One of the reasons many people fail, even badly, at the investment game is that they play it without understanding the rules that govern it. Obviously, you can’t win a game if you break the rules. However, you must know the rules before you can avoid breaking them. Another reason why people fail at investing is that they play the game without understanding what it is. That’s why it’s important to unmask the meaning of the term “investment”. What is an investment? An investment is an income-generating asset. It is very important that you take note of each word in the definition as they are important to understand the real meaning of investment.
According to the above definition, an investment has two essential characteristics. Any possession, property or ownership (on your part) must meet these two conditions before it can become (or be called) an investment. Otherwise, it will be something other than an investment. The first characteristic of an investment is that it is a value – something very useful or important. Therefore, any possession, asset or property (on your part) that does not have value is not, and cannot be, an investment. By this definition, a worthless, useless or insignificant possession, property or asset is not an investment. Any investment has a value that can be quantified monetarily. In other words, every investment has a monetary value.
The second characteristic of an investment is that, in addition to having a value, it must generate income. This means that it must be able to make money for its owner, or at least help him or her earn money. Every investment has a capacity, an obligation, a responsibility and a wealth-creating function. This is an inalienable characteristic of an investment. Any possession, asset or property that cannot generate income for its owner, or at least help to generate income for its owner, is not and cannot be an investment, regardless of its value or price. Furthermore, any asset that cannot play one of these financial roles is not an investment, regardless of its price or cost.
There is another characteristic of an investment that is very closely related to the second characteristic described above that you should pay close attention to. It will also help you determine whether a security is an investment or not. An investment that does not generate money in the strict sense, or does not contribute to generating income, saves money. Such an investment saves the owner some expenses that would have been incurred in its absence, even if it does not have the capacity to attract money into the investor’s pocket. In doing so, the investment generates money for the owner, but not in the strict sense. In other words, the investment still performs a wealth creation function for the owner/investor.
As a general rule, anything of value, in addition to being very useful and important, must have the capacity to generate income for its owner or save money for him/her, before it can be called an investment. It is very important to emphasize the second characteristic of an investment (i.e., an investment must generate income). The reason for this statement is that most people only consider the first characteristic when judging what constitutes an investment. They understand an investment simply as a value, even if that value is income-producing. This misconception usually has serious long-term financial consequences. These people often make costly financial mistakes that cost them fortunes in life.
Perhaps one of the causes of this misconception is that it is acceptable in the academic world. In the financial studies of conventional educational institutions and academic publications, investments – otherwise known as assets – refer to objects of value or property. Therefore, companies consider all their valuables and properties as assets, even if they do not generate any income for them. This notion of investment is unacceptable to the financially literate, as it is not only incorrect, but also misleading and deceptive. This is why some organizations ignorantly consider their liabilities to be their assets. This is also why some people also consider their liabilities to be their assets/investments.
It is unfortunate that many people, especially the financially ignorant, consider valuables that consume their income but do not generate any income for them to be investments. These people list their income consuming valuables as investments. People who do this are financially illiterate. That is why they have no future in their finances. What financially literate people describe as income consuming values are considered investments by the financially illiterate. This shows a difference in perception, reasoning and mindset between the financially literate and the financially illiterate. This is why the financially literate have a future in their finances, while the financially illiterate do not.
Based on the above definition, the first thing to consider in investing is, “What is the value of what you want to acquire with your money as an investment?” The higher the value, all else being equal, the better the investment (even though the cost of acquisition will likely be higher). The second factor is, “How much can it earn you?” If it is a valuable but non-income producing asset, then it is not (and cannot be) an investment, needless to say, it cannot be income producing if it is not valuable. Therefore, if you cannot answer both questions in the affirmative, then what you are doing cannot be an investment and what you are acquiring cannot be an investment. At best, you can acquire a liability.