What is investing?

Investing is a broad term referring to any commitment of resources (money, time or effort) with the expectation of making a profit at some time in the future. Examples include:

  • Putting money into a business in hopes of earning a share of the business’s profits.
  • Buying a house, putting money, time and energy into fixing it up, then selling the home based on its increased equity.
  • Buying stocks with the expectation that, some time in the future, their value will increase.
  • Putting money into a higher education, increasing your chances for employment, allowing opportunities for a higher salary.
  • Buying knick-knacks at a garage sale, then reselling them at a higher price on Craigslist or eBay.

While some may try to persuade you that buying a vehicle or an expensive coat is an investment, this kind of purchase very rarely results in any profit. In fact, most personal finance experts agree that it is financially dangerous to think of a car as an investment; its effect on your overall financial situation typically behaves more like an expense than an asset.

How do you know the investment is worth it?

In short, you don’t. There are always risks with any investment, but asking yourself key questions before you decide to invest may help you better understand the risk you’re taking and whether that risk is worth it to you.

  1. Are you getting a good deal? You should first determine whether an asset is fairly valued today. If we’re talking about a house, you should know if its price per square foot is equal to or lower than similar sales in the same neighborhood. For education, you should know if tuition and fees are similar to other educations of similar quality. Stock prices can be compared with ratios like price-to-earnings (or P/E) or debt-to-equity, as well as historical price fluctuations for that stock.
  2. Is the investment safe? Government bonds may be one of the safest investments, but for riskier capital commitments, it is helpful to research whether an asset will hold its value. Researching price fluctuations for a particular asset can help you better estimate its value in the future.
  3. What is your “exit strategy”? Whether you sell back stocks on the market or cash in bonds at a set time, it is important to know how you can get your money back. Trickier investments, such as investing in a friend’s business, may require more discussion up front–at what point will your friend begin paying you a percentage of the profit? In this case, you should also prepare for the business to go under, in which case you may lose money.
  4. How will timing affect your investment? If you plan to resell a jogging stroller the next day on Craigslist, timing and inflation won’t likely be a big concern. If you don’t plan on getting out of your investment for decades, you should think about inflation and whether other long-term investments, like bonds or savings accounts, could provide a better return.

Investing can be complicated, especially if you’re dealing with relationships between multiple investing partners. Be sure you fully understand the risks and potential rewards when considering whether or not to invest.

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