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A Quick Overview of Investing
What is an investment?
When money is put into some tangible item or financial instrument for the
purpose of increasing an original amount of money, an investment has been
made. An investment can be made in many different ways, such as buying
land, antiques, gold, cattle, bonds, fine artworks, or stocks, or money can
be put into bank accounts. When money is used to purchase any of these
items in the hope of creating more money, then an investment has taken
place.
How are investments made?
Regardless of where a person decides to invest money, there are a few
basic steps in the process that are worth reviewing before we plunge ahead.
First, an investor must decide how he or she wishes to invest his or her
money. Many investors choose stocks, bonds, or other financial
instruments for two very good reasons.
First, stocks and bonds are considered to be liquid assets. This means
that stocks and bonds, in most cases, can be easily sold when the investor
is ready to sell. If you put your money into a piece of fine art or a
herd of goats, for example, there may not be another investor who is ready
to buy it when the time comes.
Second, the rate of return, or profit, is often "promised" before money
is put into an investment. In the case of a bank account, an
interest rate is promised by the bank. In other words, the bank pays
the investor a fixed amount to keep his money in a bank account. Some
companies pay investors interest to own stocks (called dividends). In
this way, some of the uncertainty is removed before an investor commits his
or her money to an investment. The investor has an idea of what to
expect before the investment has even been made.
At some point, the investment must be sold in order for the investor to
make a profit. This can happen in a variety of ways, depending on
where an investor has put his or her money. It may be a s easy as
cashing in a bank account, sending a rare work of art to be sold at an
auction house, or selling stocks through a stock exchange.
More information will follow on exactly how stocks and bonds are sold,
but the process can be as easy as calling a stockbroker or placing a sell
order online with a computer. What causes an investment to go up (or
down) in value? Many factors can influence the value of an investment.
Most investments are determined by the simple economic principle of supply
and demand. For most goods, the price of the item goes up as the
supply gets lower. A simple example would be that of a popular toy
during the holiday season. Once the limited supply of that toy sells
out at the retail store, you'll often see it offered for sale in the
newspaper classifieds or online auctions at a much higher price.
Scarcity has caused the price of this item to rise sharply. Likewise,
after the holiday season is over and the toy stores are able to re-stock
this popular item, the price will return to normal, since many are readily
available. Since a share of stock is basically a tiny ownership stake in a
particular company, stocks work somewhat like the simplified toy example.
The main difference is that many things affect the price of a stock.
What type of product does the company produce? How good are they at
competing with other companies that are in the same line of business?
How much money does this company earn, and what are its profits? The
answers to these questions help determine the price of a particular
company's stock. Since so many factors can contribute to a stock's price,
predicting the future value of a stock can be a risky business for the
investor. Keep in mind that putting money into an investment does not
always ensure that a profit will be made for the investor. Sometimes
investments lose money. Questions to Consider
1.) Would loaning a friend $10 to buy a movie ticket be considered an
investment? Why or why not? 2.) If a person invested $10,000
to start a small computer repair service but lost most of that money in the
first three months, would this be considered an investment? Why or why
not? 3.) Why do you think it is important to so many investors to
invest in liquid assets, things that can readily be turned into cash, such
as stocks, bonds, or bank accounts? 4.) Why would buying an antique
automobile probably be a poor choice as an investment for most people when
compared to simply opening a bank savings account? 5.) Imagine that
you have made an investment by buying one of only five known autographs of a
famous musician who lived during the 1700s. Shortly afterward, you
hear that an auction house has just announced the discovery of 200 pieces of
sheet music with this same musician's authentic signature on each piece.
What would you expect to happen to the value of your investment? 6.)
If a company makes an excellent product that you enjoy using, should it
follow that the company's stock would make an excellent investment?
Why or why not? 7.) Do you think the price of an investment can be
affected by the way people might feel about that investment, as opposed to
the investment's real underlying value? Explain your position. 8.)
What kinds of questions would you ask of someone offering you the
opportunity to invest money in an idea, product, or company?
Group Activity Look up the following
financial terms on the internet and write down a definition for each one.
- margin buying
- investment
- commission
- risk
- municipal bond
- junk bond
- treasuries
- stock index
- cost basis
- short sell
- stock
- dividend
- bears/bulls
- P/E ratio
- dollar cost averaging
- day trading
- diversification
- interest
- blue chip stock
- mutual fund
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