There are lots of things that change in value, both up and down. It can seem that things like the stock market are gambling. Why not buy gold? What about bitcoin? Real estate? How do you tell an investment apart from gambling? Is investing just the same as gambling, except that the cards might be stacked in your favor? Here’s a simple way to tell if something that you’re buying is an investment or just a gamble:
Does the asset have the ability to produce an income? If yes, it’s an investment. If no, it’s speculation.
Here’s another way to think about it:
Is someone making good use of the asset while I’m holding it? If yes, it’s an investment. If no, it’s speculation.
Note: if it’s an investment, that doesn’t make it a good investment, of course. Here’s a table:
When you own a stock, you are actually a part-owner of the company. For example, right now there are 4.2 billion shares of the Coca-Cola Company. So, if you buy one Coca-Cola share, you own a 4.2-billionth part of the Coca-Cola company. This entitles you to vote on certain matters in the company (1 share=1 vote) and it entitles you to a portion of the profits when/if Coca-Cola decides to disburse profits to shareholders, called dividends. The dividends are income, so this is an investment. Even stocks that currently pay no dividends are investments, since they might pay dividends at a future date.
|Gold||No||Gold goes up and down in value, so it is possible to buy gold low and sell gold high, but that doesn’t make it an investment. If you have a stash of gold, there’s no way it’s going to generate an income for you, unless you sell off some of the stash. In fact, gold is an anti-investment, since you’ll probably have to hire someone to guard the gold for you (or spend money on safes and security systems).|
|Bonds||Yes||When you own a bond, that means that you’ve lent some money to a company. Typically, if you buy a bond, you are promised regular interest payments (quarterly, semi-annually, annually), and at the end of the time period you’re promised your principle back. So, you get a promised income stream with a bond (however, the company backing the bond could go bankrupt, so bonds are not without risk – ever hear the term junk bond? Those are bonds from organizations that have a high risk of not paying back.) Because bonds provide an income stream, they are an investment.|
|Short selling stocks||No||Short selling is a mechanism to bet against a stock, so that you profit if a particular stock goes down. However, there’s no chance for an income stream. Any dividends would work against you instead of for you. It would be an expense stream, not an income stream. Short selling can make you money, but it’s not an investment, it’s just speculation.|
|Real estate||Yes||Houses, land, condos, commercial real estate, etc are all investments. You can rent a house and get an income stream. You can lease land to a farmer. You can get income from a cell phone tower on your land. There are many ways to get income from real estate. So, it is an investment. (Again, however, not all investments are good investments. Most real estate also comes with an expense stream, in the form of property taxes and maintenance, so you have to be diligent to ensure that it is an investment.)|
|Bitcoin and other cryptocurrencies||No||Bitcoin had a huge surge in 2017, followed by a massive reversal in 2018. In Bitcoin history there was a day called “pizza day” where someone in 2010 offered 10,000 bitcoin for two pizzas. If the person who received the Bitcoin held them until their peak in 2018, those Bitcoins could have been sold for around $190,000,000. (However, if you were foolish enough to spend $190,000,000 on Bitcoin in 2018, you would have lost over a hundred million dollars in about half a year. Ouch.) But wins and losses aren’t what make something an investment. It’s the ability to produce an income. If you have Bitcoin, do you earn a stream of income from it? Nope. It just sits there and does not. No one can make use of it. It idles.|
|Savings accounts||Yes||Now, this may be a bad investment, since the average interest is consistently below the rate of inflation, so your income stream is less than the dwindling real value of your account. However, the bank pays you actual money for leaving your money on deposit with them.|
|Cash||No||It may be a nice safety to have a wad of cash in your house, in case the power goes out all across town in a big storm, and electronic payments all go down. But wads of bills don’t bring you an income.|
|Mutual funds||Yes, in most cases||A mutual fund is just a mechanism for a group of investors (or speculators) to get together and pool their resources and coordinate management of their money. Most mutual funds invest in stocks and/or bonds. Since they are a mechanism to hold money in investments, those mutual funds would be investments. Some mutual funds put their money in non-investments, like a short sale mutual fund, or a cryptocurrency mutual fund. There the underlying assets aren’t investments, so those funds would not be investments.|
|Foreign currency||No||Foreign currencies do go up and down in value against your country’s home currency, so a well timed pair of trades can net you good profits, or terrible losses. However, owning foreign currency gives you no stream of income, so it’s not an investment.|
Those are just some examples of common investments and non-investments. However, just because something is an investment, it doesn’t make it a good investment. And just because something is not an investment, it doesn’t mean you should have none of it. (For example, if you travel frequently to Canada, it probably makes sense to have a few Canadian dollars around the house to cover incidentals when you get there. A gold ring can be a great symbol of your love and devotion to your spouse. But those aren’t investments.)