What is investing?
In this section, we will talk about what investing is and we’ll see some clear examples of how it looks like to set a solid foundation.
Let’s start with the general definition
Investing is the act of allocating (or putting) effort, time and/or money into a certain asset or endeavor that is expected to generate a future long-term benefit. For instance, putting effort, time and possibly money into getting a school degree is an investment because it may help you achieve your career and life goals. Another example of an investment could be putting in the effort and time into practicing a sport, which brings you satisfaction and it helps you stay healthy, it can even help you make money!
Now, we will focus on the finance side of the definition of investing
It is the allocation of funds (or money) into assets (such as stocks or bonds) or endeavors (like starting a project or a business) in order to generate some future gains. Basically, the essence of the term is not spending money now to have more money to spend in the future and by that, we mean the Long-Term future.
Differences between investing and speculating
When you put money into an asset or business, in order to call it an investment it is important to take into account certain crucial factors:
- Previous exhaustive analysis: the exhaustive analysis of the assets in which you intend to invest is a basic requirement for any investment to be called an investment. You would be speculating if you bought assets without analyzing their value and characteristics beforehand. Later we will show you the main techniques to value assets.
- Risk vs reward: the most important factor in the world of investments is risk; since there are virtually no risk-less investments. Therefore, you must pay special attention to the level of risk that you can tolerate to obtain the desired return. Later we will see what risk in investing is and how to manage it in your favor.
- Time horizon: as we have seen before, investments are only considered as such when they are long term; that is when you hold them for 5-7 years or more. On the other hand, when someone acquires shares to sell them the next day (or even the same day), this is known as speculation – even if the shares are from a company with a promising future. The time factor is important since the speculator intends to obtain a higher return faster, which entails more risk; while the investor intends to obtain a competitive return minimizing risks.
Let’s look at an example of what an investment looks like
Laura has an amazing idea to start a business, so she decides to invest $ 5,000 into starting SmarPie Company, a bakery specialized in organic low-calory pies. She also put in countless hours and effort in finding the right people, optimizing the production and distribution systems and coming up with new ideas. Let’s fast forward 20 years to look at how the investment turned out. Her business exploded shortly after it started and it has had continuous growth all throughout the years. Now, the SmartPie Co. is worth $ 50,000 and Laura has fulfilled her dream of helping people be healthy. Doing some math we find that, after 20 years, she has almost 9 times more money than when she started.
+ Company’s value (20 years later): $ 50,000
– Initial investment: $ 5,000
= Net worth (20 years later): $ 45,000
Net worth: $ 45,000 / Initial investment: $ 5,000
End return: 900% (or 9 times)
In the next section, we will see why investing is important.