Chapter 4: Intro to Investing
Investing is putting money to work for a period of time in some sort of project or undertaking in order to generate positive returns. It is the act of allocating resources, usually capital, with the expectation of generating an income, profit, or gains.
One can invest in many types of endeavors (either directly or indirectly) such as using money to start a business, or in assets such as purchasing real estate in hopes of generating rental income and/or reselling it later at a higher price. Investing differs from saving in that the money used is put to work, meaning that there is some implicit risk that the related project(s) may fail, resulting in a loss of money.
While the universe of investments is a vast one, here are the most common types of investments:
Stocks
A buyer of a company's stock becomes a fractional owner of that company. Owners of a company's stock are known as its shareholders and can participate in its growth and success through appreciation in the stock price and regular dividends paid out of the company's profits.
Bonds
Bonds are debt obligations of entities, such as governments, municipalities, and corporations. Buying a bond implies you hold a share of an entity's debt and are entitled to receive periodic interest payments and the return of the bonds face value when it matures.
Funds
Funds are pooled instruments managed by investment managers that enable investors to invest in stocks, bonds, preferred shares, commodities, etc. Two of the most common types of funds are mutual funds and exchange-traded funds or ETFs. Mutual funds do not trade on an exchange and are valued at the end of the trading day; ETFs trade on stock exchanges and, like stocks, are valued constantly throughout the trading day. Mutual funds and ETFs can either passively track indices, such as the S&P 500 or the Dow Jones Industrial Average, or can be actively managed by fund managers.
Investment Trust (REITs)
Trusts are another type of pooled investment. Real Estate Investment Trusts (REITs) are one of the most popular in this category. REITs invest in commercial or residential properties and pay regular distributions to their investors from rental income received from these properties. REITs trade on stock exchanges and thus offer their investors the advantage of instant liquidity.
Options and Other Derivatives
Derivatives are financial instruments that derive their value from another instrument, such as a stock or index. Options contracts are a popular derivative that gives the buyer the right but not the obligation to buy or sell a security at a fixed price within a specific time period. Derivatives usually employ leverage, making them a high-risk, high-reward proposition. We will cover options in more detail in a later section.
Commodities
Commodities include metals, oil, grain, and animal products, as well as financial instruments and currencies. They can be either traded through commodity futures which are agreements to buy or sell a specific quantity of a commodity at a specified price on a particular future date—or ETFs. Commodities can be used for hedging risk or for speculative purposes.