There are several types of investment. You can put your funds in real estate, goods, commodities, or securities. Companies often invest in their development by buying other companies, building factories, purchasing machines, etc. In all these cases, an individual or a company sets part of its money aside, instead of consuming it outright, with the aim of reaping uncertain profit from this investment.
Investing in the world of finance
In the world of finance, investment means a purchase of a financial asset (e.g. stock, bond, investment certificate, etc.) with the intention to gain additional income – either in the form of a regularly paid out remuneration from an asset (e.g. dividends in case of stocks, coupons in case of coupon bonds, etc.), or by selling the asset for a higher price after a certain period of time.
Warren Buffett, one of the most famous and well-known investors of our time, defines two basic character types when assessing approaches to investing: investors and speculators. Many people mistakenly confuse these terms but, in fact, these are two very different groups of capital market participants.
An investor is interested in holding on to his/her purchased investment instrument for a much longer period of time. That is also one of the reasons why he/she devotes more time and effort to analyze suitable investment opportunities, study them carefully and compare them. The most prominent object of the inquiry is the so-called company fundamentals (sales, margins, costs, debt…) which are necessary in order to determine the fair value of a company.
A speculator, on the other hand, has a much shorter time horizon as far as his/her investments are concerned. Company fundamentals are of no interest to him/her. For most of the time his/her opinions and decisions are based on technical analysis, a study of past market data, primarily price and volume. A decision to buy or not to buy a given investment instrument depends on the assessment of relations between price developments and traded volumes, together with the study of graphic formations created by price developments of an asset.
Stocks, mutual funds, and other securities represent investments with potentially high yields. Unlike ordinary savings accounts, where yields usually do not make up even for inflation, securities allow you to increase the value of your savings. Investing in them is easy and has a lot of advantages:
Effectiveness – historically, investments in stocks are an effective way of wealth appreciation.
Store of value – by investing, you protect your funds from inflation.
Dividends – represent your share of the company’s profit.
Tax incentive – capital gains from investments held longer than 3 years are exempt from tax.
However, unlike an ordinary savings account, investing in securities carries certain risks (specific for each asset class) which can cause a loss of part of or even all the invested funds. One of the reasons for such loss can be a decline in the asset price on the market. Especially on stock markets, volatile and short-term fluctuations in individual titles are commonplace. A long time horizon and, most of all, portfolio diversification (a strategy of investing in various asset classes, e.g. according to regions, sectors, time horizons) can significantly reduce such risk.
How to invest
Each asset class can be assessed in terms of an average (expected) rate of return, risk, and liquidity. Exactly these are the criteria an investor should apply when choosing the structure of his/her portfolio.
Before you start trading on the capital market, you should know exactly how much funds do you need to cover the costs of running your household. Then you can start creating your own investment strategy. You should have a clear idea of whether you want to focus on long-, mid-, or short-term trades, what kind of gains you expect and what risks are you prepared to expose yourself to.
Types of risk associated with investments:
Market risk – includes all kinds of events: political turmoil, natural disasters, etc.
Inflation risk – inflation undermines the purchasing power of an investment. Therefore, it is necessary to take into account the yield adjusted for a change in the price level (real yield), not only the nominal yield.
Credit risk – represents the possibility that the issuer of a bond will be unable to pay back the principal, i.e. the nominal value of the bond.
Liquidity risk – can arise when an investor wants to sell his/her portfolio, but cannot find a buyer for it.
Interest risk – as interest rates rise, the price of shares or bonds on the market declines, which adversely affects the value of investments.
Currency risk – depends on the currency in which a trade was executed. If this currency weakens against the home currency, the investment yield will take a hit too.
What to choose?
The easiest way of investing in securities is through a licensed broker who will provide you with access to capital markets across the globe.
The overwhelming majority of investors – natural persons have a wide range of investments choices at their disposal.
More information about products can be found in the Products and markets section.
How to succeed?
Before choosing from a broad range of investment products, it is necessary to consider your priorities and risk associated with various types of investments. Section How To Succeed contains eight general tips (not only) for beginners which should help you enter the financial market with greater confidence.
Things to watch for
An inexperienced investor, who is new to capital markets, should exercise great caution when selecting his/her broker. He should be advised to compare well-established companies of stature, tested by the time and turmoil of capital markets. Of great importance also is the credibility of a broker, underpinned by a long history of providing quality services and by a vigilant separation of client’s accounts from those of the company. It is also considered impertinent to push an investor into a trade. Obtrusive phone calls with the aim of cajoling an investor into a “guaranteed” investment are surely not a sign of respectability.
Apart from risk, liquidity, and the expected rate of return, it is necessary to consider some other aspects of investing.
Tax liability – gains from securities are taxed.
Mathematics – individual parts of gains from securities must be added up – capital gain (selling price is higher than the purchase price), dividends, coupons, etc.
Unpredictable markets – unfortunately, markets sometimes succumb to mass hysteria, instead of following the logic.
How to analyze investment opportunities
For an investor trying to guess future market developments, there are, in theory, three basic approaches to choosing interesting, e.g. undervalued, stocks, or to the right timing of their purchase or sale: fundamental analysis, technical analysis, and psychological analysis.
Before analyzing an instrument, however, it is necessary to decide on investment style, time horizon, and investment strategy. Part of the analysis should also be devoted to considering what role risk and liquidity play subjectively for an investor in relation to the expected rate of return.
The point of fundamental analysis is to find an agreeable, right stock price – its intrinsic value. To that end, we try to find and study all the relevant factors influencing a given stock. These are divided into three categories: global, sectoral, and individual corporate.
The basic assumption of technical analysis does not require including all the relevant information into recent price developments on the market but is concerned with the market reaction to this information (which allows stocks to be incorrectly valued) and with recurring graphic patterns, or formations in the price developments. Technical analysts, who assume repetitive human reactions, take these past formations and try to project them in the expected future.
The psychological approach, unlike the first two approaches, is not focused on the asset itself but on the human psyche which is the main driver of price developments (according to this theory). The central question raised by psychological analysis is the way the investor’s behavior and judgment influence the stock market.