Before starting with the deep discussion on investing, we must know in a broad sense about investment. Investing in various types of assets is an interesting activity that attracts people from all walks of life irrespective of their occupation, economic status, education and family background. When a person has more money than he requires for current consumption, he would be coined as a potential investor. The investor who is having extra cash could invest it in securities or in any other assets like or gold or real estate or could simply deposit it in his bank account. The companies that have extra income may like to invest their money in the extension of the existing firm or undertake new venture. All of these activities in a broader sense mean investment. Now, lets define investment.
How do you define investment?
We can define investment as the process of, “sacrificing something now for the prospect of gaining something later”. So, the definition implies that we have four dimensions to an investment time, today’s sacrifice and prospective gain.
Can we think of Some Transactions, which will Qualify as “Investments” as per Our Definition!
- In order to settle down, a young couple buys a house for Rs.3 lakhs in Bangalore.
- A wealthy farmer pays Rs l lakh for a piece of land in his village.
- A cricket fan bets Rs..100 on the outcome of a test match in England.
- A government officer buys ‘units’ of Unit Trust of India worth Rs 4,000.
- A college professor buys, in anticipation of good return, 100 shares of Reliance Industries Ltd. for Rs.24, 000
- A lady clerk deposits Rs.5, 000 in a Post Office Savings Account.
- Based on the rumor that it would be a. hot issue in the market in no distant future, our friend John invests all his savings in the newly floated share issue of Fraternity Electronics Ltd., a company intending to manufacture audio and video magnetic tapes to start with, and cine sound tapes at a later stage.
Is there any Common Feature to all these Investments?
A common feature of all these transactions is that something is sacrificed now for the prospects of gaining something later. For example, the wealthy farmer in transaction 2 sacrifices Rs1 lakh now for the prospects of crop income later. The lady clerk in transaction 6 sacrifices Rs.5,000 now for the prospect of getting a larger amount later due to interest earned on the savings account. Thus, in a broad sense, all these seven transactions qualify as investment.
How is Investment Different from Speculation?
We know that investment means sacrificing or committing some money today in anticipation of a financial return later. The investor indulges in a bit of speculation involved in all investment decisions. It does not follow through that all investments are all speculative by nature. Genuine investments are carefully thought out decisions. They involve only calculated risks. The expected return is consistent with the underlying risk of the investment.
A genuine investor is risk averse and usually has a long-term prospective in mind. The government officer’s investment in the units of UTI, the college professor’s Reliance stockholding , the lady clerk’s Post Office Savings Deposit, all may be regarded as genuine investments. Each person seems to have made carefully thought out decision and each has only calculated risk. Speculative investments on the other hand are not carefully thought out decisions. They are based on rumors, hot tips, inside dopes and often simply on hunches. The risk assumed is disproportionate to the return expected from speculation. The intention is to profit from short-term market fluctuations. In other words, a speculator is relatively less risk averse and has a short-term perspective for investment.
A genuine investor is interested in a good rate of return, earned on a rather consistent basis for a relatively long period of time. The speculator, on the other hand, seeks opportunities promising very large returns, earned rather quickly. In this process, he assumes a risk that is disproportionate to the anticipated return.
Thus, from the discussion we cannot infer that there exists a demarcation between stocks and speculative stocks. The same stock can be purchased as a speculation or as investment, depending on the motive of the purchaser. For example, the decision of the professor to invest in the stock of Reliance industries is considered as a genuine investment because he seems to be interested in a regular dividend income and prospects of long-term capital appreciation. However, if another person buys the same stock with the anticipation that the share price is likely to rise, his decision will be characterized as speculation.