Introduction to Investments – Meaning, Objectives and Elements

Concept of Investment

Investment is the employment of funds with the aim of getting return on it. In general terms, investment means the use of money in the hope of making more money. In finance, investment means the purchase of a financial product or other item of value with an expectation of favorable future returns.

Investment of hard earned money is a crucial activity of every human being. Investment is the commitment of funds which have been saved from current consumption with the hope that some benefits will be received in future. Thus, it is a reward for waiting for money. Savings of the people are invested in assets depending on their risk and return demands.

Investment refers to the concept of deferred consumption, which involves purchasing an asset, giving a loan or keeping funds in a bank account with the aim of generating future returns. Various investment options are available, offering differing risk-reward tradeoffs. An understanding of the core concepts and a thorough analysis of the options can help an investor create a portfolio that maximizes returns while minimizing risk exposure.

There are two concepts of Investment:

  1. Economic Investment: The concept of economic investment means addition to the capital stock of the society. The capital stock of the society is the goods which are used in the production of other goods. The term investment implies the formation of new and productive capital in the form of new construction and producers durable instrument such as plant and machinery. Inventories and human capital are also included in this concept. Thus, an investment, in economic terms, means an increase in building, equipment, and inventory.
  2. Financial Investment: This is an allocation of monetary resources to assets that are expected to yield some gain or return over a given period of time. It means an exchange of financial claims such as shares and bonds, real estate, etc. Financial investment involves contracts written on pieces of paper such as shares and debentures. People invest their funds in shares, debentures, fixed deposits, national saving certificates, life insurance policies, provident fund etc. in their view investment is a commitment of funds to derive future income in the form of interest, dividends, rent, premiums, pension benefits and the appreciation of the value of their principal capital. In primitive economies most investments are of the real variety whereas in a modern economy much investment is of the financial variety.

The economic and financial concepts of investment are related to each other because investment is a part of the savings of individuals which flow into the capital market either directly or through institutions. Thus, investment decisions and financial decisions interact with each other. Financial decisions are primarily concerned with the sources of money where as investment decisions are traditionally concerned with uses or budgeting of money.

Elements of Investment

The Elements of Investments are as follows:

  1. Return: Investors buy or sell financial instruments in order to earn return on them. The return on investment is the reward to the investors. The return includes both current income and capital gain or losses, which arises by the increase or decrease of the security price.
  2. Risk: Risk is the chance of loss due to variability of returns on an investment. In case of every investment, there is a chance of loss. It may be loss of interest, dividend or principal amount of investment. However, risk and return are inseparable. Return is a precise statistical term and it is measurable. But the risk is not precise statistical term. However, the risk can be quantified. The investment process should be considered in terms of both risk and return.
  3. Time: Time is an important factor in investment. It offers several different courses of action. Time period depends on the attitude of the investor who follows a ‘buy and hold’ policy. As time moves on, analysis believes that conditions may change and investors may revaluate expected returns and risk for each investment.
  4. Liquidity: Liquidity is also important factor to be considered while making an investment. Liquidity refers to the ability of an investment to be converted into cash as and when required. The investor wants his money back any time. Therefore, the investment should provide liquidity to the investor.
  5. Tax Saving: The investors should get the benefit of tax exemption from the investments. There are certain investments which provide tax exemption to the investor. The tax saving investments increases the return on investment. Therefore, the investors should also think of saving income tax and invest money in order to maximize the return on investment.

Investment Objectives

Investing is a wide spread practice and many have made their fortunes in the process. The starting point in this process is to determine the characteristics of the various investments and then matching them with the individuals need and preferences. All personal investing is designed in order to achieve certain objectives. These objectives may be tangible such as buying a car, house etc. and intangible objectives such as social status, security etc. similarly; these objectives may be classified as financial or personal objectives. Financial objectives are safety, profitability, and liquidity. Personal or individual objectives may be related to personal characteristics of individuals such as family commitments, status, dependents, educational requirements, income, consumption and provision for retirement etc.

The objectives can be classified on the basis of the investors approach as follows:

  1. Short term high priority objectives: Investors have a high priority towards achieving certain objectives in a short time. For example, a young couple will give high priority to buy a house. Thus, investors will go for high priority objectives and invest their money accordingly.
  2. Long term high priority objectives: Some investors look forward and invest on the basis of objectives of long term needs. They want to achieve financial independence in long period. For example, investing for post retirement period or education of a child etc. investors, usually prefer a diversified approach while selecting different types of investments.
  3. Low priority objectives: These objectives have low priority in investing. These objectives are not painful. After investing in high priority assets, investors can invest in these low priority assets. For example, provision for tour, domestic appliances etc.
  4. Money making objectives: Investors put their surplus money in these kinds of investment. Their objective is to maximize wealth. Usually, the investors invest in shares of companies which provide capital appreciation apart from regular income from dividend. Every investor has common objectives with regard to the investment of their capital.

The importance of each objective varies from investor to investor and depends upon the age and the amount of capital they have. These objectives are broadly defined as follows.

  1. Lifestyle – Investors want to ensure that their assets can meet their financial needs over their lifetimes.
  2. Financial security – Investors want to protect their financial needs against financial risks at all times.
  3. Return – Investors want a balance of risk and return that is suitable to their personal risk preferences.
  4. Value for money – Investors want to minimize the costs of managing their assets and their financial needs.
  5. Peace of mind – Investors do not want to worry about the day to day movements of markets and their present and future financial security.

Achieving the sum of these objectives depends very much on the investor having all their assets and needs managed centrally, with portfolios planned to meet lifetime needs, with one overall investment strategy ensuring that the disposition of assets will match individual needs and risk preferences.

Investment and Speculation

“Speculation is an activity, quite contrary to its literal meaning, in which a person assumes high risks, often without regard for the safety of their invested principal, to achieve large capital gains.” The time span in which the gain is sought to be made is usually very short. Investment involves putting money into an asset which is not necessarily marketable in order to enjoy a series of returns. The investor sacrifices some money today in anticipation of a financial return in future. He indulges in a bit of speculation. There is an element of speculation involved in all investment decisions. However, it does not mean that all investments are speculative by nature. Genuine investments are carefully thought out decisions. On the other hand, speculative investment, are not carefully thought out decisions. They are based on tips, and rumors.

Speculation has a special meaning when talking about money. The person who speculates is called a speculator. A speculator does not buy goods to own them, but to sell them later. The reason is that speculator wants to profit from the changes of  market prices. One tries to buy the goods when they are cheap and to sell them when they are expensive. Speculation includes the buying, holding, selling and short selling of stocks, bonds, commodities, currencies, real estate collectibles, derivatives or any valuable financial instrument. It is the opposite of buying because one wants to use them for daily life or to get income from them (as dividends or interest).

Speculation should not be considered purely a form of gambling, as speculators do make an informed decision before choosing to acquire the additional risks. Additionally, speculation cannot be categorized as a traditional investment because the acquired risk is higher than average. More sophisticated investors will also use a hedging strategy in combination with their speculative investment in order to limit potential losses.