An investment is the purchase of goods or assets to generate wealth in the future, either through income or appreciation.

Investments can take many forms, from financial securities like stocks to collectables like rare stamps. And people invest for a variety of reasons. It could be to save money for a fancy car, pay a deposit on a house, or build a retirement nest egg.

Regardless, the principle is always the same: put money to work today to build more value in the future. However, it’s a portfolio to remember that future value is never guaranteed. All investments carry risk. And typically, the more wealth that can potentially be created, the more risk is involved.

What is the point of investing money?

While all investments share the common objective of making money in the future, individual investors often have a far more specific financial goal in mind.

• Fund Retirement – Arguably the most common investment objective shared by investors is to build up sufficient wealth to retire comfortably. The Self-Invested Personal Pension (SIPP) account is specially designed just for this.
• Education – Invest to build up funds that can be used to cover university tuition fees of children or grandchildren.
• Additional Income – Build a second stream of passive income to help cover living expenses. Some stocks offer dividends, while rental properties can provide a steady stream of money income.
• Beat Inflation – Instead of growing wealth, some investors are interested in preserving it. Several investment types can deliver inflation-beating returns without becoming exposed to high levels of risk.
• Start a Business – Build up a lump sum of capital that can be used to launch a new business venture.
• Large Expenses – Save up capital to cover the costs of a large future purchase, such as a luxury holiday, sports car, or house.
• Support Causes – Put money to work in organisations actively trying to make the world a better place. There are many approaches to this goal. But the three primary styles include ESG Investing, Socially Responsible Investing, and Impact Investing.

What are the 7 types of investments?

Investments come in lots of different shapes and sizes. Here are the seven primary categories assets are typically organised into:

• Stocks – Stocks and shares represent a small piece of an underlying business. By owning shares in a company, an investor becomes a partial owner of that business and has a claim on its current and future earnings. Stock prices can be volatile in the short term. But over long time horizons, they move in correlation with how well the underlying business is performing. Some stocks offer dividends that return excess capital to shareholders when a company has no better use for it.
• Bonds – Bonds are fixed-income debt instruments. By owning bonds, an investor has purchased securitised debt, typically from a corporation or government and is therefore entitled to receive interest payments until the loan has been repaid at the maturity date.
• Mutual Fund – Mutual funds pool investor capital together to invest in a broad range of different asset classes on behalf of shareholders. Investing in a mutual fund effectively passes on all the research, portfolio management, and decision-making to a qualified professional fund manager. This allows investors to put their investments on autopilot in exchange for annual fees.
• Exchange-Traded Fund (ETF) – Similar to mutual funds, exchange-traded funds pool together investor capital to invest in a range of asset classes depending on the ETF type. These funds are typically passively managed and designed to track an underlying benchmark’s performance. Most passive funds today are run by automated trading algorithms rather than human beings. And subsequently, the annual management fees are commonly lower than an active mutual fund.
• Commodities – Commodities are raw physical materials such as lumber, oil, gold, or grains. Investors can purchase these raw materials directly as an investment. However, doing so often comes with additional storage and transportation costs. Therefore most investors tend to invest in financial derivatives, commodity tracker investment funds, or raw material stocks as a more cost-effective investment vehicle.
• Real Estate – Investors can purchase real estate for leasing or house flipping. However, this often requires significant upfront capital. A more popular alternative is to buy shares in a Real Estate Investment Trust, which owns, maintains, and leases a portfolio of properties on behalf of its shareholders.
• Alternative – Alternative investments tend to be more unique. Examples include annuities, cryptocurrency, financial derivatives, and collectables, among others.

What are the 5 investing styles?

• Passive Investing – An investment strategy designed to replicate the performance of a specific benchmark. The most common type of passive investment is an index fund which tracks a particular stock market index such as the FTSE 100 or S&P 500.
• Active Investing – An investment strategy where the investor seeks to outperform a specified benchmark. This approach involves handpicking which investments to own, commonly through stock picking. However, investors can pass on these responsibilities to a professional by hiring an investment adviser or investing in an active mutual fund.
• Growth Investing – Growth investors seek to invest in businesses or asset classes that have the potential to outperform the stock market over the long term. Growth shares rarely pay dividends, as any excess capital is reinvested to fuel more growth.
• Value Investing – Value investors seek to invest in businesses and financial assets currently trading below their fair intrinsic value. This investing style aims to buy undervalued shares and resell them when they increase and become fairly valued in the future. Warren Buffett is arguably one of the most famous value investors in 2022 and is considered by many to be the greatest investor of all time.
• Income Investing – Income investors, seek to invest in businesses and financial assets that generate a reliable cash flow to fuel regular payouts such as dividends or bond coupons.

What to consider before investing?

Setting appropriate investment objectives is a critical first step on an investment journey. With a clear goal in mind, investors can be savvier when selecting suitable asset classes and investing strategies.

Some examples of critical factors to consider include:

• Investment Goals – What’s the ultimate objective behind the investment?
• Risk Tolerance – How much risk is an investor willing or able to take?
• Time Horizon – How long does the investor have before wanting to realise their objective?
• Investment Accounts – Which investment account is most appropriate to achieve their investment objective?
• Costs – Investors need to clearly understand the fees involved with their investing strategy, including trading costs and fund management fees.

The risks of investing

Every investment carries some level of risk. Even when buying low-volatility stocks or government bonds, there remains an element of risk, even if it is small.

Usually, the level of risk directly correlates with the potential return. Investors seeking larger returns may be more comfortable with higher volatility investments than those seeking to protect their existing wealth. Typically risk tolerance changes over time, with more conservative investing strategies being commonly recommended by professionals as investors get older.

Risk can take many forms but is commonly referred to as one of two types:

• Market Risk – This encapsulates all the risks of investing in general and can rarely be avoided or mitigated. It includes economic instability, geopolitical disputes, trade wars, and other external factors.
• Firm-Specific Risk – This encapsulates all the risks of investing in a specific business which can be mitigated through diversification. It includes factors such as supply chain disruptions, cyber security breaches, untalented management, technological obsolesce, and many more.

The bottom line

Building an investment portfolio can lead to substantial returns in the long run. But it’s not without its risks. And a poorly constructed portfolio can end up destroying wealth rather than creating it. Investors need to always keep the balance between risk and reward in mind before committing to an investment.

This article contains general educational information only. It does not take into account the personal financial situation of the reader. Tax treatment is dependent on individual circumstances that may change in the future, and this article does not constitute any form of tax advice. Before committing to any investment decision, an investor must consider their individual financial circumstances and reach out to an independent financial advisor if necessary.

Saima Naveed does not have a position in any of the financial instruments mentioned in this article. The Money Cog does not have a position in any of the financial instruments mentioned in this article.