Theme 5

Investments

1. The Nature of Investments

An investment is a financial too for maintaining, or increasing the expected value of today's funds.

Liquidity Investment experts define as-the "ability to convert an investment into cash quickly and without loss". Shares of stock in a corporation listed on a major stock exchange are highly liquid because they can be converted to cash almost immediately through a stockbroker. Funds tied up in a piece of real estate. Cash, of course, is the most liquid asset a businessperson can own because it is ready for immediate expenditure or investment. Idle cash loses value from inflation. Extreme liquidity has its price.

Liquidity requirements vary depending on the needs of the investor. Cash or highly liquid investments can help a lumberyard owner meet weekly employee payrolls. Relatively less liquid investments, such as bank certificates of deposit with penalties for early withdrawal, can be used to pay quarterly tax payments.

Risk To the investor, risk is a relative rather than absolute concept, involving the likelihood that an investor will be able to get his or her money back. In the words of a respected financial planner, "There is no such thing as no risk, only varying degrees of risk." Three specific categories of risk are (1) business/ financial risk, (2) market/ interest rate risk, and (3) political/ world events risk. Each category of risk needs to be weighed carefully prior to making an investment.

Business/financial risk This type of risk, particularly relevant to those investing in corporate stocks and bonds or those extending trade credit to a buyer, is concerned with the financial health of the company. Some companies are an unreasonable financial risk because they have taken, on too much debt. Others suffer from poor management. Business/ financial risk is also tied to the earning potential of a company. In this regard, investors want to know how much in demand a company's goods/ services are.

Market/ interest rate risk All markets are moving targets with their own dynamic relationships. This includes money markets, stock and bond markets, commodity markets, and markets for goods and services. Investors need to study historical patterns in a given market before investing. History, of course, is a helpful but not perfect predictor of future events. Interest rates, meanwhile, not only fluctuate in response to market variables such as investor confidence, they also are manipulated by the U.S. Federal Reserve as a way of stimulating dampening the economy. A widely publicized benchmark for interest rates is the prime rate.

Political/ world events risk In our increasingly globalized economy, financial markets are sensitive to worldly events. New tax legislation, revolutions, wars, and cartels take their economic toil. Far- flung people and situations can affect world markets in strange and complex ways. Wise investors stay abreast of world events to keep from being caught up in situations beyond their control.

Return Any profit that investors make from their investments is called their return. In effect, return is the reward for taking an investment risk. Two ever-present threats to investors' returns are inflation and taxes.

Risk and Return

One very important relationship need to be mentioned at this point. There is the relationship between investment risk and return. Generally, the greater the risk, the greater the return. Among other considerations, an appropriate investment depends on the investor's risk tolerance. Federally insured bank savings accounts are for those with low risk tolerance, and real estate is more appropriate for investors with high risk tolerance. On the return side of the equation, real estate investors expect a greater return than they would receive by putting the same funds in a savings account.