Investment (finance)

Investment in the context of finance involves putting money into some kind of resource or asset, with the goal of later receiving the money back along with additional value. The additional value is received in exchange for temporarily releasing control of the money. The additional value can take a variety of forms: interest earned, as on government bonds; appreciation of the asset, as with a work of art or a fine wine, which becomes more valuable in the marketplace as time passes; or dividends paid on shares of a corporation, as a means of sharing the company’s profits among those who initially provided the company with operating capital by investing.

Background

The central component to investing is risk management. The investor’s task is to select an investment that will maximize the return—that is, produce the largest possible profit—while minimizing the risk of losing the capital that has been invested. For example, an investor might consider the following two options: investing $10,000 for three years with an anticipated return of 4 percent ($400), with a small amount of risk, or investing the $10,000 for three years at 10 percent ($1,000), with a larger amount of risk. In making this decision, the investor would need to decide if the increased risk of losing the $10,000 would be worth receiving the additional $600 in returns.

In addition to risk, investor must also consider the duration of the investment. In effect, this involves deciding how long one can do without the money being invested or how quickly one would like to receive a return on investment. Generally speaking, long-term investments will have a lower risk and a lower rate of return, while short-term investments will have higher risk and correspondingly higher rates of return. An example of a high-risk, short-term investment can be seen in the practice of day trading, where investors try to predict whether the price of a stock or other asset will rise or fall during a very short period, such as a matter of hours. If investors can make an accurate prediction, then they will be able to buy the stock, wait a few minutes or hours for its value to rise, and then sell it at a higher price than they paid for it, reaping the difference as profit. The risk in doing this is that if investors’ prediction is inaccurate, they may find themselves buying an asset and then watching the value of that asset fall rather than rise, meaning they will lose money since the asset is no longer worth as much as they paid for it.

Overview

Investment has been a feature of civilized society for centuries, if not millennia. During the European age of discovery between the eleventh and seventeenth centuries, explorers traveled to distant lands in the hope of finding commodities that could be brought back home and sold at tremendous profit. Financing such voyages was a huge undertaking, requiring the hiring of crew, the purchase of supplies for the extended voyage, securing the means of travel such as the purchase or lease of a ship, and many other costs. Since few people could afford to pay so much up front on their own, investors were located to finance such expeditions, in exchange for receiving a share of the profits if the expedition returned with valuable goods. If the expedition failed to return or returned without locating anything of value, then the investor would receive nothing.

The most common types of assets investors choose to invest in are bonds issued by the government or by private companies; real estate, whether to sell later or to lease to others for their use; stocks and shares in public companies; and cash-based investment instruments such as certificates of deposit or money market accounts.

At various times throughout history, investment’s reputation has risen and fallen. During the early part of the twentieth century, investment in the stock market became a sort of popular craze, with people from many different walks of life and income levels investing in the market, often without possessing a thorough understanding of the risks they were taking. This culminated in the stock market crash of 1929, followed by the Great Depression, both of which had a profoundly chilling effect on attitudes toward investment and the stock market in general, leading to measures such as the Glass-Steagall Act of 1933, which curtailed connections between banks and securities investment firms.

By the 1980s the pendulum had swung back in the other direction, and investing, particularly in the stock market, was once again glorified in the media and in popular culture, as in the 1987 film Wall Street when fictional investor Gordon Gekko (played by Michael Douglas) opines that “greed is good.” This attitude prevailed throughout the dot-com bubble of the late 1990s, not breaking stride until the collapse of the housing market in 2007–8 revealed an investment market that had become so complicated and overleveraged that it could no longer be sustained.

Part of this complexity stemmed from so-called alternative investments, a catchall category that includes less traditional instruments such as financial derivatives, hedge funds, precious metals, antiques, artworks, venture capital, and commodities such as pork bellies. The advantage to using alternative investments is diversification; by investing in many different, loosely related aspects of the market, risk is spread out so that even if one sector of the economy experiences a severe contraction, the other investment areas will likely remain unaffected. The disadvantage usually attributed to alternative investments is that they tend to be less well understood and therefore less predictable, as happened with the mortgage-backed securities associated with the housing market collapse of 2007–8.

Following the 2007–8 crisis, the US strengthened financial regulations through the Troubled Asset Relief Program (2008–2023) and the Emergency Economic Stabilization Act of 2008, and the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 (Dodd-Frank Act). The Volcker Rule, a Dodd-Frank provision that banned depository banks from proprietary securities trading, was considered controversial. In 2018, the Economic Growth, Regulatory Relief, and Consumer Protection Act curbed Dodd-Frank through exemptions for small and mid-size banks, but kept Dodd-Frank's framework, including the Volcker Rule. Calls to reform Dodd-Frank returned in 2023 when Silicon Valley Bank and other regional lenders collapsed in the largest bank failures since 2008.

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