Learn the Basics About Investments
What are Investments?
An investment is the commitment of an asset--such as cash or capital--to purchase a financial instrument with the goal of earning a profit. Investments typically yield a return in the form of interest, appreciation, or another source of income such as a dividend.
Investments are related to savings or deferred compensation. An individual will invest to put their wealth in a long-term instrument that will secure a set interest rate or dividend where the money will hopefully grow at a rate faster than inflation.
Investments are responses to savings accounts, where interest or substantial profits will not be earned. As inflation is inevitable, the resting money loses value over time. An investment offsets inflation through the guarantee of a fixed interest rate (CDs or long-term bonds), profits (stocks), or interest.
Investments are involved in a number of areas of the global economy. An investment can be the commitment of capital to an asset or financial instrument that is intended to appreciate in value. An individual can purchase a stock, bond, piece of property, derivatives, foreign currency, Treasury bill from the government, and other forms of debt with the intent to earn a profit on the instrument in the future.
Whatever the investment type, the commitment involves the choice by an individual or organization after thorough research of the investment's yield and the characteristics associated with the investment. Although investments are solid vehicles to realize profits, they demonstrate a substantial risk in the loss of the principal sum.
Types of Investments:
Bonds: These types of investments are grouped under fixed-income securities. A bond is a form of debt investment; when you purchase a bond, you lend money to a government entity or company. In return, they provide interest payments eventually pay-back the full amount you originally lent. Bonds are a popular investment strategy because they are relatively safe. If you buy bonds from a stable company or government body, your investment is risk-free. The safety of a bond, however, comes at a cost. The mitigated risk is matched with little return on investment; the higher the credit rating of the issuing agency the lower the return on investment.
Stocks: When you purchase a stock you become a part owner of the attached company. Ownership allows you to vote at shareholders’ meetings and allows you to receive a portion of the profits that the company makes—these profits are referred to as dividends. Because your return on investment is proportional to the underlying company’s business, the potential for increased profits (when compared to fixed-income securities) is realized in stock investments. That being said, the exposure to risk is also realized; stocks are far more volatile than bonds or other investment strategies.
Mutual Funds: Mutual funds are a collection of stocks and bonds. When you purchase a mutual fund, you pool your money with a number of investors—this enables you to pay a professional manager to select securities for you. Mutual funds are packaged with specific strategies in mind; their distinct focus can be on a number of investment options, including: small stocks, large stocks, bonds from corporations, bonds from governments, stocks in specific industries or stocks in specific countries.
Alternative Investments: The two basic investment strategies are equities and debts (stocks and bonds). While a number of investments fall into these two categories, there are a number of alternative investment strategies that represent complicated types of securities. When you start a business you should avoid dabbling in this market. See below to read about why you should avoid investing in options, forward contracts and other alternative investment strategies.
How to Invest if You are a Small Business Owner:
Allocate Your Assets Properly:
Numerous studies conclude that the most important factor in small business investing is asset allocation—your investment portfolio should include a prudent mix of stocks, bonds and cash. Over the long run, stocks will earn roughly 10 percent a year—enough to double your money every seven years. Stocks, however, (as evidenced recently) are too risky for funds that you will need in the next 5 to 10 years. The bulk of your money, therefore, should go into bonds, which are less volatile, but also less profitable—average returns for bonds are roughly 5 percent a year. Cash (savings accounts and money market accounts) are extremely safe but generally will yield nothing once inflation is realized.
A common rule regarding how to invest, says a small business owner should keep enough cash for roughly 8 to 12 months of expenses. Of the remaining holdings in the portfolio, the percentage of your bonds should equal your age (i.e. if you are 50 years old, 50% of your portfolio should be comprised of bonds). The rest of your money should be invested in stocks.
Utilize E.T.F.’s and Funds:
The most efficient way to diversify your portfolio is to invest in exchange-traded funds, which are similar to mutual funds but traded like stocks. A single exchange traded fund will have dozens of bonds, stocks; these bundles of investments, through their diversification, will return a solid percentage of profit every year. These professionally-run bundles are efficient because they provide a consistent return on investment. The average exchange-traded fund charges annual fees equal to roughly 1.3 percent of the fund’s assets.
Avoid Options, Forward Contracts and Futures: The most sound investment strategy for a small business owner will not incorporate zero-sum games. Individual investors who dabble in options and other similar holdings are betting against experienced professionals—for every dollar earned, someone else loses.
Types of Business Investments:
The term “investment” must be held separate when comparing or evaluating individual investors and owners of small businesses. The difference lies in the expected goal—an individual investor will secure an investment security to earn short or long-term profits, whereas a small business owner will invest in a maneuver or initiative to publicize his or her business. A small business investment is an organizational tool; by tinkering with the business model, a small business owner can reach their consumer base in a more effective manner. Investing in this sense refers to advertising endeavors and other investment strategies that bolster the owner’s product or service.