What Is Investment?
Jun 20th 2013 9:15AM
Updated Jun 20th 2013 9:35AM
What is investment?
I would argue there are three definitions of investment, which vary depending on the discipline being discussed. There is a general definition of investment followed by more specific ones if you are looking at investment from the perspectives of finance or economics.
My definition of investment is: the transfer to others of some asset now with the rational expectation of receiving a return in the future.
I include a wider range of assets in my thinking than just money. For both the investment and the return, any asset qualifies: money, time, health, reputation, relationships, IQ, EQ, mastery.
Many people underinvest or neglect various assets of their life (health, relationships) while focusing on others such as their financial assets or immediate happiness to the detriment of their life long-term. With all investing, you need to be careful about being too focused on short-term gains and consider the long term.
Warren Buffett, chairman and CEO of Berkshire Hathaway and one of the world's greatest investors, has spoken greatly about the various assets of life and lessons he's learned. For more on this, you can read about some of the smartest things Warren Buffet has said here.
The second definition of investment is investment from a finance perspective. There are many different definitions of this kind of investment that have been put forward:
Dictionary.com defines investment as "the investing of money or capital in order to gain profitable returns, as interest, income, or appreciation in value."
Ben Graham, the father of value investing, offered this definition in The Intelligent Investor: "an investment operation is one which, upon thorough analysis, promises safety of principal and an adequate return. Operations not meeting these requirements are speculative."
I believe Warren Buffett's definition of investment is the best: "Investing [is] the transfer to others of purchasing power now with the reasoned expectation of receiving more purchasing power -- after taxes have been paid on nominal gains -- in the future."
Buffett's definition, while not the simplest, fully encompasses what the average business and investor deals with. It goes beyond just the return, taking into consideration both purchasing power (inflation) and taxes, two subjects that can have outsize effects on a financial investment's return. Let's briefly examine each of these.
- Inflation: Purchasing power is the amount of goods and services a dollar can buy you. Over time, prices generally rise, and the rate of this rise is called inflation. As prices rise, the amount of goods you can buy with a dollar becomes less and less. So to actually make a gain on your investments that will buy you more goods in the future than what your dollar can buy you now, your return must be higher than the rate of inflation. For an in-depth look at inflation and investment, I highly recommend Buffett's timeless 1977 article in Fortune, "How Inflation Swindles the Equity Investor."
- Taxes: Investment gains are taxed one of two ways, as long-term capital gains or as short-term capital gains. The lower rate at which long-term capital gains are taxed can make a massive difference to how quickly your wealth grows. Assuming the same level of returns before taxes, a short-term trader has to pay far more in taxes than an investor who holds their shares long term. It's even better if you never sell your shares, since then you never pay any capital gains.
The third definition of investment is from an economic perspective. In economics, investment is defined as the amount by which capital grows, with capital defined as the productive resources held by a business, individual, or some other organization. For a business, productive resources include machinery, buildings, inventory, and technology; for an individual, they would include education, training, and other skills that can be used in the production of goods.
A good example of the difference between the two definitions is buying a home. In economics, this would not be considered an investment, as homes are not productive resources -- they are not used in the production of other goods but are durable goods whose value declines with time. In finance, buying a home would be considered an investment as long as you have a reasonable expectation of receiving more purchasing power from its sale in the future.
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The article What Is Investment? originally appeared on Fool.com.Fool contributor Dan Dzombak can be found on Twitter @DanDzombak or on his Facebook page, DanDzombak. He has no position in any stocks mentioned. The Motley Fool recommends Berkshire Hathaway. The Motley Fool owns shares of Berkshire Hathaway. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.
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