The definition of investment is different depending on it’s context. In finance, the purchase of a financial product or other item of value with an expectation of favorable future returns is the proper definition. In general terms, investment means the use money in the hope of making more money.

In business, the purchase by a producer of a physical good, such as durable equipment or inventory, in the hope of improving future business is considered an investment. As there are different definitions, there are also different types of investments; however, this article will focus mainly on personal investments, as well as some pitfalls you may face along the way.

Personal finance

Within personal finance, money used to purchase shares, put in a collective investment scheme or used to buy any asset where there is an element of capital risk is deemed an investment. Saving within personal finance refers to money put aside, normally on a regular basis. This distinction is important as investment risk can cause a capital loss when an investment is realized, unlike saving(s) where the more limited risk is cash devaluing due to inflation. In many instances the term saving and investment are used interchangeably which confuses this distinction.

For example, many deposit accounts are labeled as investment accounts by banks for marketing purposes. To help establish whether an asset is saving(s) or an investment you should consider where your money is invested. If the answer is cash then it is savings, if it is a type of asset that can fluctuate in value then it is investment.

Mistake #1

Underestimating the time horizon for your assets. How long do you think you’ll live? Most people are far too conservative in estimating the length of their lives, and that can be a problem when planning your financial future.

How to avoid it

Breakthroughs in medicine happen so often, yet we frequently do not even hear about them. As progress has occurred the effectiveness of disease treatment, improvement in general nutrition and higher standards of living, most people now live longer than they think they will.

This means there are new and costly healthcare methods now available for increasing life span as the population ages, which raises the costs of healthcare and of living longer. For these reasons, we find that most people estimate on the low side when it comes to how long they will live.

As a result, many fail to implement financial plans to accommodate their longer life span. Many today run the risk of depleting their funds long before their lives are over. It is important to have a sound financial strategy, one that will provide for your financial stability and income needs throughout your entire life. Sound financial planning is equally important for those whose goals are to grow their assets so they can pass an inheritance on to loved ones and family members who survive them. In either case, a realistic life expectancy time horizon is vitally important.

Mistake #2

Misaligning investment objectives and portfolio strategy. Aligning your portfolio strategy with your objectives is a critical factor in determining long-term investing success. This may sound obvious, but many investors actually employ strategies that work against their objectives.

How to avoid it.

A common error investors make is improperly judging risk. Generally, the longer the time-horizon of your investments, the more risk you are able to take on. However, a typical mistake that investors make is to take on too little risk. They focus on short-term volatility rather than, more properly, the long-term probabilities of achieving their objectives. The result tends to be portfolios that underperform their goals. For example, some persistently load up their portfolios with low coupon Treasury bonds, due to fear that stocks will drop in the short-term. Then, they often barely generate a return that is over the rate of inflation. This reduces the odds of achieving a long-term goal of growth– especially if withdrawals are also anticipated. Conversely, those with short-time horizon objectives are often overly exposed to risk, which creates a danger of asset loss during a short-term period of volatility. This can put their entire financial future in jeopardy.

Mistake #3

Forgetting the fundamental importance of supply and demand. The fundamentals of supply and demand of securities are easy to overlook. Analysts and pundits cite an endless list of theories about what mechanisms drive stock prices. However, the simple fact remains that supply and demand of securities will always be the fundamental driver of share prices.

How to avoid it.

Basic economic theory states that the relative supply and demand for goods in an open market will determine their prices. For example, holding supply equal, the demand for ski equipment increases around the winter months, and thus the price for skis increases at that time. In the other months of the year when people ski less, demand decreases and prices fall. Stocks are no different: we think it is common sense that their prices fluctuate based on short-term demand. Supply of equities is relatively fixed in the short run because it takes time for companies to create new issues of stock.

Therefore, shifts in demand primarily cause price changes in the markets in the short term. However, in the end, supply has the ability to change almost infinitely. That makes supply the dominant factor in stock prices over longer periods. Understanding the relationship between the supply and demand of securities is vital in choosing whether to be invested in stocks or not. The ability to accurately track, analyze, and evaluate this fundamental tenet of economic theory is vital, in our view, to making successful forecasts in the markets because it allows you to screen out unimportant noise.

Other type of Investment: Real Estate Investment

Within real estate, money used to purchase property for the sole purpose of holding or leasing for income and where there is an element of capital risk is deemed a real estate investment. Real Estate investment is distinct from other forms of economic or financial investment in that a real estate is purchased.

Hopefully, by learning about these different types of investment, you’ll be able to invest in the right things from a financial standpoint.