Over the past months, we focused on how to set up a business, how to run the business successfully using business principles and techniques and how things should work effectively through personal development techniques. Today, I would like us to give introduction to the topic: Investment.
“An investment is an asset or item that is purchased with the hope that it will generate income or appreciate in the future. In an economic sense, an investment is the purchase of goods that are not consumed today but are used in the future to create wealth”- Investopedia.
To invest is to allocate money (or sometimes another resource, such as time) in the expectation of some benefit in the future. With this, I suppose education could also be classified as investment. What about spending time to counsel or change someone’s life?
In finance, the expected future benefit from investment is called “a return”. That is what returns to you after the investment. The return may consist of capital gain and/or investment income, including dividends, interest, rental income etc. In general, investment income includes, but is not limited to: interest, dividends, capital gains, rental and royalty income, non-qualified annuities, income from businesses involved in trading of financial instruments or commodities and businesses that are passive activities.
Let us look at the following returns in detail:-
1 Capital Gain
Capital gain is an increase in the value of a capital asset (investment or real estate) that gives it a higher worth than the purchase price. The gain is not realized until the asset is sold. For example, when you buy a piece of land for say US$2,000 and you decide to sell it after two years and the buyer is prepared to buy it at US$5,000. The gain here is the difference between the selling price and the purchase price ($5,000-$2,000=$3,000).
- Interest Income
In a bank, the excess amount of interest earned on investments over the amount paid out for deposits is referred to as net interest income. This could be on fixed deposits, treasury bills, call deposits and other forms of short term investments and instruments. Interest income is also used to describe profit earned on money lent out by both individuals and institutions. Banks and other financial institutions call their return “interest income”.
A dividend is a distribution of a portion of a company’s earnings, decided by the board of directors, to a class of its shareholders. Dividends can be issued as cash payments, as shares of stock, or other property. In other words, a dividend is a payment made by a corporation to its shareholders, usually as a share of profits. When a company earns a profit or surplus, it can re-invest it in the business (called retained earnings), and pay a fraction of the profit as a dividend to shareholders.
- Rental Income
Rental income is income you earn from renting property that you own or have use of. You can own property by yourself or with someone else. Rental income includes income from renting a house, apartments, rooms, space in an office building, or other real or movable property.
- Royalty Income
A royalty payment is made to the legal owner of a property, patent, copyrighted work or franchise by those who wish to make use of it for the purposes of generating revenue or other such desirable activities. In most cases, royalties are designed to compensate the owner for the asset’s use, and are legally binding. The difference here between Rental Income and Royalty Income is that, royalty is the consideration payable for the use of special right for both tangible and intangible assets (patents, brands, copyrights, etc.). But rent is the consideration payable for the use of only tangible assets. Consideration is the legal term for the price paid or amount received after an offer is accepted by both parties to a transaction.
To get the major difference between tangible and intangible assets, click here.
6 Profit from Business
Profit is a financial benefit that is realized when the amount of revenue gained from a business activity exceeds the expenses, costs and taxes needed to sustain the activity. Any profit that is gained goes to the business’s owners, who may or may not decide to spend it on the business. Many businesses exist to make profit; with some charitable organisations who are developmental in nature. What sorts of business do you have or which type are you dreaming of? Profit-making or not for profit?
In the next write- up we shall focus on how to maximise the benefits of the various returns given above. Stay tuned!