From the course: Investment Evaluation

Components of an investment - Microsoft Excel Tutorial

From the course: Investment Evaluation

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Components of an investment

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- At a surface level, the concept of investment is easy to grasp. An investment is a purchase you make hoping to get a profit later on down the road. That's easy to understand. But there are also several components to an investment. Specifically, time, capital, and profitability. Time is the period that you should expect to hold an investment. You might have heard this referred to as the time horizon. Time horizon can last from seconds for day traders, to years for those taking the longterm approach. The time horizon you have is purely dependent on your situation and your risk tolerance. For example, if you're a 70 year old retiree, your time horizon and risk tolerance are going to be much slower than a 24 year old who's just entered the workforce. The rationale for that is that market trends shift over time but ultimately, if you hold the investment long enough, it'll pay out profitably. As you can imagine, a retiree has a much shorter time window and doesn't wanna see short term losses as the money might be needed sooner. A younger individual can wait out market forces to liquidate later on and still see profit. Of course, age isn't the only reason one may have a short time horizon. Recently I purchased a new home and needed to sell stock to make a down payment. So I too, had a short time in the market. It's an unfortunate situation but we all have to deal with it on occasion. The second component is capital. That's essentially the financial value of assets. You can think of it as monetary funds. It can also refer to tangible items such as plant, property, and equipment. That's pretty easy, right? The only caveat is that in order to be categorized as capital, the goods or money have to continuously provide a service to the business. Whether that's paying salaries, or purchasing assets to create value. So how does this fit in with the investment component? Well, when you invest, you're making capital investment. You're helping a company or product reach its business goals by giving it money. Last but definitely not least, we have profitability. A quick definition of the term answers the question, how much money am I gonna make? Most people would say this is the most important part of an investment. Before you invest in a business or goods or people, you have to ask yourself if the investment will result in a profit. Always optimize your investment to have the highest ROI or Return On Investment possible. Again, only three basic components. But investing is a lot more nuanced. However, keep in mind, if you're making business decisions regarding investment, be sure to think about how much time the investment needs to see a return, how much capital you're gonna use in the investment that you can potentially use for other things, and what kind of profit you expect to see when you get the return.

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