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Investing

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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.

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KEY TAKEAWAYS

  • An investment is an asset or item that is purchased with the hope that it will generate income or appreciate in value at some point in the future.
  • An investment always concerns the outlay of some asset today (time, money, effort, etc.) in hopes of a greater payoff in the future than what was originally put in.
  • An investment can refer to any mechanism used for generating future income, including bonds, stocks, real estate property, or a business, among other examples.

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. For example, it’s also a possibility that you will invest in a company that ends up going bankrupt or a project that fails to materialize. This is the primary way that saving can be differentiated from investing: saving is accumulating money for future use and entails no risk, whereas investment is the act of leveraging money for a potential future gain and it entails some risk.

Basic Types of Investments

Savings Accounts
Savings accounts are a safe haven to store your emergency funds. They provide easy access to your money and are generally insured. If you or your family’s deposit accounts at one FDIC-insured bank or savings association total $100,000 or less, your funds are fully insured. The chief drawback of such accounts is that interest rates tend to be low since they offer a very high degree of safety.

CDs (Certificates of Deposit)
A CD is a special type of deposit account that typically offers a higher rate of interest than a regular savings account. Just like savings accounts, CDs are also insured up to $100,000. When you purchase a CD, you invest a fixed sum of money for fixed period of time. Usually, the longer the period, higher is the interest rate. There are penalties for early withdrawal.

Money Market Deposit Accounts
These accounts generally earn higher interest than savings accounts. They are very safe and provide easy access to your money. They are also insured by the FDIC. They offer many of the services that checking accounts offer, however, a limit is normally placed on the number of withdrawals or transfers you can make during a given period of time.

Stocks
When you buy stocks, you own a part of the company’s assets. If the company does well, you may receive periodic dividends and/or be able to sell your stock at a profit. If the company does poorly, the stock price may fall and you could lose some or all of the money you invested.

Bonds
A bond is a certificate of debt issued by the government or a company with a promise to pay a specified sum of money at a future date and carries interest at a fixed rate. Bond terms can range from a few months to 30 years. Bonds are tradable instruments and are generally considered safer than stocks because bondholders are paid before stockholders if a company becomes bankrupt. Independent bond-rating agencies rate the likelihood that any given bond will default.

Mutual Funds
A mutual fund is generally a professionally managed pool of money from a group of investors. A mutual fund manager invests your funds in securities, including stocks and bonds, money market instruments or some combination of these, based upon the fund’s investment objectives. By investing in a mutual fund you can diversify, thereby, sharply reducing your risk. Most mutual funds charge fees. You often pay income tax on your profits.

Annuities
Annuities are contracts sold by an insurance company designed to provide payments to the holder at specified intervals, usually after retirement. Earnings cannot be withdrawn without penalty until a specified age and are taxed only at the time of withdrawal. Annuities are relatively safe, low-yielding investments. An annuity has a death benefit equivalent to the higher of the current value of the annuity or the amount the buyer has paid into it.