Definition of Investment

Introduction

Investment is the employment of funds on assets with the aim of earning income or capital appreciation Investment has two attributes namely time and risk. Present consumption is sacrificed to get a return in the future. The sacrifice that has to be borne is certain but the return in the future may be uncertain. This attribute of investment indicates the risk factor. The risk is undertaken with a view to reap some return from the investment. For a layman, investment means some monetary commitment. A person’s commitment to buy a flat or a house for his personal use may be an investment from his point of view. This cannot be considered as an actual investment as it involves sacrifice but does not yield any financial return.

To the economist, investment is the net addition made to the nation’s capital stock that consists of goods and services that are used in the production process. A net addition to the capital stock means an increase in the buildings, equipments or inventories. These capital stocks are used to produce other goods and services.

Financial investment is the allocation of money of assets that are expected to yield some gain over a period of time. It is an exchange of financial claims such as stocks and bonds for money. They are expected to yield returns and experience capital growth over the years.

The financial and economic meanings are related to each other because the savings of the individual flow into the capital market as financial investments, to be used in economic investment. Even though they are related to each other, we are concerned only about the financial investment made on securities.

Thus, investment may be defined as “a commitment of funds made in the expectation of some positive rate of return”. Expectation of return is an essential element of investment.

Since the return is expected to be realized in future, there is a possibility that the return actually realized is lower than the return expected to be realized. This possibility of variation in the actual return is known as investment risk. Thus, every investment involves return and risk.

Characteristics of Investment

All investments are characterized by certain features. Let us analyse these characteristic features of investment.

Return

All investments are characterized by the expectation of a return. In fact, investments are made with the primary objective of deriving a return. The return may be received in the form of yield plus capital appreciation.

The difference between the sale price and the purchase price is capital appreciation. The dividend or interest received from the investment is the yield. Different types of investments promise different rates of return. The return from an investment depends upon the nature of the investment, the maturity period and a host of other factors.

Risk

Risk is inherent in any investment. This risk may relate to loss of capital, delay in repayment of capital, non-payment of interest, or variability of returns. While some investments like government securities and bank deposits are almost riskless, others are more risky.

The risk of an investment depends on the following factors.

The longer the maturity period, the larger is the risk.

The lower the credit worthiness of the borrower, the higher is the risk.

The risk varies with the nature of investment. Investments in ownership securities like equity shares carry higher risk compared to investments in debt instruments like debentures and bonds.

Risk and return of an investment are related. Normally, the higher the risk, the higher is the return.

Safety

The safety of on investment implies the certainty of return of capital without loss of money or time. Safety is another feature which an investor desires for his investments. Every investor expects to get back his capital on maturity without loss and without delay.

Liquidity

An investment which is easily saleable or marketable without loss of money and without loss of time is said to possess liquidity. Some investments like company deposits, bank deposits, P.O. Deposits, NSC, NSS, etc. are not marketable.

Some investment instruments like preference shares and debentures are marketable, but there are no buyers in many cases and hence their liquidity is negligible. Equity shares of companies listed on stock exchanges are easily marketable through the stock exchanges.

An investor generally prefers liquidity for his investments, safety of his funds, a good return with minimum risk or minimization of risk and maximization of return.

Objectives of Investment

An investor has various alternative avenues of investment for his savings to flow to. Savings kept as cash are barren and do not earn anything. Hence, savings are invested in assets depending on their risk and return characteristics. The objectives of the investor are minimizing the risk involved in investment and maximize the return from the investment.

Our savings kept as cash are not only barren because they do not earn anything, but also loses its value to the extent of rise in prices. Thus, rise in prices or inflation erodes the value of money. Savings are invested to provide a hedge or protection against inflation. If the investment cannot earn as much as the rise in prices, the real rate of return would be negative. Thus, if inflation is at an average annual rate of ten percent, then the return from an investment should be above ten percent to induce savings to flow into investment.

Thus, the objectives of an investor can be stated as:

Maximisation of return.

Minimization of risk

Hedge against inflation.

Investors, in general, desire to earn as large returns as possible with the minimum of risk. Risk here may be understood as the probability that actual returns realized from an investment may be different from the expected return. If we consider the financial assets available for investment, we can classify them into different risk categories. Government securities would constitute the low risk category as they are practically risk free. Debentures and preference shares of companies may be classified as medium risk assets. Equity shares of companies would form the high risk category of financial assets. An investor would be prepared to assume higher risk only if he expects to get proportionately higher returns. There is a trade-off between risk and return. The expected return of an investment is directly proportional to its risk. Thus, in the financial market, there are different financial assets with varying risk-return combinations.

Investment Vs Speculation

Investment and speculation are two terms which are closely related. Both involve purchase of assets like shares and securities. Traditionally, investment is distinguished from speculation with respect to three factors, viz. (1) risk, (2) capital gain and (3) time period.

Risk

It refers to the possibility of incurring a loss in a financial transaction. It arises from the possibility of variation in returns from an investment. Risk is invariably related to return. Higher return is associated with higher risk.

No investment is completely risk free. An investor generally commits his funds to low risk investment, whereas a speculator commits his funds to higher risk investments. A speculator is prepared to take higher risks in order to achieve higher returns.

Capital Gain

The speculator’s motive is to achieve profits through price charges, i.e. he is interested in capital gains rather than the income from the investment. If purchase of securities is preceded by proper investigation and analysis to receive a stable return and capital appreciation over a period of time, it is investment.

Thus, speculation is associated with buying low and selling high with the hope of making large capital gains. A speculator consequently engages in frequent buying and selling transactions.

Time Period

Investment is long-term in nature, whereas speculation is short-term. An investor commits his funds for a longer period and waits for his return. But a speculator is interested in short-term trade gains through buying and selling of investment instruments.

Analysis of these distinctions helps us to identify the role of an investor and a speculator. An investor is interested in a good rate of return earned on a rather consistent basis for a relatively longer period of time. He evaluates the worth of a security before investing in it. A speculator seeks opportunities promising very large returns earned rather quickly. He is interested in market action and price movements. Consequently, speculation is more risky than investment.

Basically, both investment and speculation aim at good returns. The difference is in motives and methods. As a result, the distinction between investment and speculation is not very wide. Investment is sometimes described as a well grounded and carefully planned speculation.

Investment Vs Gambling

Investment has also to be distinguished from gambling. Typical examples of gambling are horse races, card games, lotteries, etc. Gambling consists in taking high risks not only for high returns, but also for thrill and excitement. Gambling is unplanned and non scientific, without knowledge of the nature of the risk involved. It is surrounded by uncertainty and is based on tips and rumors. In gambling artificial and unnecessary risks are created for increasing the returns.

Investment is an attempt to carefully plan, evaluate and allocate funds to various investment outlets which offer safety of principal and moderate and continuous return over a long period of time. Gambling is quite the opposite of investment.

Types of Investors

Investors may be individuals and institutions. Individual investors operate alongside institutional investors in the investment arena. However, their characteristics are different.

Individual investors are large in number but their investable resources are comparatively smaller. They generally lack the skill to carry out extensive evaluation and analysis before investing. Moreover, they do not have the time and resources to engage in such an analysis.

Institutional investors, on the other hand, are the organizations with surplus funds who engage in investment activities. Mutual funds, investment companies, banking and non-banking companies, insurance corporations, etc. are the organizations with large amounts of surplus funds to be invested in various profitable avenues.

These institutional investors are fewer in number compared to individual investors, but their investable resources are much larger. The institutional investors engage professional fund managers to carry out extensive analysis and evaluation of different investment opportunities.

As a result their investment activity tends to be more rational and scientific. They have a better chance of maximizing returns and minimizing risk.

The professional investors and the unskilled individual investors combine to make the investment arena dynamic.

Investment Avenues

There are a large number of investment avenues for savers in India. Some of them are marketable and liquid while others are non marketable. Some of them are highly risky while some others are almost riskless. The investor has to choose proper avenues from among them depending on his preferences, needs and ability to assume risk.

The investment avenues can be broadly categorized under the following heads:

Corporate securities

Deposits in banks and non-banking companies

UTI and other mutual fund schemes

Post office deposits and certificates

Life insurance polices

Provident fund schemes

Government and semi-government securities.

Corporate Securities

Corporate securities are the securities issued by joint stock companies in the private sector. These include equity shares, preference shares and debentures. Equity shares have variable divided and hence belong to the high risk-high return category, while preference shares and debentures have fixed returns with lower risk.

Deposits

Among the non-corporate investments, the most popular are deposits with banks such as savings accounts and fixed deposits. Savings deposits have low interest rates whereas fixed deposits have higher interest rates varying with the period of maturity.

Interest is payable quarterly or half-yearly. Fixed deposits may also be recurring deposits wherein savings are deposited at regular intervals. Some banks have reinvestment plans wherein the interest is reinvested as it gets accrued. The principal and accumulated interests are paid on maturity.

Joint stock companies also accept fixed deposits from the public. The maturity period varies from three to five years. Fixed deposits in companies have high risk since they are unsecured, but they promise higher returns than bank deposits.

Fixed deposit in non-banking financial companies (NBFCs) is another investment avenue open to savers. NBFCs include leasing companies, investment companies, chit funds, etc. Deposits in NSFCs carry higher returns with higher risk compared to bank deposits.

UTI and Other Mutual Fund Schemes

Mutual funds offer various investment schemes to investors. UTI is the oldest and the largest mutual fund in the country. Unit Scheme 1964, Unit Linked Insurance Plan 1971, Master Share, Master Equity Plans, Master gain, etc. are some of the popular schemes of UTI. A number of commercial banks and financial institutions have set up mutual funds. Recently mutual funds have been set up in the private sector also.

Post Office Deposits and Certificates

The investment avenues provided by post offices are generally non-marketable. Moreover, the major investments in post office enjoy tax concessions also. Post office accepts savings deposits as well as fixed deposits from the public. There is also recurring deposit scheme which is an instrument of regular monthly savings.

Six-year National Savings Certificates (NSC) are issued by post office to investors. The interest on the amount invested is compounded half-yearly and to payable along with the principal at the time of maturity which is six years from the date of issue.

Indira VikasPatra and KissanVikasPatra are savings certificates issued by post officers.

Life Insurance Policies

The Life Insurance Corporation (LIC) offers many investment schemes to investors. These schemes have the additional facility of life insurance cover. Some of the schemes of LIC are whole Life Polices, Convertible Whole Life Assurance Polices, Endowment Assurance Polices, JeevanSaathi, Money Back Plan, JeevanDhara, Marriage Endownment Plan etc.

Provident Fund Schemes

Provident fund schemes are compulsory deposit schemes applicable to employees in the public and private sectors. There are three kinds of provident funds applicable to different sectors of employment, namely Statutory Provident Fund, Recognised Provident Fund and Unrecognised Provident Fund.

In addition to these, there is a voluntary provident fund scheme which is open to any investor whether employed or not. This is known as the Public Provident Fund (PPF). Any member of the public can join the scheme which is operated by the post offices and the State Bank of India.

Government and Semi-Government Securities

The government and semi-Government bodies like the public sector undertakings borrow money from the public through the issue of government securities and public sector bonds. These are less risky avenues of investment because of the credibility of the government and government undertakings.