When we have enough money to save, we think about investment. Investment is a useful method for increasing the wealth of an individual. Investment options, performance and holdings are explained in this article and it enlightens your path if you are up to investing your money.
What is Investment?
An asset acquired to generate income or appreciation is called an investment. In terms of economy, it is defined as the purchase of goods that are not consumed present but are used in the future to generate wealth. In terms of finance, it refers to a monetary asset purchased with the idea that it will provide income in the future or will be later sold at a higher price for profit. The monetary asset can be bonds, stocks, or real estate property.
Types Of Investments
There are 4 types of investments, each with distinct characteristics, risks, and benefits. Based on personal circumstances and risk tolerance, you can think about investing in different types of assets.
Long term investors will choose this type of investment because they can withstand market ups and downs. Shares and property are types of growth investments.
Shares can help grow the value of an original investment over the medium to long term. The income can be from dividends, which are actually a portion of the company’s profit paid out its shareholders. Obviously, the price of the share might fall below the price you paid for them. Prices can be volatile every day and are the best option for long term investors. Shares are also known as equities and it is considered as one of the riskiest types of investment. Bonds, index funds, and mutual funds can also be a growth investments.
The price of the houses, buildings, and other properties you have might rise substantially over a medium to long term period. The price of the property can also fall in value and carries the risk of losses. You can directly buy the property or indirectly buy it through a property investment fund.
They concentrate more on generating income rather than growth. The risk is lower than the growth investments.
Bank accounts, high-interest savings accounts, and term deposits come under cash investments. The return for this is lower than all the investment types. There is no chance of capital growth in this type of investment. They play an important role in protecting the wealth of an individual and deliver normal income. There are risks in an investment portfolio and it reduces it.
Bonds are the best-fixed interest investments. The companies or government borrow money from the investors and the rate of interest is given in return. They offer low potential returns and the risks are lower than shares or property. Like cash, they can be sold quickly.
Business Investment Types
When businesses become successful and the owners might want to invest their profit by reinvesting into the business or put elsewhere to grow their money. They can select the best decisions about how to maximize your growth opportunities. You can find some of the best business investment types.
The business can be expanded by adding new products or services or purchasing an existing business. In a manufacturing business, you might purchase an additional product that fits into your line. If you don’t want that product to interfere with current operations, you can manufacture the product where it’s currently being produced. Sometimes, you can expand the business by buying another company and merging it into yours to expand your locations, customers, and distribution. You can also purchase a competitor business and shut it down or add its unique technology to your product.
Direct investments include purchasing memory, software, computers, trucks, or any assets. They help to lower your costs or increase production, improving your profits. They don’t generate interest or increase sales.
Investing in real estate is also a good idea. Some property might depreciate, providing you with a tax deduction. Some properties might increase in value.
Investing your profits into the marketing department in areas such as conducting market research, holding focus groups, customer surveys, funding product research, and development, building distribution channels, and creating and maintaining a brand is a good idea. It provides potential long-term payback through increased sales.
Improve your workforce and invest in training to improve job-specific skills and general management competencies. Update your office with the latest technologies to increase productivity and efficiency. Good compensation and benefits should be given to the employees to help you in recruiting and retention.
The investment cost is defined as the amount of money spent on the investment. It is important to understand about costs before investing. Here is some information about the different types of investments.
Types of Investing Costs
Mutual funds are one of the common investment charges which is called an expense ratio. It measures the costs needed to manage the fund that is expressed as a percentage. It is calculated annually based on the total assets invested in the fund. The high expense ratio has two problems. The first problem is that a higher portion of the money will be added to the management team. Second, when the management team charges more money, it is difficult to match the fund or beat the market’s performance. Expense ratios might drain some assets.
Marketing costs: The fees are for marketing or distribution costs. To promote a fund to other potential investors, you should pay the managers.
Annual and Custodian Fees: Annual fees are mostly low. But, every dollar adds up. Custodian fees are applied to retirement accounts and cover costs are given for fulfilling IRS reporting regulations. You are expected to pay from $10 to $50 per year.
Other costs: Purchase and redemption fees are included in some mutual funds.
Load and Commission: When you buy shares, a front-end load is paid as a fee. When selling those shares, a back-end load is a fee. Commissions are paid to the broker for their services.
How Investment Returns Are Applied?
When we invest in something, we expect profit in return. Return On Investment(ROI) plays an important role in calculating profit.
What Is Return On Investment?
A performance measure utilized to evaluate the efficiency of an investment is called Return On Investment(ROI). You can compare the number of investments. It can directly measure the return amount on an investment, relative to the investment’s cost. ROI is calculated by dividing the benefit of an investment with the cost of the investment.
ROI=Cost of Investment-Current Value of Investment/Cost of Investment
When ROI is measured in percentage, it can be easily compared with returns from other investments.
Understanding Return On Investment(ROI)
ROI is a popular term because of its simplicity. ROI can be applied to stock investment when a company expects on expanding a factory, or real estate transaction. The calculation is easy to calculate and simple to interpret its wide range of applications. If the ROI of an investment is net positive, then it is a good sign. Many investments have higher ROIs which helps the investors eliminate or select the best options. Negative ROIs imply net loss and investors should avoid it. For example, suppose Will invested $1000 in Coca-Cola, in 2018 and one year later, sold his shares for a total of $1200. The profit is ($1,200 – $1,000 = $200). For calculating ROI, the profit is divided by the investment cost ($200/$1,000). The ROI is 20 percent. He can compare this ROI with the other company ROIs he invested in.
Developments in ROI
Some businesses and investors developed a new form of the ROI metric called Social Return On Investment(SROI). It helps to understand the value proposition of ESG(Environmental Social and Governance) criteria in socially responsible investing(SRI) practices. A company might attempt to recycle water or replace its lighting with LED bulbs. This type of immediate cost may negatively impact traditional ROI. It is a net benefit to society and the environment and it could lead to a positive SROI. In marketing, ROI is based on advertising or marketing campaigns. Learning ROI is based on the amount of information learned and retained as a return on education or skills training.
Different Ways To Measure Investment Returns
You can find the different methods used to measure investment returns below:
The total amount you gain on your principal investment is called absolute returns. It is rarely used for computing investment returns because of a lack of time horizon. For example, if your investment is Rs. 1 lakh on fixed deposit and after 5 years you get Rs 1.5 lakh. The absolute return for this principal investment is 50%.
The annualized returns give a better idea of investment returns. It includes the time value of money. If your investment grows from ₹1 lakh to ₹2.5 lakh in 5 years, then the absolute returns are 150%. The annualized returns for this investment is 20.11%
CAGR(Compound Annual Growth Rate)
CAGR is used to calculate annualized returns. It is applied on a yearly basis because it helps an investment grow from the initial value to the final value. Over a particular time horizon, compound interest is calculated. For example, If you want to grow an investment from ₹1 lakh to ₹2 lakh, calculate the compound annual growth rate to find the interest rate. CAGR for this investment is 14.87%.
The difference between the final value and the initial value of the investment is called price returns. Only, the capital appreciation of investment is taken into account. It does not involve dividend returns or interest income. For example, if the Net Asset Value(NAV) for any mutual fund investment is Rs 10( buy units of the fund), then the NAV of the fund is Rs 11 after a year. The price return value for this investment is 10%.
In total returns, the dividends earned are invested upon declaration. It takes price returns, income generated through dividend distribution, and interest income into consideration.
Advantages of Return On Investment(ROI)
The biggest advantage of ROI is that it is relatively easy to calculate and understand it. It is a standard, universal measure of profitability. It cannot be misunderstood or
Disadvantages of Return On Investment(ROI)
One disadvantages of the ROI measurement is that the holding period of an investment is not taken into account. It can be an issue when comparing investment alternatives. If the potential returns are higher, then the risks are higher. The small-cap stocks have higher returns than large-cap stocks. The risks must be taken into consideration because the result may be different from the expected result. ROU figures can have an error if all the costs are not included in the calculation. Eg, when evaluating the ROIs on a piece of real estate, expenses such as mortgage interest, property taxes, insurance, and all costs of maintenance should be included. They can rule out a large amount from the expected ROI. ROI figure can be grossly overstated without all the expenses in the calculation.
Some investment types carry tax advantages. For example, investments for objectives like retirement plans, college saving plans and certain type of life insurance policies may reduce the tax for a year. The profit you earn from investments can be paid as capital gain taxes.
You have to decide what you are saving for. It can be for retirement, emergency fund, or for a dream vacation. Your objectives will help you to make decisions based on the amount of risk you are willing to take and the types of investment products. You can select a low-risk investment for an emergency fund. You can make investments for some special circumstances like helping a child with a disability, pursue philanthropic interests, or support a blended family. You can make a financial plan based on the information from this article. Are you planning to invest to increase the wealth, or any specific objectives, plan it well based on the risks and other factors.