Investment is an essential financial activity that contributes to the expansion of business operations of a company. In addition, it is also a marker of growth in a country’s economy. Investment is usually undertaken by governments and business entities to enhance transactions and boost employment.
Investment assumes an important position in any economic and business activity. Therefore, it is necessary for students to understand the meaning of investment.
What is Investment?
The financial aspect of the term ‘investment’ has several features. First of all, investment involves the purchase of an asset for long-term financial advantages. Therefore, an individual has the option to invest money in a company’s resources. These resources are financial in nature and typically include bonds, stocks, and equities.
Investment is thus the act of channelling one’s capital to any business project or government activity. In addition, the invested funds are exposed to the money market as well. Therefore, investors are eligible to receive periodic dividends from their financial investments.
All these characteristics make investment a process to generate wealth. For instance, investors anticipate that the monetary value of an asset will increase over time. As a result, they can sell their assets after a stipulated time to gather profit.
For example, suppose that an investor channels Rs.5,000 to buy stocks at a company with a high growth performance. Therefore, after a period of time, the investor expects the value of the stocks to be Rs.6,000. Therefore, the asset that he/she has invested in experiences appreciation, making his/her investment profitable.
Investment and Consumption
Experts define investment differently from consumption. It is mainly because consumption does not create additional value for a product. Whereas, investment is subject to time constraints and usually generates returns after a point of time.
Investment meaning also includes infrastructural activities undertaken by the government. It is often seen that municipal authorities and government bodies invest in bridges, roadways, and railways to improve connectivity and infrastructure. Consequently, these organizations can increase the scale of their business processes, thus raking in higher profit. Therefore, their initial investment enables the appreciation of the value of an asset.
What are the Risk Factors in Investment?
Individuals invest only when there is an assurance of appreciation in an asset’s value. Therefore, the investment definition also includes the risk factors that investments are exposed to.
For instance, different investment instruments have distinct risk factors. However, risk and return on investment have a directly proportional relationship. When an investment option is riskier, the return on such investment or the appreciation of the assets value is higher.
On the other hand, when an investment avenue is considerably safer, investors receive lower returns. As a result, risk-prone investors tend to invest their money in risky assets for higher profit. Whereas, individuals who do not want exposure to market risks typically purchase low-risk assets. Thus, the definition of investment actively takes into account the risk factors that individuals have to deal with.
In addition, scale and volume of investment depends largely upon the return expectations of an individual. Therefore, some of the well known avenues for safe investment are land, real estate, and gold. It is because investors expect the appreciation in their value with the passage of time. As a result, when the market prices of these assets reach the highest, they can sell these off to generate profit.
What are the Types of Investment?
Investment can be classified into several categories. These types of investment options are available to individuals looking to bring about profit on their capital commitment.
However, the prevailing types of investment are as follows –
Stocks – Stocks are one of the most prominent investment avenues available in the market. Individuals invest in a publicly traded company’s stock to own a percentage of the company. Therefore, stockholders buy stocks to directly become a part of the company’s financial consequence.
For instance, when an organization gathers higher revenue in a particular business timeframe, these are passed on to stockholders as dividends. As a result, investors have the option to make profit from stocks.
However, the performance of stocks in the stock market is directly influenced by its financial performance. Therefore, investors commit their capital to the stock of a company that shows financial promise in future.
Bonds – Bonds are among the most secure investment types that have garnered an investor’s confidence. This investment option can be equated to a type of loan that investors offer to a company. In this particular case, investors are referred to as creditors.
Creditors usually have to invest a principal amount into bonds for a maturity period. After the stipulated maturity period ends, investors receive the principal amount along with the predetermined rate of interest. Therefore, individuals can appreciate the value of their investment with a secure avenue such as bonds.
In addition, the return on investment (ROI) on bonds is lower than stocks. It is because bonds are exposed to less market risks than stocks. On top of that, companies that offer bonds to creditors are under legal obligations to return the principal and interest amount after the maturity period.
Mutual funds – Financial institutions offer the option of mutual funds as one of the most popular types of investment. With this investment tool, these institutions create a pool of money with the funds collected from multiple investors. This pool of money is then offered as an aggregate investment to various companies.
As a result, the risk factor gets distributed among the companies, thus offering low risk to investors.
Since mutual funds have a diversified investment meaning and portfolio, it has emerged as a dependable investment option among several categories of investors.
Induced Investment – This type of investment covers a wide range of financial instruments. Primarily, investments that are directly influenced by an alteration in national income or rate of interest fall under induced investment.
Factors such as the cost of raw materials, changes in transaction rates and customer preferences have an impact on this kind of investment. As a result, an organization with a high profit margin becomes more likely to attract higher volume of investment from prospective investors.
Test your knowledge
Consider that an investor Mr. Rahul purchases 50 shares of Spencers on 24th May @ Rs.1,000 per share. When the price rises to Rs.1200, Mr. Rahul decides to sell 50 shares at the market price. Calculate the profit from the sale of these shares.
Let’s suppose that creditor Mr. Jones buys a bond with its principal value set at Rs.5,000 for a maturity period of 5 years. The rate of interest (i.e. coupon rate) is 6% per year. Find out the value of the bond at the end of the period.
In case you want a detailed look into the meaning of investment, do visit the official website of Vedantu.
FAQs on Investment: Meaning, Types, and Importance
1. What is the basic meaning of investment in commerce?
In commerce, an investment is the allocation of monetary resources to an asset with the expectation of generating a future income or profit. It essentially means sacrificing current consumption for future financial benefits, such as capital appreciation (an increase in the asset's value) or regular returns like interest or dividends.
2. What are the primary types of investments?
The primary types of investments available to individuals and businesses include:
- Stocks (Equities): These represent a share of ownership in a public company.
- Bonds (Fixed-Income): This is a type of loan made by an investor to a borrower, such as a corporation or government, in return for periodic interest payments.
- Mutual Funds: These are professionally managed funds that pool money from many investors to purchase a diversified portfolio of stocks, bonds, or other assets.
- Real Estate: This involves purchasing physical property with the goal of earning rental income or benefiting from price appreciation.
- Commodities: These are raw materials or primary agricultural products like gold, oil, and wheat that can be bought or sold.
3. What are the main objectives of making an investment?
The main objectives behind any investment are typically centred around financial growth and security. Key goals include:
- Capital Appreciation: To increase the market value of the initial amount invested over a period of time.
- Regular Income: To generate a steady stream of cash flow through instruments that pay dividends or interest.
- Wealth Creation: To build a significant corpus over the long term for major life goals like retirement.
- Capital Preservation: To protect the purchasing power of money from being eroded by inflation.
4. Why is investment considered important for a country's economy?
Investment is a critical driver of economic growth. It leads to capital formation, where businesses purchase new machinery, build infrastructure, and invest in technology. This process increases the country's overall productive capacity, which in turn creates new jobs, fosters innovation, boosts national income (GDP), and improves the standard of living for its citizens.
5. What is the fundamental difference between investing and speculating?
The fundamental difference lies in the level of risk, the time horizon, and the basis for the decision. Investing is generally a long-term activity based on an asset's fundamental value, with a moderate level of risk. In contrast, speculating is a short-term activity that involves taking on high risk in the hope of making a large profit from market price fluctuations, rather than the intrinsic worth of the asset.
6. How does the relationship between risk and return work in investments?
The relationship between risk and return is a core principle of finance, often called the risk-return trade-off. It states that higher potential returns on an investment are generally associated with higher risk. Safe investments, like government bonds, offer lower returns because the probability of loss is very low. Conversely, riskier assets, like stocks, must offer the potential for higher returns to compensate investors for taking on the increased chance of losing money.
7. How does an investment decision, or capital budgeting, impact a business?
An investment decision is crucial for a business's long-term success and sustainability. A wise investment in new equipment, technology, or market expansion can lead to increased production efficiency, higher revenues, and a stronger competitive position. Conversely, a poor investment decision can result in significant financial losses, wasted resources, and can severely hamper the company's ability to grow and operate effectively.
8. What key factors should a student of commerce consider before making their first investment?
Before making a first investment, a commerce student should carefully consider several factors:
- Financial Goals: Clearly define the purpose of the investment, whether it's for long-term growth or short-term needs.
- Risk Tolerance: Honestly assess how much financial risk you are comfortable and capable of taking.
- Time Horizon: Determine how long you can leave the money invested, as this influences the type of assets you should choose.
- Knowledge and Research: Never invest in something you don't understand. Thoroughly research the investment option first.
- Liquidity: Consider how easily and quickly the investment can be converted into cash without a significant loss in value.
