Investment spending is an important part of financial planning in any business and Forex trading is not an exception. Investing in the financial markets has the same goal as any other business - getting profits. Of course, there is an initial investment in Forex trading as there is no other way to get profits rather than invest in the trading account. However, a certain part of profits received from trading can be used to increase the efficiency of trading strategies, improve the overall performance or build a long-term portfolio aimed to create wealth. This article is aimed to provide an in-depth guide of the investment spending in the financial markets.
What is investment spending?
The main idea here is that business owners and managers always decide where to head their companies’ profits. Of course, they have to spend cash for salaries, taxes and other important types of periodic spendings like paying bills for electricity and so on. However, not all of the rest of the profit is converted into net payouts such as dividends. Companies may expand their footprint in a particular market they operate in, and increase potential profits by enlarging output, production and sales at the end of the day. To do that, managers decide to invest in the infrastructure that produces the profit. For instance, a taxi company could consider purchasing more vehicles, a plant might need to enlarge the number of machines or equipment, while a baker would need more ovens to produce snacks.
When it comes to the financial markets, a certain part of the income or profit received from previous trading activity could also be redirected or reinvested in the same field the money came from. For example, a Forex trader might be interested to invest some of his profit from trading in a long-term perspective, buying several attractive assets that have the potential to get more expensive. Such an approach is called creating an investment portfolio, which may include stocks, indices, commodities, currency pairs or cryptos. The brightest example is in the price of Bitcoin, which used to stall for some time, but in two first weeks of 2020, the price soared for more than 20% on the back of positive fundamental news from Chicago Mercantile Exchange. An investment portfolio is aimed to provide a stable income and wealth in the future, and it is a balanced and hedged set of assets to use the buy-and-hold strategy.
Types of investment spending
Any kind of spending aimed to improve the overall situation with capital goods is an investment as the main goal is to increase profits. However, some businesses might consider renovation or upgrade investment spending instead of increasing the number of machines or equipment. This type of investment spending is called replacement.
Imagine a car producer that already has a certain number of plants working to assemble and supply vehicles to consumers around the globe, like Volkswagen. At some point, the company’s management decides to go in line with the global demand for electric cars. So they need to replace some of the equipment designed to produce internal combustion engines with machines to deliver electric engines.
Another type of investment spending targets new purchases to increase the overall volume of production, output, income and profits. This kind of approach is keen on simply increasing the number of machinery and equipment, and fulfil the growing consumption of the company’s products.Talking about the analogy of financial markets, Forex traders and investors also have two choices:
- The first one suggests rebalancing their portfolios, deleting assets and trading positions that bring lower profits, and increasing the investment volume in those assets, which deliver the best performance;
- The second option is just to increase the overall trading volume without changing the portfolio allocation.
How to calculate investment spending?
Investment spending formula comes from economics. Besides the Gross Domestic Product formula used in the calculation of wealth in different countries, there are several approaches to formulate investment spending for different businesses and private companies. However, the general approach remains the same.Here is the GDP formula used in macroeconomics: Y = C + I + G + NX, Where:
- Y is GDP,
- C is Consumption,
- I is investment,
- G is government spending,
- NX is net export.
Several terms are used in the investment spending formula. Such terms as the gross investment and net investment are described in separate articles. The main difference between them lies in a space of the third term which is depreciation. This factor is used to calculate the pace of the decline in the price of existing equipment and machinery. Regardless of which type of investment spending is used (new purchases or renovation), net investment consists of gross investment minus depreciation.
Projecting these factors on the financial markets, some of the assets in the investment portfolio might not bring a stable profit all of the time. So depreciation could be implemented as the difference between profitable and losing deals, while the investment spending will be aimed to cover that difference. Any portfolio needs rebalancing from time to time, while investment spending could be forwarded to those assets that bring more profits while losing deals can be deleted from the equation.