The word investment is used rather loosely in context to where you keep your savings. Buying an insurance policy when your child is born, is not an investment. Putting money in a fixed deposit, is not an investment. Getting involved with a multi-level marketing scheme, is not an investment. Buying a house to live in, is not an investment. Buying an equity stock at your broker’s insistence, with the objective of holding for 3 months in not an investment. Gold lying in your locker too is not an investment.
There are so many examples, of what you think might be the best investment you ever made but in reality, the purpose of the transaction, its objective, is different. Your intention may have been on track to make an investment towards your financial future, but unless you spend time understanding what makes for a good investment, you are likely to miss the mark.
For any money transaction to qualify as a good investment, you need to have at least some basic characteristics in place. If you can tick those off before you put money in, there is more certainty that you are making a genuine investment. Don’t just buy what looks good, shop like an aware customer, make the right purchase.
1. Will you make gains?
Gains in the traditional sense are thought of as earning anything in excess of your principal investment. In that sense, an insurance policy or a fixed deposit can also qualify as investments. However, investment gains are not fixed returns which deposits give.
When you seek gains, you are really looking at your principal itself increasing or multiplying.
In fixed return products like deposits, you get a pre-defined interest payout and nothing more. As opposed to this when you invest in an asset, you seek price appreciation along with some regular income in the form of interest or dividend or even rental income. Putting money in insurance, bank deposits and gold does not give you the benefit of investment gains. Thus, these will not help your wealth to grow, rather they are more suited to safe guard capital value and earn a regular income.
When you are making an investment, you should be buying a financial or physical asset which will help you grow the value of the principal amount or original amount.
This can be achieved by investing in growth assets like equity, real estate or even small businesses but with the understanding that your investment has to stand the test of time and you need to hold it for at least a decade or more.
An investment should help you grow wealth along with getting some regular income. Check this facet before putting your money in.
2. Is it saleable?
This is perhaps the most important part of identifying an investment.
How easily can you sell or exit or redeem your money?
You must ask this question before making an investment. For example, are you really going to sell the house you live in when property prices are at a peak? Are you going to sell your gold in the locker if it shows that gold prices gained unusually in the last few months? What about the insurance policy you bought – can you sell that for gains? An investment is made in assets which can be sold once the investment objective or goal is achieved.
The timely selling is what makes you able to book the gains and realise the growth in your wealth.
If you can’t sell a financial or physical holding or don’t have the intention to, then it cannot be classified as an investment. It is either for insurance and protection or for consumption and use.
Don’t confuse insurance and assets which you use, as investments. You may argue that the value of gold and the house you live in continue to rise and you are making a gain. However, if you have no intention to even sell this asset to lock-in those gains, it is really something you are using rather than something you are investing in.
3. Is there an underlying value?
The question you really need to ask, is what is the underlying value of this asset and by investing in it are you gaining from this value? For example, many people are ‘investing’ in Bitcoin. What is the underlying value in a Bitcoin? Can you quantify it? Yes, there is an idea that can be enhanced and may someday become of primary use, but at the moment there isn’t any logical underlying value, its simply faith based.
While you may put money in such instruments where prices gains are attractive, at best they can be a good trade but not a genuine investment.
It is akin to a gamble; if the faith-based rally recedes to can lose all your money, if it continues you will continue to gain. This is also true for the daily, weekly and monthly stock tips you are given by your broker. While the company issuing the stock does have earnings, the stock tip for buying or selling is not based on these earnings. It really can’t be based on these earnings, as those are a matter of many quarters and years, not just a few days.
When you hold that same stock for a few years hoping to capitalize on its growing earnings, it is an investment; otherwise, it’s just a short-term trade.
You may buy a financial instrument even though there is no underlying value but understand that without value the price gains from this can fall fast too and you won’t know why price is falling or what can trigger a likely move back up. You may get lucky and book profits in time, but there is an equal chance that you may not.
Given this uncertainty and the lack of visible value creation, such transactions are risky and should only be a small proportion of your overall portfolio. It’s no different for physical assets; buying an obscure piece of land in the wilderness as an investment may or may not pay off, but the certainty of getting a pay off with a completed and built-up property, in a bustling location is relatively higher.
Similarly, a multi-level marketing scheme is more in the category of work and venture. If the subsequent levels you add don’t make any sales then you can’t hope to keep gaining. If they do make sales then its income from professional work not an investment.
When you invest your hard-earned money, ensure that at least these three basic characteristics are ticked off. There is the other matter of a basic hygiene check; ask about the costs, ensure the investment is made in your name and check on the risk of losing capital. Investing without understanding is the biggest risk and can land you with a dud investment. It’s a risk that you can easily avoid just by asking the right questions.