A financial investment is an asset that you put money into with the hope that it will grow or appreciate into a more significant sum of money. You can later sell it at a higher price or earn money on it while you own it. You may be looking to grow something over the next year, such as saving up for a car, or over the next 30-35 years, such as saving for retirement.
How much time you have on your side is often essential to consider when making a financial investment.
The more time you have, the more risk you can usually take. The more risk you take, the more potential for making more money!
Let’s look at a few key terms worth knowing regarding financial investments.
Equity represents the claims of the company’s owners on the company’s assets.
From an accounting standpoint, equity is calculated as total assets minus total liabilities. All company assets must be “owed” to and “owned by” someone. They are either owed to other parties (in the form of liabilities) or the company’s owners (in the form of equity).
The vehicle through which an individual becomes an owner of a company is by purchasing the shares of that company. Each share represents an ownership interest in a company.
Every company has equity, though the form of equity could be different depending on the ownership structure of a company. In most companies, there are two major types of shares – common and preferred.
Bonds are a means of financing in which a company borrows money by selling bond securities to investors.
A bond represents a loan to the issuing company. By selling a bond, a company promises to pay the investor a specific interest every period until the bond matures. At maturity, the company promises to pay the face amount of the bond to an investor. The interest paid each period, the face (or maturity) value, and the maturity date, are all printed on the face of the bond itself.
A bond would have a par value – its stated amount (also known as; face value), a stated interest rate, maturity date, and information about when interest is paid.
The maturity date is the date on which the issuer will “retire” the bond by paying the face amount of the bond to the bondholder.
Mutual funds are an investment tool that pools money from several investors and invests it in company stocks, bonds, government instruments, etc., to generate a profit for investors.
This profit may be paid out as dividends to investors (dividend plans) or reinvested by the fund for capital appreciation (growth plan).
There are many different types of mutual funds based on various features. For example, most mutual funds try to diversify their investments into as many other companies and industries as possible. On the other hand, some invest in only specific industries and sectors of an economy.
Some funds aim for high-risk-high-reward strategies, while some opt for low-risk-regular-income plans. There’s a huge variety of funds to choose from, and many Asset Management Companies (AMCs), also known as fund houses, offer excellent schemes for all investors. In addition, banks and financial distributors sell mutual funds.
Different Types of Mutual Funds
- Equity Fund.
- Debt Fund.
- Balanced Fund.
- Tax Saving Fund, etc.
Cash and Cash Equivalents
Cash and cash equivalents (CCE) are the most liquid investments.
An investment typically counts as a cash equivalent with a short maturity period of 90 days or less.
Cash includes legal tender, bills, coins received but not deposited, checking, and savings accounts.
Cash equivalents are any short-term investment securities with 90 days or fewer maturity periods. These include bank certificates of deposit, banker’s acceptances, treasury bills, commercial paper, and other money market instruments.
A life insurance plan is a contract with an insurance company. In an insurance plan, in exchange for premium payments, an insurance company provides a lump-sum payment, known as a death or maturity benefit, to beneficiaries upon the insured’s death or policy maturity.
Typically, life insurance is chosen based on the financial needs and goals of the policy owner.
Term life insurance generally protects for a set period, while permanent insurance, such as whole and universal life, provides lifetime coverage.
Insurance policies like whole life, endowment, and Unit Linked Insurance plan provide insurance and investment features. Although investment return from these types of policies could be lesser than other investment options, they provide certain benefits in the form of tax that could make them an attractive investment option.
A derivative is an instrument whose value is derived from the value of one or more underlying, and this could be commodities, precious metals, currency, bonds, stocks, stocks indices, etc. The four most common derivative instruments are Forwards, Futures, Options, and Swaps.
The value of the underlying assets changes frequently.
For example, a stock’s value may rise or fall, the exchange rate of a pair of currencies may change, indices may fluctuate, and commodity prices may increase or decrease. These changes can help an investor to make a profit. However, it could also cause losses. This is where derivatives come in handy. It could help you make additional profits by correctly guessing the future price, or it could act as a hedging tool that protects from losses in the spot market, where the underlying assets are traded.
Types of Derivatives
Forwards and Futures
These are financial contracts obligate a contract buyer to purchase or sell an asset at a pre-agreed price on a specified future date. Both forwards and futures are essentially the same. However, forwards are more flexible because the parties can customize a contract in quantity, date, price, etc. On the other hand, futures are standardized contracts traded at exchanges. Hence, contract specifications of Futures will be identical and can’t be customized.
In both forwards and futures, there is an obligation on buyers and sellers to fulfill the terms of the contract.
Options provide the buyer of the contract the right and no obligation to purchase or sell the underlying asset at a predetermined price. Based on the Options type, the buyer can exercise the Option on the maturity date (European Options) or any date before the maturity (American Options).
Swaps are derivative contracts that allow the exchange of cash flows between two parties. The swaps usually involve the sale of a fixed cash flow for a floating cash flow. The most popular types of swaps are interest rate swaps.
Conclusion: Financial Investment for Growth and Future
A financial investment is an asset that you put money into with the hope that it will grow or appreciate into a more significant sum of money. A few of the most common financial investments are CDs and bonds, which pay interest to the owners. A person can also make financial investments in stocks and mutual funds, which can appreciate and pay dividends. These are often held in individual and company retirement accounts. Other alternative investments are real estate and gold, which can appreciate over time. These two investments require a little more advanced investing knowledge but can be a great way to diversify your portfolio.