Investment In Economics

An investment is an activity that consists of dedicating resources with the objective of obtaining a benefit of any kind.

In economics, resources are usually identified as the associated costs. The main resources are time, labor and capital . With which, whatever it is to make use of any of these three resources in order to obtain a benefit is an investment.

When an investment is made, an opportunity cost is assumed  by giving up these resources in the present to achieve the future benefit, which is uncertain. Therefore, when an investment is made, a certain risk is being assumed.

Types of investment

The classification of investments can be done from different points of view. Thus, there is no single classification, nor one that is better. There are several, all valid and useful depending on the context.

According to the time horizon:

  • Short term: Less than 1 year.
  • Medium term:Between 1 and 3 years.
  • Long term:More than three years.

According to the element in which it is invested:

  • Machinery: Tractors, robots, packaging machines …
  • Raw materials:Metals, food, fuel …
  • Transport elements: Vans, trucks, cars …
  • Buildings:Industrial buildings  , offices, commercial premises …
  • Investment in participations of other companies
  • Investment in research and development (R&D).

Depending on the scope:

  • Business.
  • Personal.
  • Financial.

According to the nature of the subject:

  • Private.
  • Public.

According to the adaptation to the recipient:

  • Personalist or custom.
  • Generalist or standard.

We could cite many more investment classifications, but the above are the essential ones. That is, the most important.

The most important variables of an investment

An investment in economic terms, whatever its type, is governed by three fundamental factors. The yield, the risk and the term. This is, what we gain, what we could lose and time.

  • Performance:Performance is what we get in exchange for making the investment. It is usually measured in terms of profit or profitability, although it does not have to be that way.
  • Risk:Refers to uncertainty. In economics nothing is 100 percent safe. With which, we must always work with assumable risks in case the investment does not go as expected.
  • Term:Time is the third fundamental variable. We can expect a certain return, but depending on the time it takes to obtain it, will it compensate or not the investment?

Addressing these three factors, although it may seem obvious is not so common. Many investors often focus on the first of the factors. Focusing on how much I will earn is not always a good idea. We must also pay close attention to the other two factors. And especially at risk.

How to know if one investment is better than another?

Knowing if one investment is better than another or others is something frankly difficult. In essence, it will depend on the preferences of each investor. Some will consider that a 50% return is very good and others will settle for 10%.

More if possible, we must also take into account risk aversion and the patience or impatience of the investor (term).

That said, and taking into account that it is not black or white, there are several methods to compare different investments monetarily. For example:

  • Internal Rate of Return (IRR).
  • Pay-Back.
  • Net present value (NPV).
  • Cash flow discount.
  • Profitability-risk ratios.
  • Valuation ratiosROCE , ROE , ROI, PER or 

There are other methods to compare, but these are the best known and affordable. Using one or the other will depend, among other things, on the nature of the investments we make.

Difference between savings and investment

On the one hand, we call savings to the money we save so that we can dispose of it in the future. We renounce to spend it in the present, putting it in a safe and risk-free place, but that usually generates interest. We are saving when we keep our money in cash, when we keep it in a bank account or when we keep it in a deposit , for example.

On the other hand, we call investment to that money that we renounce to spend in the present so that in the future we contribute extra money. We associate the investment with the purchase of a good or a financial asset , hoping to make a profit. This extra profit that the investment brings us with respect to saving is due to the fact that with the investment we are risking our money, and therefore we receive compensation. We can invest our money in a myriad of things, from something immaterial like education to financial assets such as stocksbonds or investment funds .

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