30 Kasım 2012 Cuma

What is an Investment?

Investment comes from the root “to invest”. This word is derived from a root which means “to clothe in” or “to clothe with”. This might be seen strange but we know that the suitable investment of capital clothes it with authority and with power to work for and bring gain to its owner.[1]

We also know that to invest means to spend money on something from which a return or profit is expected. A clear distinction needs to be made between “physical’ investment – e.g. the purchase and installation of machinery or other fixed assets – and “financial’ investment – e.g. the purchase of shares.[2]

According to a dictionary definition, investment is: [3]  

The act of putting money, effort, time, etc. into something to make a profit or get an advantage or the money, effort, time, etc. used to do this.”

The investments can be called as good or bad depending on the earnings or their utility. An investment is said to be perfect if:[4]
  • It is easily and speedily bought and sold with low transaction costs
  • It produces an income in order to battle against inflation
  • It is homogenous and divisible
  • It is fully documented
  • There is demand
  • It requires minimal management
It is not likely to be subject to the interference of the government.

The investments can be categorized under different classes. One of these classes is the maturity based classification. The maturities; short, medium or long term depend on the stability of the economy:
  • Short term investments: The Investment maturity is not longer than 5 years.
  • Medium term investments: The Investment maturity is not longer than 15 years.
  • Long term investments: The Investment maturity is longer than 15 years. For example, a real estate investment is usually a long term investment.
  • One way option stock: This is undated, hence there is no maturity.
 Another class might be the asset based classification. These are as follows:
  • Short term deposits: The simplest kind of short term deposit investment is a savings account. Returns are low compared to other investments but returns are guaranteed by the bank. The customer can withdraw part or all of his or her money whenever he or she wants. This makes them ideal for short term savings goals or as a place to keep the customers’ emergency fund. There are also time deposit accounts which are short in terms of maturity but the money is locked for a specific period of time.
  • Bonds: A bond is a debt certificate issued by a government, municipality or a company. This is usually issued in order to finance the debt of the government. The investor gives them money for a certain period and they promise to pay a certain interest rate and the capital to the investor at the maturity. Bonds lock money away for a set period of time but they can sometimes be traded in the secondary markets.
  • Property: The investor may invest money on a property or any kind of tradable good in order to make speculation. They intend to make money out of this business. The property may not provide big cash flows but it might appreciate and when the investor sells it he or she gains more money. The property ownership is a cultural and traditional activity and therefore many people living in different lands of the world try to own one house in order not to pay rent and live with the landlord problems. In Turkey, 68% of the people are living in their own house.[5] The figure is 70% in Australia.[6]
  • Shares: By investing in shares in a public company listed on a stock exchange the investor gets the right to share in the future income and value of that company. The return can come in two ways:
    • Dividends paid out of the profits made by the company.
    • Capital gains made because the customer is able at some time to sell the shares for more than he or she has paid. Gains may reflect the fact that the company has grown or improved its performance or that the investment community sees that it has improved future prospects.
An investment can be also categorized subject to its risk. An investment basically has two objectives. One of them is the risk objective the other one is the return objective. According to the risk objective the following questions should be answered by the investor:[7]
  • How do I measure risk?
  • What is the investor’s willingness to take risk?
  • What is the investor’s ability to take risk?

[1] Samuel Orrick Rice, Fundamentals of Investment, US, Ayer Publishing, 1975, p.3.
[2] Department for International Development UK, “Background Briefing”, Trade Matters, September 2001, p.1.
[3] Cambridge Dictionary, “Investment”, http://dictionary.cambridge.org/define.asp?key=41840&dict=CALD 
[4] Douglas Scarrett, Property Valuation: the Five Methods, US, Taylor & Francis, 1990, p.20.
[6] Peter Cerexhe, Smarter Property Investment: Ways to Make More out of Residential Property Investment, US, Allen & Unwin, 2008, p.3.
[7] John L. Maginn, Managing Investment Portfolios: A Dynamic Process, US, John Wiley and Sons, 2007, p.11-12.

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