What Is Investing?

Why this matters

Almost everything else in the curriculum builds on three ideas from this lesson: what you're buying when you invest, what you hope to get back, and what you're risking to get it. If those three are clear, the rest of Part 1 will make sense quickly.

What investing means

When you invest, you use money to buy something you expect to be worth more later, or to pay you something along the way. The thing you buy is called an asset.

The most common assets for individual investors are:

• Stocks. A stock is a small share of ownership in a company.
• Bonds. A bond is a loan you make to a government or a company, which pays you interest.
• Funds. A fund pools money from many investors to buy a collection of stocks, bonds, or both.

Part 2 covers each of these in detail, starting with What a Stock Is. For now, the important part is that assets can make you money in two ways. They can pay you income, like interest from a bond or a share of a company's profits. And their value can grow, so you can sell them later for more than you paid. What an investment earns or loses overall is called its return.

Saving vs. investing

Saving and investing are both ways of setting money aside, but they do different jobs.

Saving means keeping money somewhere safe and easy to reach, such as a savings account. At many US banks, deposits are insured by the FDIC up to a legal limit,¹² and the bank pays you a little interest. Your balance doesn't go down because markets fall.

Investing means putting money into assets whose value moves up and down. That movement is what gives investments the chance to grow faster than savings. It also means they can lose value.

A worked example

Ana and Ben each set aside $10,000 and leave it alone for 20 years.

• Ana keeps hers in a savings account that earns 2% a year.
• Ben invests his in assets that earn an average of 6% a year.

Both rates are made up for this example. They aren't predictions of what any account or investment will actually earn.

After	Ana, saving at 2%	Ben, investing at 6%
Start	$10,000	$10,000
5 years	$11,041	$13,382
10 years	$12,190	$17,908
20 years	$14,859	$32,071

After 20 years, Ben has about $17,200 more than Ana. Notice that the gap grows faster in the second decade than the first. That's compounding: Ben's earlier gains start earning gains of their own. It gets its own lesson later in this module: Compounding.

Here's the part the smooth line hides. Real investments don't earn 6% every year. An average of 6% could include years where Ben's balance rose sharply and years where it fell by a fifth or more. If Ben had needed his money in one of the bad years, he would have had to sell for less than he put in.

Why people accept the risk

If investing can lose money, why do it at all? Two main reasons.

Long-term goals. Retirement, or anything else decades away, usually needs more growth than savings interest provides. A long time horizon also gives investments time to recover from bad years.

Inflation. Prices tend to rise over time. That's inflation. If your savings earn 2% a year while prices rise 3% a year, your money buys roughly 1% less each year, even though the balance goes up. Keeping all your money in savings for decades means slowly losing purchasing power. Inflation also gets its own lesson in this module: Inflation and Purchasing Power.

Behind both reasons is the most important relationship in investing: a higher potential return usually comes with higher risk. There's no reliable way to get the growth without accepting some chance of loss. The next lesson is about exactly that.

Investing and speculating

One more distinction is worth making early. When you invest, you expect the asset itself to produce value: a company earning profits, or a borrower paying interest. Speculation is buying something mainly because you hope someone will pay more for it later, whether or not it produces anything.

The line isn't always sharp, and the same asset can be bought either way. What matters is the reason you're buying and what you expect the return to come from. Hyperion Entities teaches investing, and the lessons ahead focus on understanding what an asset actually produces.

Key takeaways

• Investing means buying assets you expect to produce income or grow in value, while accepting that their value can fall.
• Saving keeps money safe and available. Investing aims for growth and accepts risk to get it.
• Higher potential return usually comes with higher risk. There's no reliable way to get one without the other.
• Money you'll need soon usually belongs in savings, not investments.

Check your understanding

Maria is saving $5,000 for a car down payment she'll make in eight months. Based on this lesson, where does that money most likely belong?

1. In stocks, because they have a higher potential return over any period.
2. In a savings account, because she'll need it soon and can't afford a drop in value.
3. Half in each, so she gets some growth while keeping half of the money safe for the car.

A friend says an investment pays 20% a year and "can't lose money." What's the most reasonable reaction?

1. Invest. A friend wouldn't recommend it without seeing it work, and 20% is a great return.
2. Invest a small amount first, and add more once you've seen a few months of returns.
3. Be skeptical. High returns come with high risk, so a promise of both is a warning sign.

What's next

This lesson said that higher potential return usually comes with higher risk. The next lesson, Risk and Return, looks at what "risk" actually means in investing, how it's measured, and why the two can't be separated.