What is Investing?
Investing is giving your money to someone else who is going to make better use of it than you can to produce goods, build buildings, do research or otherwise create wealth. Then, at some later date, this person or corporation is going to give your money back, along with a share of the wealth created while they were using your money. This is a grossly oversimplified definition of capitalism. Capitalism is the economic system that allows (encourages) individuals to put a portion of their capital (savings) into the economy so that other people can risk it to develop and sell products, mine raw materials, build factories and, in general, create wealth. In return for allowing others to use our capital, we expect to share in any new wealth that is created. We also share in the risk.
• Capital is invested
• Risks are taken
• Wealth is created (or lost)
• The owner of the capital shares in the gain or loss
How does this capital (money) get to the people that have a more creative use for it than we do? For a very local example, your community bank deposit could be loaned to a new homebuyer. For a new corporation, it’s more complicated. Our economy has developed organized markets to conduct the business of getting the capital to the people that need it. Some of these markets are the New York Stock Exchange (NYSE) and the National Association of Securities Dealers Automatic Quote System (NASDAQ). There are similar markets in many other countries and, as the global economy gets more sophisticated, all of the markets are becoming more closely intertwined.
The function of these markets is to provide a place where corporations can come to raise capital for investing in new ventures, to grow existing businesses, or to finance ongoing operations. Companies offer shares in their businesses (and hopefully, in their future success) in order to entice you, a complete stranger, to give them your hard-earned money. After shares in a business have been sold to the public, the markets also provide a place for individuals to buy, sell, and trade these shares to other individuals. This is called the secondary market, which is actually the market that you and I are dealing with when we purchase our shares in Apple or Google. So, to summarize, investing is putting money into a venture that will create wealth. In return for risking your capital, you expect a reasonable return on your investment.
A few words on what investing is NOT. Investing is not:
• buying a car
• buying a lottery ticket
• acting on the latest hot tip from your brother-in-law.
When people say that paying money for an expensive car is a “good investment” they are not using the word correctly. Perhaps, if a person finds that the car they drive impresses clients and brings in more business, they could look at it as an investment but, for most of us, a car is an expense, period, just like our utility bill. Obviously, money spent on lottery tickets or any kind of gambling cannot be thought of as an investment. This is entertainment, not investing. The test here is “What wealth is being created”? The answer is NONE. Money is only being shifted around, with the only real winner being the state, in the case of the lottery, or the “house” or the bookie in the case of gambling. Putting money on the latest hot stock tip is also not investing, in my opinion. This is speculation and, while it can be fun and sometimes very rewarding, speculation is not what you want to be doing with your retirement or college savings account.
©Neil Macneale Inc., 2018