The word "investment" has become muddled with overuse. Referring to a stock or a bond as an investment is still in regular use, but now people make "investments" in their education, their cars and even their flat screen TVs. In this article, we will look at the three basic types of investment as well as some of the things that are definitely not investments - no matter what the commercial says.

The Three Types of Investment
Investment, as the dictionary defines it, is something that is purchased with money that is expected to produce income or profit. Investments can be broken into three basic groups: ownership, lending and cash equivalents.

Ownership Investments
Ownership investments are what comes to mind for most people when the word "investment" is batted around. Ownership investments are the most volatile and profitable class of investment. The following are examples of ownership investments:

Stocks
Stocks are literally certificates that say you own a portion of a company. More broadly speaking, all traded securities, from futures to currency swaps, are ownership investments, even though all you may own is a contract. When you buy one of these investments, you have a right to a portion of a company's value or a right to carry out a certain action (as in a futures contract).

Your expectation of profit is realized (or not) by how the market values the asset you own the rights to. If you own shares in Sony and Sony posts a record profit, other investors are going to want Sony shares too. Their demand for shares drives up the price, increasing your profit if you choose to sell the shares.

Business
The money put into starting and running a business is an investment. Entrepreneurship is one of the hardest investments to make because it requires more than just money. Consequently, it is also an ownership investment with extremely large potential returns. By creating a product or service and selling it to people who want it, entrepreneurs can make huge personal fortunes. Bill Gates, founder of Microsoft and one of the world's richest men, is a prime example.

Real Estate
Houses, apartments or other dwellings that you buy to rent out or repair and resell are investments. The house you live in, however, is a different matter because it is filling a basic need. The house you live in fills your need for shelter and, although it may appreciate over time, it shouldn't be purchased with an expectation of profit. The mortgage meltdown of 2008 and the underwater mortgages it produced are a good illustration of the dangers in considering your primary residence an investment.

Precious Objects
Gold, Da Vinci paintings and a signed LeBron James jersey can all be considered an ownership investment - provided that these are objects that are bought with the intention of reselling them for a profit. Precious metals and collectibles are not necessarily a good investment for a number of reasons, but they can be classified as an investment nonetheless. Like a house, they have a risk of physical depreciation (damage) and require upkeep and storage costs that cut into eventual profits.

Lending Investments
Lending investments allow you to be the bank. They tend to be lower risk than ownership investments and return less as a result. A bond issued by a company will pay a set amount over a certain period, while during the same period the stock of a company can double or triple in value, paying far more than a bond - or it can lose heavily and go bankrupt, in which case bond holders usually still get their money and the stockholder often gets nothing.

Your Savings Account
Even if you have nothing but a regular savings account, you can call yourself an investor. You are essentially lending money to the bank, which it will dole out in the form of loans. The return is pitiful, but the risk is also next to nil because of the Federal Deposit Insurance Corporation (FDIC).

Bonds
Bond is a catchall category for a wide variety of investments from CDs and Treasuries to corporate junk bonds and international debt issues. The risks and returns vary widely between the different types of bonds, but overall, lending investments pose a lower risk and provide a lower return than ownership investments.

Cash Equivalents
These are investments that are "as good as cash," which means they're easy to convert back into cash.

Money Market Funds
With money market funds, the return is very small, 1 to 2%, and the risks are also small. Although money market funds have "broken the buck" in recent memory, it is rare enough to be considered a black swan event. Money market funds are also more liquid than other investments, meaning you can write checks out of money market accounts just as you would with a checking account.

Close, but Not Quite
Your education is called an investment and many times, it does help you earn a higher income. A case could be made for you "selling" your education like a small business service in return for income like an ownership investment.

The reason it's not technically an investment is a practical one. For the sake of clarity, we need to avoid the ad absurdity of having everything be classified as an investment. We'd be "investing" every time we bought an item that could potentially make us more productive, such as investing in a stress ball to squeeze or a cup of coffee to wake you up. It is the attempt to stretch the meaning of investment to purchases, rather than education, which has obscured the meaning.

Not Investments
Consumer purchases - beds, cars, TVs and anything that naturally depreciates with use and time - are not investments. You don't invest in a good night's sleep by buying a foam pillow, or invest in entertainment by buying an mp3 player. Unless you're very famous, and even then, it's a stretch, since you can't reasonably expect someone to pay more for your pillow than the initial purchase cost. Don't take it personally, but there's very little demand in the second-hand pillow market.

The Bottom Line
There are three types of investments: ownership, lending and cash equivalents. There is no fourth category of consumer purchases. Admittedly, it's a clever piece of advertising that removes some of the guilt from impulse purchasing; you're not spending money frivolously, you're investing! The decisive test is whether there is a potential to turn a profit. The important word is "potential" because not every legitimate investment makes money. Making money through investing requires researching and evaluating different investments, not simply knowing what is and is not an investment. That said, being able to see the difference between an investment and a purchase is an essential first step.

Related Articles
  1. Economics

    Understanding Cash and Cash Equivalents

    Cash and cash equivalents are items that are either physical currency or liquid investments that can be immediately converted into cash.
  2. Personal Finance

    6 Tips for Investing in Antiques

    Historically, antiques are highly appreciating assets, but be prepared for a long-term investment.
  3. Professionals

    5 Unique Assets to Invest Your Retirement Money In

    Investing for retirement doesn't always mean 401(k)s and IRAs. Here are five unique assets to invest your retirement money in.
  4. Professionals

    Why Investors Should Consider Cash Right Now

    With so many market watchers thinking that the current stock rally is getting long in the tooth, investors might considering upping their cash holdings.
  5. Investing

    Payroll Processors, Regional Banks await Rate Hike

    Short-term interest rates are creeping higher, which is good news for money market fund managers, payroll processors and consumer banks.
  6. Entrepreneurship

    Bill Gates Success Story: Net Worth, Education & Top Quotes

    Learn about billionaire Bill Gates, and how the computer genius forged his own path from an early life and eventually changed the world with his innovation.
  7. Investing

    Why Cash is King When Markets are Volatile

    After the past several years, you might be addicted to equity. But when markets turn volatile, cash is the best option. Here's why.
  8. Investing Basics

    What are Cash Equivalents?

    Cash equivalents are money market instruments.
  9. Trading Strategies

    Microsoft's Game of Catch-Up With The Dow

    Microsoft (MSFT) underperformed the Dow Jones Industrial Average during the 2002 to 2007 bull market, but it has played catch-up in recent years.
  10. Entrepreneurship

    10 Richest, Most Successful Tech Geniuses

    Unlike many industries, tech billionaires are mostly self-made. Many of these billionaires came from humble means and, through their own genius, changed the world.
RELATED TERMS
  1. Emergency Banking Act Of 1933

    A bill passed during the administration of former U.S. President ...
  2. Regional Asset Liquidation Agreement ...

    An agreement between an asset manager and the Federal Deposit ...
  3. D’Oench Duhme Doctrine

    A banking rule which states that a borrower or guarantor cannot ...
  4. Advance Dividend

    An estimate of the present value of an asset being liquidated ...
  5. Asset Specialist

    A professional who is responsible for the management and disposition ...
  6. Appraised Equity Capital

    The excess of the market value of an asset over its book value. ...
RELATED FAQS
  1. What are some examples of money market funds?

    Money market mutual funds are designed to offer savers low-risk, liquid and short-term investments. They are normally offered ... Read Full Answer >>
  2. For what types of accounts are demand deposits available?

    There are essentially three types of accounts available as demand deposits: checking accounts, savings accounts and money ... Read Full Answer >>
  3. What are some of the major regulatory agencies responsible for overseeing financial ...

    There are a number of agencies assigned to regulate and oversee financial institutions and financial markets, including the ... Read Full Answer >>
  4. Under what circumstances would someone enter into a repurchase agreement?

    In finance, a repurchase agreement represents a contract between two parties, where one party sells a security to the other ... Read Full Answer >>
  5. Which federal regulatory agencies approved and are now responsible for enforcing ...

    Five federal regulatory agencies approved and are jointly responsible for enforcing the Volcker rule. These agencies include ... Read Full Answer >>
  6. How does the velocity of M2 money supply change?

    According to economic theory, the velocity of money is the number of times a unit of currency changes hands over a set period ... Read Full Answer >>

You May Also Like

Trading Center
×

You are using adblocking software

Want access to all of Investopedia? Add us to your “whitelist”
so you'll never miss a feature!