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What is Investment?
According to Warren Buffet
“Investment is the process of laying out money now to receive more money in the future.”
In a broader sense, investment is the activity of using financial and physical resources, including labor, capital and intellectual resources in a certain time to gain economic profits and other socio-economic benefits. There are many ways to invest, such as using your resources to run a new business, possessing valuable property, or buying real estate with the expectation of gaining a bargain later on. Recently, investment has become a trend that attracts a lot of attention from both old and young generations around the world.
Risk in investment
However, the risk always goes hand in hand with the expected return of an investment. When investing in high-risk assets, people would expect and demand a higher return. While conversely, they can comfortably accept the lower return on investment when participating in lower-risk assets.
At the lowest risk category, there are basic investments that could be easily invested in like certificates of deposit, bonds issued by reliable organizations, or other fixed-income instruments. Stock is a higher-risk investment. Finally, commodities and derivatives are considered one of the riskiest investments due to the high volatility and high financial leverage involved in the buying/selling process. Beside traditional financial investment, people can also invest in tangible properties such as land, real estate projects, or high-value items, namely art and antiques.
Risk and return expectations can be extremely varied in the same kind of asset. For example, a blue chip traded on the New York Stock Exchange will have very different risks compared to a small capitalization company on a small stock exchange such as the Mongolian Stock Exchange.
How to expect a reasonable return from an investment?
In addition to the risk level of an asset, the expected return of an investment is also more or less depending on certain types of asset and its properties. There are two main sources of income retrieved from investments: periodic interest and price appreciation of the assets held. For example, many stocks will not pay periodic interest, while bonds often pay quarterly interest. Yet, stocks have the potential to increase a lot in price (high potential for capital appreciation) and bring back more profits when being resold. Therefore:
Investment’s return = period interest income + price appreciation of asset holding.
As a result, if you invest in bonds, you should not expect to sell those bonds at an exorbitant higher price than the initial purchase price. Instead, you should figure out the committed periodic interest payment when you start buying bonds. As for investing in stocks, you should find out if the company is doing well and research stocks effectively to see if the stock price can increase in the future.
Keep in mind that the higher the risk of an investment, the more prudent the investor has to be. It is best that you should compare your investment with other low risk and guaranteed investments such as government bonds and savings deposits. The higher the investment return, the more effort an investor has to give out in order for equal achievements. Nothing is free lunch.