Overview – Isn’t Buying Assets the Same as Investing?
Thanks to advances in modern technology, investing is more accessible than ever before. Not only that, but people now have a wide variety of asset classes to choose from. Equities, fixed income, real estate, GICs, cryptocurrencies, precious metals: the list goes on.
Additionally, there are very few, if any, capital requirements. Whether a person has $100,000 or $100 on hand, there are all sorts of ways to put their funds to work.
As investing becomes more accessible, an interesting phenomenon has started to appear: people have begun to use the term “investor” much more liberally. It seems that the only thing someone needs to do to qualify as an “investor” is to buy some assets.
It’s true that investors usually own a variety of assets for investment purposes, but what separates a “true” investor from someone who simply buys assets?
Revisiting the Definition of Investing
To understand why buying assets doesn’t automatically make someone an investor, let’s back up for a minute and remember what the definition of investing is (at least the one we refer to for all our content). In a previous article, it was defined as:
“An investment operation is one which, upon thorough analysis promises safety of principal and a satisfactory return. Operations not meeting these requirements are speculative.”
Security Analysis, Sixth Edition. page 106.
We’ve already broken down what each part of this definition means in the aforementioned article, but for our purposes, the key takeaway here is that there is no mention of assets, let alone needing to acquire them, in order to call yourself an “investor”.
Instead, an investment is something that must meet specific criteria, in this case, two. Therefore, for something to be considered an investment it must earn that classification; it isn’t some intrinsic trait.
Many investors choose to acquire assets such as equities and bonds because many of them satisfy the criteria of keeping their capital safe while also providing adequate returns. Assuming they know what they’re doing, these are decisions they made after performing careful analysis.
Almost anybody has the ability to purchase assets, but what sets investors apart from the crowd is that they clearly understand why they chose to pursue certain assets, and why they passed over others. Non-investors, on the other hand, will simply acquire any assets they can get their hands on without stopping to ask why.
Conflicting Definitions From Different Contexts
Even if they’ve never heard of the definition proposed in Security Analysis, the definition of investing that many investors probably abide by is something along the lines of “putting money down today with the expectation of getting more in the future”.
However, there exists another definition of investing, which is commonly used in the realms of corporate finance, economics, and accounting. Although there are some subtleties between these different fields, the definition of investing they use is largely the same, which is: the acquisition and disposal of assets.
If you look at a cash flow statement, any time a company purchases or sells certain assets, the cash involved with those transactions appears in the “investing activities” section. This makes sense because the cash flow statement is created using accounting principles.
So, in the eyes of corporate finance, economics, and accounting, it doesn’t matter what sort of assets they acquire, any time they do so it’s considered to be “investing”.
Now, it’s important to note that one definition isn’t more “correct” than the other. They come from different contexts and convey different things.
However, should a person choose to abide by the corporate finance/economics/accounting definition, this may be a problem. That’s because they could potentially disregard the need to properly analyze if a given asset is indeed worthy of investment, and instead purchase assets indiscriminately yet still classify it as “investing”.
If all it took to become a successful investor was to acquire as many assets as possible, then there would be far more successful investors around the world than there are now. So why isn’t that the case?
Most Investments Are Assets, but Is the Reverse Also True?
One of the major problems behind the corporate finance/economics/accounting definition of investing is that it assumes every asset has investment merit. Any investor with even a modicum of experience knows that isn’t true at all.
In the broadest sense, an “asset” is nothing more than a classification. Identifying something as an asset simply means it has been classified as such – calling something an “asset” doesn’t grant it any special powers or merit.
Take for example mortgage-backed securities (MBS). Technically speaking, they are classified as a type of financial asset. Before the height of the 2007 – 2008 Global Financial Crisis, they were the hottest assets on the block for investors and speculators alike.
According to the alternate definition, it didn’t matter if MBS were comprised of subprime mortgages that could collapse at a moment’s notice. MBS were classified as assets, so if a corporation purchased them then by definition they just made an “investment”.
The same can be said for junk bonds. Junk bonds are simply bonds with very low credit ratings – that is, there is a high chance that the bond issuer will default. Again, junk bonds are a type of asset, so a corporation that purchases junk bonds will have made an “investment”.
You can start to see the problem with the logic of “buying assets = investing”.
An “asset” is simply a name given to some object, tangible or intangible, that has financial importance to the entity that owns it. If you run a food delivery service and you have a fleet of 10 delivery vehicles, then those 10 vehicles are assets because they help you generate income by completing the service you offer.
Some assets end up providing some kind of return, whereas others fail to achieve that. Again, investment merit is not a trait inherent to all assets.
If you were to purchase hundreds of shares simply because you want to without any prior research, this doesn’t make you an investor, this simply makes you someone who bought hundreds of shares. These shares could have no investment merit whatsoever, which would ultimately just make you a speculator.
An investor is someone who pursues an operation they know, upon thorough analysis, will keep their money safe and will give them more money in the future. By this definition, blindly buying assets just for the sake of buying them doesn’t make you an investor.
Wrapping Up
If you were to successfully diagnose yourself with the flu, would you go around telling others that you’re now a physician? Probably not. However, some people buy a couple of shares on a whim and then proceed to announce to the world that they’re now “investors”.
Corporate finance, economics, and accounting say that an “investment” is when a corporation buys and sells assets. The problem with this definition is that it conflates “investing” and “asset purchasing” as meaning the same thing. It’s entirely possible to buy an asset that ultimately hurts your financial position, such as junk bonds.
Any investment operation must always assure the investor two things: that the money they’re putting down is safe, and that they will receive a return on this money in the future. Not every asset is able to satisfy these two criteria, so it would be untrue to say that buying assets and investing are the same thing.
