the returns to its investors, more risky or volatile. 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 cash flow.
- Capital accumulation
- Capital gains tax
- Diversification (finance)
- Financial risk
- Foreign direct investment
- Fundamental analysis
- Fundamental Analysis Software
- Hedge fund
- 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
- Technical analysis
- Time value of money
- Mutual Fund