Investing is one of the most popular forms of saving, whereby people plow all or part of their cash into financial assets such as stocks, bonds, and other securities. Investing funds allows people to earn money through speculation. The idea is that the return on a given investment fund can be greater than the cost for an investor to make a profit.
Investment usually involves different aspects of risk and reward.
1. Speculating
Investing is essentially speculation, where investors assume that the value of some asset will go up over time. For example, if an investor buys shares in a company at $1 each, and the price increases to $4 each, then the investor can sell their shares for $4 each and earn a profit.
a) Risk Awareness
Speculation involves calculation, risk awareness, and sound financial knowledge. Speculators may lose money, but they know this in advance and try to minimize their risks while considering the ever-changing stock market.
b) Risk Management
The risk management process is key to success as a speculator. How a speculator manages risk depends on the specific investment, but the goal is always to maximize profit and minimize loss.
A good speculator’s long-term record should preserve enough credibility and avoid damaging incidents such as insider trading or insider threats that would damage reputation in a short period of time, which could have an affect on future success.
2. Manipulating
Investing is essentially manipulation. Investors manipulate their investments by trying to foresee future trends and events, such as company earnings, interest rates, and upcoming elections, which allow them to make more informed decisions about what companies or products to buy or sell.
a) Leading Indicators
This means that the signs that lead to the momentum in an asset are used as indicators. For example, one leading indicator for a stock can be when a company reports earnings.
The leading indicators are crucial investment tools because they provide a basis for making easy and quick decisions.
b) Technical Indicators
Technical indicators on how an asset will perform in the future are used. These include momentum and cycles. Momentum is when stocks react immediately after companies announce their earnings, decreasing further; this is known as follow-through selling.
3. Diversifying
To better reduce risk and increase profits, it’s often a good idea to diversify. This can be done by choosing individual stocks from different sectors or industries. Alternatively, investors can diversify by buying a mutual fund with stocks across many other industries.
a) Sector Diversification
An investor can buy a mutual fund with stocks from across many different sectors. This way, they are less susceptible to catastrophic losses. If an investor buys a mutual fund with money in stocks in 6 other sectors, then if five sectors were to decrease dramatically, only 1 of the sectors needs to increase to make up for the loss in the different sectors.
b) Industry Diversification
Investors sometimes choose mutual funds that offer broad diversification within an industry. Since most individual stocks overlap with similar initiatives, this can help reduce risk.
c) Diversification Between Stocks and Bonds
An investor can also diversify by buying both stocks and bonds. This is called asset allocation. An asset allocation limits risk by having investors own companies in different industries and bonds from corporations or governments.
4. Liquidity
Liquidity is the ability of an individual to purchase and sell an asset without changing the underlying price. Liquidity refers to whether a given asset can be bought or sold at any time to access its profit potential.
a) Buying Liquidity
When an investor can purchase stocks easily, then that is called buying liquidity. The less time it takes to acquire an asset and the more liquid it is, the better the liquidity of that asset.
If an investor wants to buy a stock that requires them to wait two days before buying, that stock will be very illiquid. If an investor has to wait seven days before they can buy a stock, then that stock will be relatively more illiquid.
b) Selling Liquidity
Investors should also consider how easily an asset can be sold. This refers back to the concept of potential returns on those assets. The easiest way for an investor to access liquidity is by buying and holding an index fund containing many different types of stocks from other companies.
Investment is one of the most popular forms of saving, whereby people plow all or part of their cash into financial assets such as stocks and mutual funds. Investing funds allows people to earn money through speculation. The idea is that the return on a given investment fund can be greater than the cost for an investor to make a profit.