Introduction to Investment 1

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Investment Types

Introduction to Investment

Investment

Definition: Commitment of money that is expected to generate additional money. Investment is the application of money or other assets in the hope that, in the future, it will appreciate or generate more income.

Why Do Individuals Invest?

  • To achieve a higher level of consumption in the future by forgoing consumption today.
  • To improve welfare in the future.
  • Investments help achieve a tradeoff between current and future consumption.

Types of Investments:

  1. Fixed Income and Equities
  2. Alternative to Fixed Income and Equities
  3. Other Investment Assets

1. Fixed Income and Equities

Fixed Income: Refers to interest payments that an investor receives, based on the solvency of the borrower and current interest rates. It offers higher interest based on maturities.

Fixed income investments include bank deposits, bonds, treasury bills, money market instruments, and asset-backed securities.

Equities: Equity investment refers to buying shares in a company, thereby gaining ownership interest that can be sold later to generate returns based on investment objectives.

Investment Types, Definitions, Advantages, and Disadvantages

  1. Stocks (Equity)
    • Definition: A type of security that signifies ownership in a corporation and represents a claim on part of the corporation's assets and earnings.
    • Advantages:
      • Unlimited upside potential.
      • Diversification strategies.
    • Disadvantages:
      • No guaranteed returns.
      • Risky; can lose more than 50% of investment in one day.
  2. Bank Deposits (Fixed Income)
    • Definition: Money placed into a banking institution for safekeeping, often with a fixed interest rate.
    • Advantages:
      • Known income based on outstanding principal and current interest rate.
      • Shorter holding period than bonds.
    • Disadvantages:
      • Lower interest income compared to bonds.
      • Settlement risks if the bank closes.
  3. Bonds (Fixed Income)
    • Definition: Debt investments where an investor loans money to an entity, which borrows the funds for a defined period at a fixed interest rate.
    • Advantages:
      • Known periodic payments for a defined period.
      • Can't lose money if held until maturity.
    • Disadvantages:
      • If not held to maturity, can gain or lose depending on prevailing interest rates.

2. Alternative to Fixed Income and Equities

Definition: Alternative investments are financial assets that don't fall into conventional categories (equities, income, or cash). These are not easily converted to cash (illiquid).

  1. Mutual Funds
    • Definition: An investment made up of a pool of funds collected from many investors for the purpose of investing in stocks, bonds, and similar assets.
    • Advantages:
      • Access to professionally managed, diversified portfolios.
    • Disadvantages:
      • Values fluctuate like the stock market.
  2. Unit Investment Trust Fund (UITF)
    • Definition: A collective investment scheme similar to mutual funds, where investors pool their money in a bank-managed trust account.
    • Advantages:
      • Easier access; no entry and management fees.
    • Disadvantages:
      • No shareholder rights, such as dividends or voting rights.

3. Other Investment Assets

Definition: Tangible or intangible items obtained for producing additional income or held for speculation, such as currencies, cryptocurrencies, commodities, insurance, and real estate.

  1. Currencies
    • Definition: The most generally accepted form of money, including coins and paper notes, issued by a government and circulated within an economy.
    • Advantages:
      • Largest market globally, with liquidity.
    • Disadvantages:
      • Volatile; requires close monitoring.
  2. Cryptocurrencies/Digital Currencies
    • Definition: A form of digital or virtual currency that uses cryptography for security and operates on blockchain technology.
    • Advantages:
      • Protection from inflation.
      • Decentralized and secure.
    • Disadvantages:
      • Can be used for illegal transactions.
      • Susceptible to hacks.
  3. Commodities
    • Definition: A basic good used in commerce that is interchangeable with other goods of the same type (e.g., gold, oil, wheat).
    • Advantages:
      • Natural hedge against inflation.
    • Disadvantages:
      • Storage, transportation, and insurance costs involved.
  4. Real Estate
    • Definition: The purchase, ownership, management, or sale of land and any improvements for profit.
    • Advantages:
      • Appreciates over time.
      • Can provide rental income.
    • Disadvantages:
      • Requires large capital and is illiquid.
  5. Insurance
    • Definition: A contract where an individual or entity receives financial protection or reimbursement against losses from an insurance company.
    • Advantages:
      • Financial protection against unforeseen events.
    • Disadvantages:
      • Insurance premiums can be costly; some plans may offer no benefit if no event occurs.

Generalization

Investments offer high opportunities and returns but also come with risks, including potential scams. Investors should know their goals, prioritize effectively, and be willing to face risks, as higher risk often indicates the potential for higher returns.

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