Canto 1

What is Investing?

A dictionary would say that investing is putting money or capital into an enterprise with the expectation of receiving profit. It's different from saving, because there is risk involved. Saving - everything from piggy banks and mattresses to bank accounts or guaranteed investment certificates (or certificates of deposit, as they're called in the U.S.) - involves almost no risk. It's possible for a bank to fail, though that is especially rare in Canada, but other than that your money is not really at risk when you put it in savings. When you invest, however, you are trusting someone else with your money and expecting them to go do something with it and then pay you for the privilege of having used your money.

You can lend the money to a government or a business, often by buying a "bond" issued by that government or business. Or you can buy a part of a business, often by buying stocks. Either way, if something bad happens to the enterprise you have lent money to or bought a part of, you could lose your money. The more risky the investment, the more money you deserve to be paid for taking the risk. Markets exist to help decide, by a form of consensus, how much the investors deserve to be paid for the risk they are taking. To oversimplify somewhat, if a bond or stock offers too little expectation of profit (bond interest, stock dividends, or likely increase in the value of either the stock or bond) for the amount of risk involved, very few investors will want to buy it. If there are fewer buyers than sellers, the value of the investment will fall until it is cheap enough that things even out.

People invest instead of just saving, because savings accounts (and mattresses) don't tend to keep up with the rate of inflation. If you're just saving up to buy a bicycle in two months, that doesn't matter. If you're saving for retirement, however, inflation will devour the value of your money if you just keep it in savings. For example, if you put $1000 in a sock to save for your retirement and you expect to retire in 40 years, inflation of 2% per year over that period would make your sockful of money worth only $453 when you retire. If you invest in a 40-year bond that pays 4% per year, on the other hand, your $1000 would be worth $2,174 (after 2% inflation) at the end of the 40 years. So don't keep all your money in a sock.

 


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