What is an investment?

An investment is an asset or item acquired with the goal of generating income or appreciation. Appreciation refers to an increase in the value of an asset over time. When an individual purchases a good as an investment, the intent is not to consume the good but rather to use it in the future to create wealth. An investment always concerns the outlay of some asset today—time, money, or effort—in hopes of a greater payoff in the future than what was originally put in.

For example, an investor may purchase a monetary asset now with the idea that the asset will provide income in the future or will later be sold at a higher price for a profit.

How an Investment Works

The act of investing has the goal of generating income and increasing value over time. An investment can refer to any mechanism used for generating future income. This includes the purchase of bonds, stocks, or real estate property, among other examples. Additionally, purchasing a property that can be used to produce goods can be considered an investment.

In general, any action that is taken in the hopes of raising future revenue can also be considered an investment. For example, when choosing to pursue additional education, the goal is often to increase knowledge and improve skills (in the hopes of ultimately producing more income).

Because investing is oriented toward the potential for future growth or income, there is always a certain level of risk associated with an investment. An investment may not generate any income, or may actually lose value over time.

Investing vs Speculating

Investing is also different from speculation as speculation is generally considered as targeting high returns from your investments within a short period of time. Speculation may be considered as a form of a very high risk investment within a short time horizon. Investments are generally long term in nature and take care of the risks such that the returns are commensurate with the undertaken risk.

Why you invest

1. Higher Investment Returns

Investing funds in an asset involves a tradeoff as the investor foregoes the utility of using the funds for his investment in the present for some higher utility in the future.

• Investment in stock can lead to returns through two ways – one could be through dividends while the other could be from capital gains.
• Investing in a bond can benefit the investor in the form of regular payouts or coupons which are given during predetermined time periods.
• Investing in real estate can also benefit an investor through rental income and capital gains.

2. Retirement Plan or FIRE

The majority of people invest for retirement purposes. As most people rely on their salary income for meeting their needs, it becomes difficult to sustain their lifestyles after retirement when one does not have a job. This means that everyone needs to invest a part of his income during working years to ensure a nest egg during his retirement years. While the government and companies used to give a defined benefit pension plan for employees earlier, now one has to mostly rely on defined contribution plans.

A lot of young people also want to retire early so they need to invest a larger portion of their income in order to meet their goals. The “FIRE” movement has become a major movement amongst millennials. “Financial Independence, Retire Early (FIRE)” is a goal that many are striving for these days. Saving a major proportion of income from a young age (as high as 70% of your income) can allow one to retire at the age of 40-45 years, instead of the 60-65 years. The FIRE movement advocates a frugal lifestyle both at the time of investing as well as during early retirement.

3. Tax Efficiency

Investing can also help in saving taxes as there are accounts such as the RRSP, TFSA, 401k, Roth IRA and others where the taxes on your investments is lower or non-existent. As governments reduce their responsibility towards funding their citizens’ retirement years, they have created these types of accounts so that citizens can contribute and fund their own retirement.

4. Beat Inflation

Investing is also important to beat inflation. If you don’t invest your money but just leave it in your checking or savings account, the money will decline in purchasing power as inflation will eat away the value of your money.

While the reported inflation is quite low nowadays, the actual inflation is quite high as education and healthcare expenses are increasing much faster than reported inflation. Banks are not even paying 2% on your savings deposit which means that if you do not invest, your money will lose value over time. Even this 2% return may not sustain for long as other foreign central banks have cut close to 0% or even lower. This means that you could face a day when your bank deposits earn 0% return or even negative returns sometime in the future when inflation is taken into account. To insure yourself against such a situation, it might make sense to start investing in a mix of assets which can beat inflation.

5. Reach Your Financial Goals

Investing is one of the key ways in achieving the financial goals for oneself. As an individual grows through life, there are new financial requirements that come up. It usually starts with buying a house. Even if one funds a house through a loan, there is the requirement of a substantial down payment. By investing through a mix of assets, an individual can build up the corpus required for the down payment.

Another major investment goal can be the college education of children. With the steep college tuitions required these days, a parent can start investing for college tuitions even when the children are still very young. Besides these financial goals, retirement is always an omnipresent financial goal for people during their working lives.

When one should start investing

One should not start investing with their first salary first of all everyone should create an emergency fund which will have an amount which can full fill your requirements for atleast six months in case you want to switch your job or want to start something new or it can be any emergency like we are facing right now.

Where you can invest

1. Mutual funds
2. Retirement plan
3. Stocks and Bonds
4. Gold investment
5. Real estate