Investments: All you need to know
Investments are currently an increasingly discussed topic. It is not surprising, especially when we are constantly teased from all sides by agonizing words such as recession, inflation or stagflation. But do you really know what an investment is?
What is an investment?
From a general point of view, investment is defined as the postponement of (or a part of) current consumption for the purpose of future benefit. In practice, this means saving part of the income for future benefit, which is either interest, ensuring the appreciation of money, or some other non-monetary benefits in the future. For example, the purchase of housing for children can be considered non-monetary benefit. When they eventually become adults, they will be able to live on their own, and apart from the value being passed over, also both they and their parents enjoy privacy.
Why to invest?
By investing, we protect our earned money above all against it being devalued by inflation. Inflation can be simply defined as the loss of purchasing power of money. Although inflation has a significantly negative connotation in recently, it is healthy and necessary for any economy to a certain extent. However, if it gets out of control, something we call an inflationary spiral can hit the entire economy. This phenomenon and its practical effects on the lives of ordinary people were described by Erich Maria Remarque in his novel The Black Obelisk.
The opposite of inflation is deflation. When deflation occurs, the prices of goods fall, increasing purchasing power. Although this may sound positive, it quite really isn’t. In the short term, there will be an increase in demand, but in the long term, companies experience a decrease in sales, which leads to a reduction in costs but also wages, which then again has a negative impact on demand. In some extreme cases, the entire economy can be affected by a phenomenon called a deflationary spiral.
Investment types
So, what are the investment options? With the passage of time and the development of modern technologies, there is increasing number of possibilities to evaluate your resources. Investment options are pretty much unlimited these days. Nevertheless, there are some trends that are more popular and used than others.
The most popular nowadays are:
- Savings accounts
- Bonds
- Stocks
- Mutual funds
- Cryptocurrencies
- Other types of investments (collectibles, etc.)
Savings accounts
These days, savings accounts mainly care about the nominal increase in the value of money. Though in the overwhelming majority of cases money loses its real value. The interest rates that banks offer on accounts are not remotely at such a level that could cover the rate of inflation. So, while a few cents jump into your savings account here and there, in reality, you will still buy less for the amount you have managed to save.
Bonds
A bond is a form of security that guarantees its holder the right to be paid the agreed amount owed. Their publisher or issuer can be the state or a private entity. The bond's potential yield usually also depends on it. Government bonds are generally considered one of the safest ways to invest, but the appreciation they offer is relatively low. On the other hand, corporate bonds can offer a higher yield, but the risk of obligations not being repaid is significantly higher for companies than for institution like the state treasury.
Stocks
Like a bond, a stock is a security. In this case the share confirms that its holder is a shareholder of the company. That means he most likely invested into it. The shareholder then for his investment acquires certain rights. He can have the company's profit paid out to him (a so-called dividend) or he can also participate in decision-making process on matters related to the company's operation.
Mutual funds
These funds collect assets from small savers, who are called shareholders. They are then issued unit certificates, the value of which is determined based on the performance of the portfolio managed by the fund. In a way, all participants in supplementary pension savings can call themselves shareholders. Pension companies invest the funds they collect from them in different types of portfolios according to the client's risk profile.
Cryptocurrencies
This is a very young and dynamic environment. The first cryptocurrency dates only back to 2009, and since then thousands of other currencies have been created to this day. The essence of cryptocurrencies is blockchain technology, which has the potential to find application in many areas of human activity. Compared to other investment opportunities, cryptocurrencies are characterized by significant volatility, though extreme price fluctuations are redeemed by the opportunity for significant asset appreciation. In the history of this industry, there are no exceptions when virtual coins and tokens have grown by thousands of percent almost overnight.
Other types of investments
As already mentioned above, these days it’s possible to invest in basically anything. These can be traditional collectibles, such as postage stamps, works of ar or even trading cards. These can be from very different industries. Some may raise their eyebrows, for example, over cards from the Pokemon series. This yet again proves that basically anything which someone is willing to pay some money for can be included in the investment category.
Investment horizon
Before starting any investment, it is always necessary to think about several important factors. One of them is also the investment horizon. What is an investment horizon? This is a period of time during which the investor should not withdraw the invested capital. Depending on the chosen investment horizon, investments are usually divided into three basic types:
- Short term
- Medium term
- Long term
Each of these investments has its pros and cons, which must always be properly considered before proceeding. What every investor is most interested in at the beginning is the potential return of the investment. In this regard, in the vast majority of investments, the longer the investment horizon, the higher the potential return. Though, it is also not uncommon for long-term investments to be more volatile than short-term ones. If the investor does not have sufficient discipline and does not adhere to the investment horizon, he may lose part of his investment.
Return on investment
One of the most important factors that decide which investment option an investor chooses is the potential return. Although no investment is 100% guaranteed success and there is always at least a minimal risk for each type, it is possible to at least estimate the return they will result in at the end of the period for each type of investment. Accordingly, investments are divided into three basic groups:
- Conservative investment
- Mixed investments
- Dynamic investments
Whether an investment is conservative, mixed or dynamic can usually be determined by the type of underlying asset in which the investment is made. It is quite clear that government bonds are safer than shares of a small unknown company. Therefore, they are generally considered conservative.
Investor profile
It is also necessary to consider the individual profile of the investor. Banks and large investment companies mostly use the so-called investment questionnaire for this purpose. Using a set of questions, they assess what kind of investor they are dealing with. It always depends on the assessment and proper evaluation of the given questionnaire, but usually investors are divided into the following categories:
- Conservative investor
- Balanced investor
- Growth investor
- Dynamic investor
This is an assessment of institutions, who by law must evaluate investments enabling their clients to invest. Each person can download one such questionnaire and find out their profile taking in account factors like experience with investing, investment intervals, potential risk and volatility tolerance, even details such as age are assessed. In general, rather conservative forms of investing are recommended for older investors, as their investment horizon is usually not that long.
