What is investing and what does it stand for?

Unless a person is self-taught, is interested in or studies investing, they have no way of knowing what investing stands for and how to invest properly. Finax brings you a basic overview of what investing is and explains why should it be part of everyone's life.

Radoslav Kasík | Personal finance | 28. May 2020

Investing is one of the most amazing inventions of capitalism and the market economy. If done correctly, and the investor follows a few basic investment rules, investing will bear fruit for everyone. There is no rational argument against investing.

At the same time, investing is no rocket science, and in order to invest effectively and to be able to achieve results, one does not need to graduate from a financial university. All you need to know are a few basic details, understand the rules of investing, look under the hood and, most importantly, experience investing.

What is investing and what does it stand for?

Investing is the allocation of capital or money in a business effort, with the goal of achieving additional income or profit. This effort or endeavour represents any business, project or real estate, either directly related to the investor or another person.

The main goal of any business is income or profit. Every entrepreneur sets up business with the vision of creating a product or service, which they then sell to consumers, other companies or the state.

If the business is successful, i.e. there is sufficient demand on the market for its products or services, it creates added value. In such cases, consumers or companies are willing to pay for the idea of business, its uniqueness, quality, or processing, which is then reflected in income exceeding the cost of business, i.e. in the creation of profit.

Investing means to provide capital (money) to a business. The business will use this money to implement business ideas and plans in order to create added value and achieve profit, which will then be shared with shareholders who have invested in the business or with creditors who have lent money to the business.

This is where the two basic forms of investing come from. Investing is purchase of share or purchase of bond. Other financial instruments are more work of financial engineering and usually a means of speculation.

Shares

A share is a security that expresses an ownership relationship in a joint stock company. The number of shares held by investor in relation to the total number of shares issued by the company expresses the investor share of the company's assets (ownership share).

If you buy a share when it is being issued, you provide capital to the joint-stock company and you become a shareholder, a co-owner of this company. The shares can then be traded on a stock exchange (regulated financial market), where you can conveniently sell your stake in the company or acquire co-ownership of another company, regardless of knowing the counterparty to your trade.

All rights of the ownership are associated with the share, example being the Ltd (limited liability company), where the shareholder has the right to the company's assets, distributed economic result (profit), liquidation balance, but also to the management of the company.

The purpose of the joint stock companies is the separation of company owners from the operational management of the company. The intent is to hire professional managers, who have better skills and experience in managing companies. Their goal is to appreciate the capital invested by shareholders.

However, the shareholder has right to participate in the general meeting, where the strategic direction of the company and the management of the company itself are being decided.

Thus, for example, if you own shares of Apple, a company that makes famous iPhones, no one can deny you the entry to the general meeting at the Steve Jobs Theatre at Apple Park in Cupertino, California, where you can propose and vote for individual meeting points.

The income, in case of a share, is an increase in its value or a dividend paid as a share of the net profit distributed among shareholders. The value of the shares grows in accordance with the growth of the company's assets, through the growing revenues and profits.

Bonds

The bond is the so-called debt security. In essence, it is a conversion of the loan into a security. Among other things, the bond expresses when the borrowed amount will be repaid, what interest (coupons) will be paid and at what frequency, as a reward to the creditor.

If you buy a bond when it is being issued, you lend money to its issuer, which is usually a company or state. The borrower (issuer, issuer of the bond) undertakes to pay you interest on the borrowed money for a certain period of time and to pay its nominal value (borrowed amount) at the maturity of the bond, according to the agreed conditions.

Bonds, like shares, can be traded on stock exchanges or between banks or securities dealers. You can sell the traded bond at any time, thereby transferring your claim against the bond issuer to another person. The issuer of the bond, i.e. the borrower, has a permanent obligation to the holder of the bond.

As we have stated above, a bond represents a different kind of property-legal relationship than a share. An investment in a bond is usually of a shorter nature, as the bond has a specific maturity. For lending money, investors demand a lower return, in comparison to the direct ownership entry into the company through shares.

The bond represents only a loan of money to the company, while the purchase of a share represents the acquisition of a share in the company, i.e. its co-ownership. For this reason, share investors demand a higher long-term return and bear higher risk.

Why should everyone invest?

Investing is no science fiction. It's not incomprehensible, it's not just about charts or percentages that we can see on TV. Investing is more realistic than many people can imagine. By investing dutifully, as described above, you allocate money in real physical assets, in real companies, whose products and services you encounter on a daily basis.

You either become a co-owner of huge corporations or you lend them money. In both cases, they are large companies with successful business models. And that is where the brilliance of investing comes from.

Entrepreneurship is the most common way of building wealth, becoming financially independent and rich. However, the chance that anyone will be able to build a large successful company is low and that they will be able to create a multinational company traded on world stock exchanges with an annual turnover of several billion is slim.

But in order to secure yourself financially, this is not necessary. The market economy thought of everyone. You don't have to be an owner of growing business or an entrepreneur.

All you have to do is spend less money than you earn. The bigger the difference between your income and expenses, the more you save and the faster your assets will grow.

Today, you can invest in virtually every big successful company - buy a stake in it. You literally have the opportunity and the right to capitalize on someone else's capabilities and success.

You don't have to invent a new social network or a ground breaking device. The employees of your co-owned company will do it for you and you will benefit from their knowledge and skills. In the meantime, you can lie peacefully on the couch with your legs and arms stretched out and, most importantly, with the certainty that you will make money.

If you want to get rich like Bill Gates, all you have to do is buy Microsoft shares. If you see more potential in Mark Zuckerberg, the founder of Facebook, buy his shares. If you prefer clothes, buy shares of Spanish Inditex, owner of Zara, Pull & Bear, Bershka and Stradivaria brands, and let your assets grow at the rate of the sixth richest man on the planet, Amancia Ortega.

It might sound crazy and many of you assume that a lot of capital is needed to start investing. That is not the case. You can start with a few tens of euros.

You might say that you won't risk your hard-earned money. Yes, there is risk associated with every business. Risk is a condition of higher returns and attractive appreciation.

However, there are many ways to manage risk and choose the right investment, so that you do not lose your money, but will still appreciate them. In the following articles, we will explain how to start investing, how to choose a specific investment, how to take care of investments and what risks do you take when investing.

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