Its-YOUR-money looks at Investment Basics
What is an investment?
An investment is simply a way of obtaining cash in the future in return for handing over cash today.
When we save or invest we are setting aside cash for the future instead of spending it today. But when we talk about saving, we usually mean putting our cash in the bank or even under the bed. It is still cash. We can count it if it’s under the bed, or look at our bank or building society statement to see how much we have.
Investment means using our spare cash to buy some sort of asset such as property, shares, antiques, paintings, gold, classic cars, or even fine wines. We expect these assets to provide us with cash at some time in the future in return for us buying them now. In fact the cash we receive is called the return on our investment. We might think we can sell an investment asset for more than we paid for it, and we might also expect to receive cash whilst we own it. For example, if we buy a property to let out, we expect to receive a rent each month as long as we own it, as well as getting cash if we sell it sometime in the future. Stocks and shares usually (but not always) pay some form of regular dividend.
Saving v. investing: the question of risk
Investments are often thought of as being risky. Every advertisement for an investment product carries a wealth warning. ‘Past performance isn't a guide to the future’ and ‘The price of this investment can down as well as up’. It is right that everyone should understand that there are risks associated with investing, but there are risks attached to savings too. We will be talking a lot more about risk, but meanwhile keep in mind that inflation is the biggest risk to our savings. The longer we keep our money in savings accounts the less it will buy when we draw it out.
There is also the risk, albeit a very small one, that a bank or building society will go bust. There is some protection for consumers in that situation (see above), but it may not apply to offshore banks and the amount that is protected is quite low.
Investing is risky in the short term because the market price of whatever assets you buy is volatile, and there isn’t time for that to be cancelled out by any income that the assets bring in. Long term, assets that generate income become less risky because more of the total returns come from income instead of capital. And as time goes on, the effect of inflation and economic growth also offset occasional falls in market prices. However, it is also very important to reduce the risks of any particular investment going seriously wrong. We will be looking into that later.
In simple terms, the risks of saving v. investing are as follows:
Saving: pretty safe in the short term, but exposed to inflation over time
Investing: risky short term, but generally safer in the long run.
Let's look at bit deeper at some of the main types of investment.