A lot of times, in my tests, I ask for an example of investment and I get “buying shares” or “putting money into something” as answers. Unfortunately, I have to mark both of these as incorrect. But why you may ask. Well lets take the first answer, buying shares in a company, and see why this is problematic. Let’s start with a few definitions.
What is investment?
Investment is the production or purchase of Capital goods.
What is Capital?
Capital is anything man made that is used in the production of goods and services.
In essence, investment is buying stuff (machines) that helps to make stuff.
So, why is buying shares not necessarily investment. Well thew reason is that it depends who gets the money and what do they do with it. Let’s say that you buy a share of stock in the business guys (which is not traded on the stock exchange yet), is that an investment? It depends. What do the business guys do with it?
Scenario 1: The business guys issue 100 new shares and and you buy one of them. With that money the business guys receive from selling shares we buy a new computer (machine) that helps use to produce more blogs and send out more email (produce goods and/or services). Was that an investment? The answer is yes. The business guys used this money too buy more capital, and investment is the production or purchase of capital goods. So, in this case, buying shares is investment.
Scenario 2: The business guys issue 100 new shares and and you buy one of them. With that money the business guys receive from selling shares we use it to just pay ourselves higher wages and put none of it back into the company. Was that an investment? The answer is no. The reason being that no new capital was produced or purchased and as such our operations are no more efficient as a result. We are better paid, and I think you would agree, deservedly so!!! But no more productive as there is no new capital. So, in this case, buying shares is not an investment.
Scenario 3: The Business Guys issue no new shares so you just buy one from an already existing shareholder. Is this an investment. Well, in this case, the company never even got the money and as such it could not be an investment from the Business Guys point of view as we never got the money. Is it an investment? Has new capital been created? Not yet but lets expand the story. Lets say that you paid €20,000 for that one share. The guy who sold you the share is €20,000 richer and he buys a new car. Is that investment? Well, it’s something manmade so the first half of the definition has been satisfied, but is its used in the production of goods and services, the answer, it depends. If he just uses that car for personal use like driving his family around and going to and from work, then its not an investment. If he uses it for commercial use like drives it as a taxi or an Uber, then it is investment. But to be absolutely clear, the potential investment that occurs here when he buys a car and use4s it in a business sense, was his personal investment. It was not an investment when you bought the share off him. It only became an investment when he chose to put that one into a good or service producing asset. So in this scenario, we are going to count buying shares as not an investment.