What is investing?

About what investing exactly is countless books have been written. In general we can say investing means allocating your capital. This is not only investing in for example real estate, bonds or stocks but also putting your money on a bank account is also a form of investing.

Flow of funds

An investment can be defined as the current commitment of funds for a period of time in order to derive a future flow of funds that will compensate the investing unit for the time the funds are committed. This also corrected for the rate of inflation and also corrected for the uncertainty involved in the future flow of funds. This means that when inflation is high we would demand a higher return of the investment. This also holds for the uncertainty; the higher the uncertainty the higher the demanded return.

So from the very moment you put money on your bank account you are already investing. As from 2008 almost nobody would say that putting money on a bank account has risks. After 2008 we know that wasn’t the case and also putting money on a bank account has it’s risks. We all know the dramatic events from collapsing banks everywhere in the world so that many people lost full or parts of their money from their bank accounts. So the so-called risk free rate certainly doesn’t exist anymore.

Varieties in risk and reward

Having said that we are still convinced that putting money on a bank account has relatively low risks. In general we can state that there is a kind of risk order that sorts the risks from high to low.

This is:

  • Bank account
  • Government bonds
  • Corporate bonds
  • Stocks

    This is in general the classic order of investment categories sorted by risk. We don’t need to add here that the returns are also in the order from low to high. This means that bank accounts have relatively low returns and stocks have the highest returns. This sounds like a linear trade-off: the higher the risk the higher the return and the lower the risk the lower the return. With these education videos we focus the most on investing in stocks.

    Stocks did best

    Historical results show us that investing in stocks (over the long run) had yielded by far the highest return. But this is only for the long run the case. Investors who invested their money early 2001 and kept their stocks would until today in 2014 still have lost huge amounts. This is also for investors that invested in 2008 the case. So we must always be aware of the bizar events on the financial markets (black swans for example).

    So investors should always be aware that financial markets might crash anytime. Therefor it’s extremely important to spread your investments not only per investment category but of course also within the investment categories. In another video will elaborate more on this topic.

    Video done by Denise Lindemann and Tim van Thienen.