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.

Good Debt Vs Bad Debt

There are two different categories of debt you can accumulate, Personal Debt and Investment Debt. Personal debt, often called “bad debt”, results from the purchase of an asset that will likely depreciate over time. This includes borrowing for such items as a new car, clothes, or furniture. With personal debt, it is important to note why you have it in the first place and to what degree it is necessary. Financing a car because it gets you to work or school may be an acceptable form of personal debt. Purchasing a new car on a whim is not. Each situation should be considered and analyzed in accordance to its situation.

Investment debt, often called “good debt”, results from the purchase of an asset that will likely appreciate over time. This includes borrowing for an education, the purchase of a new home, or starting a business. The tax deduction on mortgage interest makes investment debt one of the more acceptable types of debt.

Debt Payments

When it comes to making debt payments, some debts are more essential than others are. There are Essential debts to pay, that must be paid, to avoid court and legal actions, as well as maintain good credit, while Nonessential debts, while still affecting your credit if not paid, do not affect it nearly as much. Below, there is a table dividing the Essential and nonessential debts into an easy to understand chart.

Your financial situation must not be plagued with high personal debt. What determines that is your ability to understand the different types of debt and priorities of debt payments. They are important factors in determining your success. Below, there are examples for each type of debt, as well as suggested methods of taking care of these debts.

Non-priority Debts

Credit debts are classed as non-priority debts. This means the action that creditors can take against you to recover their money is usually less severe than for priority debts. For instance, you do not usually lose your home or risk imprisonment if you cannot pay back a credit debt. However, some non-priority creditors may take court action against you and, if you are a homeowner, this could result in a charge being put on your home. Types of credit debt include bank loans, credit cards, overdrafts, store cards, catalogues; other debts to banks, conditional sale agreements, interest free credit, bill of sale, debts to pawnbrokers, debts to individuals below are a few suggestions on what actions you can take if your credit debt is out of control.

Make a deal-Most creditors will accept a low repayment offer if it is all you can afford. Many times, monthly payments may even be lowered or dismissed. Ask for any interest to be frozen on your account and any administration charges to be waived. If this is the only way to pay off your debt properly, many creditors will understand and be sympathetic.

Make Some Changes-Consider changing your account if your bank is taking money from your current account to repay a debt such as a credit card. Also, make changes in the way you use your credit cards. Do not increase the debt that you have on them by continually using them.

Priority Debts

These types of debts are ones that will need to pay quickly or you may lose something or will be to your future disadvantage. Debts such as Mortgage or car payments or student loans all fall into this category. When trying to resolve these issues, most times, contact with the creditors is the best option for resolving your financing issues and reaching an acceptable medium between you and your creditor. Below are some words of advice on contacting your creditors.

Answer your phone - Don’t ignore letters or phone calls from your priority creditors. Get in touch with them as early as possible and explain to them why you are in debt. If you call them over the telephone, you should follow up the call with a letter, confirming what you said on the phone. Keep copies of any letters you write to them. An advice agency such as your local Citizens Advice Bureau can help you write to your creditors. If you have poor writing skills, or are unsure of proper terminology or correct structure, these facilities can be of paramount usefulness.

Holding Letters -- If your priority creditors are threatening to take court action or have started to take court action against you and you need a little time to sort out your finances, send them a holding letter explaining your problems. Say that you will contact them again within two or three weeks. Ask them not to take any further action during this time. For more about negotiating with your creditors, see under heading Negotiating with creditors.

Make Payment Arrangements - Once you have paid off your mandatory expenses, (Food, clothing, etc.) contact each of your priority creditors and arrange to pay back what you what you owe. If you cannot pay back all of the debt at once, arrange payment plans satisfactory to both sides.

For example, you may be able to pay an extra bit each month until the debts are cleared. Another possibility is that you may not have any extra money now, but know you will have a lump sum in four months’ that will clear the debt completely. When it comes to these payment plan types, creditors are typically very understanding, helpful, and accommodating.

When you just can’t pay

If you cannot afford to pay anything to your priority creditors and your situation is not likely to get better, the outcome may be very serious. Examples of this could be being laid off on a job, or have received an injury preventing you from working. Get advice straight away. There are several agencies that specialize in these situations, and they may be able to help before your only choice is to file for bankruptcy.