To invest in any financial market is actually to commit money with the intention of receiving a return/benefit in the near future. Simply put, to invest simply means buying an asset or an object with the aim of generating an expected return or an increased value in the current sale price of that asset/instrument. The return may be in terms of cash, profit, interest or dividends depending on the investment type that is taken. There are investment types such as business investment, bond investment etc. For any investment there is a risk involved and investors therefore need to consider their risk tolerance, financial planning and return expectations.
For any investment decision one needs to determine which asset or instrument is the most appropriate for the planned return. There are several factors that one needs to consider while investing like: liquidity, safety, growth potential, price stability, company’s history, dividend yield and liquidity. Among all these factors, safety of bonds and stocks comes at the top of the list. Safety of bonds is attributed to the ability of companies to service their debt obligations as well as to their credit worthiness. Moreover, safety of stocks is ensured by the ability of companies to pay out dividends on time as well as to accumulate significant value through capital gains.
Liquidity refers to the ease of access to funds. A company with substantial liquidity is expected to be able to pay out its full dividend as and when required which would in turn increase the liquidity. On the other hand, a company with poor or negligible liquidity would have limited liquidity and its assets would be quickly drained of any meaningful value. Thus, to ensure that funds are available for daily use it is important to consider growth potential and price stability in any investment.
Cash flow, also known as operating liquidity, refers to the amount of cash generated from the assets during a particular period for the purpose of paying expenses, capital expenditures and other debts. A high cash flow enables a firm to easily meet its daily operational requirements while low flow of cash can lead to financial distress if proper attention is not paid to core business concerns. Cash Flow Risk is an important concept that must be understood carefully during the selection of an appropriate asset class for investment.
There are several factors that influence prices of investments such as: demand, supply and the financial status of an economy. These three factors play important roles in determining the price appreciation of the underlying asset i.e. inflation. The primary determinant of price appreciation is the relative elasticity of supply of the underlying asset i.e. its relative level of efficiency versus the potential of demand.
Inflation plays an important role in determining the cost of capital for any fixed assets such as stocks, bonds and mutual funds. An increase in supply of the underlying asset will reduce the cost of capital for long-term investments. Conversely, a decrease in supply of an asset will increase the cost of capital for short-term investments. The time period over which a portfolio is invested should also be considered while comparing long-term and short-term investments.