What is investing? In theory, it is quite simple. It is the outlay of money today with the reasonable expectation that you will get more money back in the future. The concept is very simple, but in practice it is much more complex. What makes a good investment? What is the difference between an investment and speculation?
Are you investing or speculating?
Lets start with narrowing down the difference between investment and speculation. An investment involves purchasing a productive asset. What is a productive asset? A rental property, a share of stock in a company, or purchasing something larger like a car wash, self storage facility, or other business. The common theme with all of these is that they produce cash flow. Lets take a second and compare these assets to something that would fall into the speculation category, like gold, fine wine or art. Does gold produce any cash flow? You can purchase an ounce of gold for $1,200 as of this writing. Ten years from now, you will still have that same ounce of gold. Will it be worth more? Maybe, or maybe not. During that 10 year period, does it produce any cash? Does it pay you back? Simply put, you are speculating that at some point in the future, the gold will be worth more than it is today. Gold does not earn money by itself.
Now lets compare that ounce of gold to a share of stock. As an example, lets use a share of Colgate-Palmolive (CL). You can currently buy a share of Colgate for $67. Colgate, as a company, earned approximately $2 billion dollars in 2017. That share of Colgate is entitled to $2.28 of those profits. The management of the company reinvested a portion of those profits back into the business, and returned some of those earnings to you in the form of dividends. Every 90 days, Colgate paid you $0.39 for a total of $1.59 over the year. Colgate has been paying a dividend since 1895, and is showing no signs of stopping anytime soon.
The difference between a productive asset like Colgate and a non productive asset like gold should now be much clearer. As Colgate is working around the clock to produce toothpaste and soap, the gold is sitting in a safe somewhere, collecting dust. An investor can reasonably estimate what Colgate is worth based on the cash it produces every year, while the owner of the gold is left with hoping someone, somewhere will be willing to pay more than they did for their shiny chunk of metal. Investing in a productive asset is a very methodical way to grow your wealth. Being able to value a stream of future cash flows is what sets the investor apart form the speculator.
