What is an investment?

Why this matters

Every market you’ll meet in this book, whether stocks, bonds, currencies or oil, exists because people are trying to do one thing: put money to work today so they have more of it tomorrow. Before we get to central banks and currency crises, we need to be clear about what an investment is, and who is on the other side of every trade.

What is an investment?

An investment is money you put into something today because you expect it to be worth more, or to pay you something, in the future (SEC Investor.gov).

The thing you put money into is called an asset. The main types are:

• Cash and savings. Money in a bank account. Very safe, but it usually grows slowly.
• Bonds. Loans to a government or company. They pay you interest and give your money back at the end.
• Stocks (shares). Small pieces of ownership in a company. You share in its profits and in its growth, or its decline.
• Real estate. Property that can earn rent and rise (or fall) in value.
• Commodities. Raw materials like oil, gold, copper and wheat.
• Currencies. Holding one country’s money instead of another’s.

It helps to separate investing from two things it’s often confused with:

• Saving is setting money aside. Investing is putting it to work. Your savings account is safe but earns little; an investment aims to earn more, and accepts some risk to do it.
• Gambling is a bet where the odds are stacked against you. A real investment has a reason to grow: a company earning profits, a borrower paying interest, a building collecting rent.

Risk and return

What you earn from an investment is its return, usually expressed as a percentage per year. If you invest $1,000 and a year later it’s worth $1,050, your return is 5%.

The chance that things go worse than you expected, including losing money, is risk.

The single most important idea in investing is that risk and return go together. Investments that can earn more usually can also lose more. Cash in the bank rarely loses value but rarely grows much. Stocks have historically grown faster over long periods, but they can fall sharply in a bad year. Nobody pays you a high return for taking no risk.

The other big idea is compounding: when your returns start earning returns of their own. It’s why time matters so much. Try it below.

Try it

Watch money compound

Simplified model. Returns are fixed each year here; real returns jump around, and higher-return investments can also lose money.

Starting amount: $1,000Years invested: 30

After 30 years: $1,811 at 2% · $4,322 at 5% · $10,063 at 8%

What your money grows to

x-axis: years

Data as of n/a (simulation) · Source: Illustrative model

Things to try:

1. Set 30 years and compare the three lines. How much bigger is the 8% ending value than the 2% one, even though the rate is only 4 times higher?
2. Change only the number of years. Notice how the lines curve upward: most of the growth happens near the end.
3. Remember the fine print. The 8% line is smooth here, but in real life it would have bad years, which is the price of the higher return.

Who invests? The different types of investors

Markets aren’t one big crowd. They’re made of very different players with different goals, time horizons and amounts of money. Knowing who’s who helps you understand why prices move.

Retail investors are individuals investing their own money, through a brokerage account or a retirement plan. There are millions of them, but each is small. They usually invest for long-term goals like retirement, a house or education.

Institutional investors are organizations that invest large pools of money, usually on behalf of other people (source). They control most of the money in markets. The main kinds:

• Pension funds invest workers’ retirement savings so they can pay pensions decades from now (source). They’re patient and very long-term.
• Insurance companies invest the premiums people pay so they can cover future claims. They favor safe, steady assets like bonds.
• Asset managers (mutual funds and ETFs) pool money from many investors and invest it for them, often tracking an index like the S&P 500.
• Endowments and foundations invest to fund universities and charities indefinitely.
• Sovereign wealth funds invest a country’s savings, often from oil revenue (source). Norway’s fund, built from its oil income, is one of the largest investors in the world (source).

Hedge funds are lightly regulated funds for wealthy individuals and institutions (source). They can bet on prices falling as well as rising and often use leverage. Global macro funds, the subject of this book, are one type of hedge fund.

Central banks and governments also buy and sell in markets. They aren’t trying to make a profit; they’re trying to steer the economy, for example by buying government bonds to push interest rates down. Because their pockets are so deep, they can move markets more than anyone else. You’ll meet them properly in Part II.

Investors differ by time horizon, too

The same person can act very differently depending on how long they plan to hold:

• Long-term investors buy and hold for years or decades, like a pension fund or someone saving for retirement.
• Traders hold positions for days, hours or even seconds, trying to profit from short-term price moves.
• Macro investors usually sit in between, holding a view for weeks to years while a big economic story plays out.

Real-world example: one piece of news, four reactions

Imagine the US central bank unexpectedly raises interest rates. The same news hits four investors differently:

• A retail investor saving for retirement sees their stock fund drop for a few days, and (wisely) does nothing.
• A pension fund is quietly pleased: higher rates mean the bonds it buys will pay more interest for decades.
• A day trader tries to profit from the minutes of wild price swings after the announcement.
• A global macro hedge fund asks the big question: what does this mean for the dollar, for other countries, for the next year? It might buy the dollar, betting that higher US rates will attract money from around the world.

Same news, four different goals, four different trades. That mix of players, all acting at once, is what a market is.

Key takeaways

• An investment is money put into an asset today in the hope of getting more back later.
• Risk and return go together. Higher potential returns come with a bigger chance of losses.
• Compounding means time is an investor’s biggest ally.
• Markets are made of retail investors, institutional investors, hedge funds and central banks, each with different goals and time horizons. Global macro funds are one kind of hedge fund.