Types of investments
The term "investment" is used differently in economics and in finance. Economists refer to a real investment (such as a machine or a house), while financial economists refer to a financial asset, such as money that is put into a bank or the market, which may then be used to buy a real asset.
The investment decision (also known as capital budgeting) is one of the fundamental decisions of business management: managers determine the assets that the business enterprise obtains. These assets may be physical (such as buildings or machinery), intangible (such as patents, software, goodwill), or financial (see below). The manager must assess whether the net present value of the investment to the enterprise is positive; the net present value is calculated using the enterprise's marginal cost of capital.
A business might invest with the goal of making profit. These are marketable securities or passive investment. It might also invest with the goal of controlling or influencing the operation of the second company, the investee. These are called intercorporate, long-term and strategic investments. Hence, a company can have none, some or total control over the investee's strategic, operating, investing and financing decisions. One can control a company by owning over 50% ownership, or have the ability to elect a majority of the Board of Directors.
In economics, investment is the production per unit time of goods which are not consumed but are to be used for future production. Examples include tangibles (such as building a railroad or factory) and intangibles (such as a year of schooling or on-the-job training). In measures of national income and output, gross investment I is also a component of Gross domestic product (GDP), given in the formula GDP = C + I + G + NX, where C is consumption, G is government spending, and NX is net exports. Thus investment is everything that remains of production after consumption, government spending, and exports are subtracted.
I is divided into non-residential investment (such as factories) and residential investment (new houses). Net investment deducts depreciation from gross investment. It is the value of the net increase in the capital stock per year.
Investment, as production over a period of time ("per year"), is not capital. The time dimension of investment makes it a flow. By contrast, capital is a stock, that is, an accumulation measurable at a point in time (say December 31st).
Investment is often modeled as a function of Income and Interest rates, given by the relation I = f(Y, r). An increase in income encourages higher investment, whereas a higher interest rate may discourage investment as it becomes more costly to borrow money. Even if a firm chooses to use its own funds in an investment, the interest rate represents an opportunity cost of investing those funds rather than loaning them out for interest.
In finance, investment=cost of capital, like buying securities or other monetary or paper (financial) assets in the money markets or capital markets, or in fairly liquid real assets, such as gold, real estate, or collectibles. Valuation is the method for assessing whether a potential investment is worth its price. Returns on investments will follow the risk-return spectrum.
Types of financial investments include shares, other equity investment, and bonds (including bonds denominated in foreign currencies). These financial assets are then expected to provide income or positive future cash flows, and may increase or decrease in value giving the investor capital gains or losses.
Trades in contingent claims or derivative securities do not necessarily have future positive expected cash flows, and so are not considered assets, or strictly speaking, securities or investments. Nevertheless, since their cash flows are closely related to (or derived from) those of specific securities, they are often studied as or treated as investments.
Investments are often made indirectly through intermediaries, such as banks, mutual funds, pension funds, insurance companies, collective investment schemes, and investment clubs. Though their legal and procedural details differ, an intermediary generally makes an investment using money from many individuals, each of whom receives a claim on the intermediary.
Within personal finance, money used to purchase shares, put in a collective investment scheme or used to buy any asset where there is an element of capital risk is deemed an investment. Saving within personal finance refers to money put aside, normally on a regular basis. This distinction is important, as investment risk can cause a capital loss when an investment is realized, unlike saving(s) where the more limited risk is cash devaluing due to inflation.
In many instances the terms saving and investment are used interchangeably, which confuses this distinction. For example many deposit accounts are labeled as investment accounts by banks for marketing purposes. Whether an asset is a saving(s) or an investment depends on where the money is invested: if it is cash then it is savings, if its value can fluctuate then it is investment.
In real estate, investment is money used to purchase property for the sole purpose of holding or leasing for income and where there is an element of capital risk. Unlike other economic or financial investment, real estate is purchased. The seller is also called a Vendor and normally the purchaser is called a Buyer.
Residential real estate
The most common form of real estate investment as it includes the property purchased as other people's houses. In many cases the Buyer does not have the full purchase price for a property and must engage a lender such as a Bank, Finance company or Private Lender. Herein the lender is the investor as only the lender stands to gain returns from it. Different countries have their individual normal lending levels, but usually they will fall into the range of 70-90% of the purchase price. Against other types of real estate, residential real estate is the least risky.
Commercial real estate
Commercial real estate is the owning of a small building or large warehouse a company rents from so that it can conduct its business. Due to the higher risk of Commercial real estate, lending rates of banks and other lenders are lower and often fall in the range of 50-70%.