What are direct and portfolio investments?

What are direct and portfolio investments?

In this material, we will explore what direct and portfolio investments are: what they mean, the differences between them, and which type of investment is right for you.

Direct and portfolio investments are two different approaches to investing in the capital market. They differ in their goals, risks, and strategies. Each of these investment types offers unique advantages to the investor, so if you're interested in unlocking your investment opportunities, it's important to understand these terms.

What are direct investments?

When it comes to investments, most people only see one side of them – the potential for growing capital. However, under certain conditions, they also serve another important function – acquiring the investor's ownership rights or control over a company. These types of investments are called direct investments.

Direct investments are the injection of funds or assets into the capital of a legal entity, where the investor (individual or company) receives direct ownership rights or control over a specific company or project in return.

In developed countries, a direct investment is defined as a contribution of no less than 10% of the company's capital. However, if a smaller stake allows the investor to influence the company’s activities, it will still be considered a direct investment. Therefore, if the stake exceeds 10%, but the investor does not have actual control over the object, the investment is not considered direct.

An interesting feature of direct investments is the variability in the form of the investment. Direct investments can be made in several ways:

• Purchasing a significant share of a company's stock. This amount can vary, but it typically should be no less than 10% of the total number of shares.
• Transferring property to the company’s ownership. This can include real estate, equipment, intellectual rights, etc.
• Contributing funds to the company's authorized capital. This method can be applied to most types of companies, including private ones or startups.

It can be difficult to understand without examples, so let’s look at two practical cases of direct investments:

In October 2006, Google announced its intention to acquire a young, ambitious project called YouTube, which at that time was less than two years old. The deal was valued at an astounding $1.65 billion, which was the largest purchase by Google at that time.

Sixteen years later, in 2022 alone, YouTube’s revenue reached $29.2 billion. This is almost 18 times the purchase price. As the sole owner, Google receives 100% of the profits from this project. This direct investment is considered one of the best investments in the company's history and continues to be one of the main drivers of its growth today.

Google-YouTube-Acquisition
The acquisition of YouTube by Google – an example of a successful direct investment.
Photo: HOME.org.

Another example: Let’s say you own a property valued at $5,000. Your acquaintance offers to transfer this property to his chain of coffee shops in exchange for a stake in the company. The current value of the business is $20,000.

After the transfer, you become a co-owner of the coffee shop chain with a 20% stake. From now on, you are entitled to 20% of the coffee shop's profits and can propose management decisions for consideration among the other owners, who will have at least 20% support. Therefore, you are a direct investor in the coffee shop.

Summary:

• Direct investments involve injecting funds into a company with the goal of gaining partial or full control over it.
• Through direct investments, you can invest in any company in various forms.
• Direct investments are low-liquidity and non-diversified, meaning they carry high risk.
• A direct investor aims for higher long-term profits due to a large shareholding and the ability to influence the company's operations.

What are portfolio investments?

Unlike direct investors, portfolio investors do not aim to control a company. The main goal of such investments is to grow capital through the appreciation of stock value and dividend payments. Most likely, you are either already a portfolio investor or plan to become one.

What Are Direct and Portfolio Investments?

In this article, we will explore what direct and portfolio investments are: what they mean, the differences between them, and which of these investment types might suit you best.

Direct and portfolio investments are two different approaches to investing in the capital market. They differ in terms of goals, risks, and strategies. Each of these investment types offers unique advantages for the investor, so if you're interested in exploring your investment opportunities, it's essential to understand these terms.

What Are Direct Investments?

When it comes to investments, most people only see one aspect – the potential for capital growth. However, under certain conditions, investments also serve another crucial function: the investor gaining ownership rights or control over a company. Such investments are called direct investments.

Direct investments are the contribution of funds or assets to the capital of a legal entity, where the investor (individual or company) receives direct ownership rights or control over a particular company or project in exchange.

In developed countries, the criterion for classifying investments as direct is a contribution of at least 10% of the company's capital. However, if a smaller stake also allows influencing the company’s operations, such an investment is still considered direct. Conversely, if a stake exceeds 10% but actual control over the entity is absent, the investment is not considered direct.

An interesting feature of direct investments is the variety of forms in which they can be made. Direct investments can be realized in many ways:

• Buying a significant share of a company’s stock. This amount can vary, but usually, the share must be at least 10% of the total shares.
• Transferring property to the company’s ownership. This could be real estate, equipment, intellectual rights, etc.
• Contributing funds to the company’s authorized capital. This method can be applied to most types of companies, including private ones or startups.

It's hard to understand without examples, so let’s go through two direct investment cases in practice:

In October 2006, Google announced its intention to acquire a young, ambitious project called YouTube, which at that time was less than two years old. The deal was worth a staggering $1.65 billion, making it Google's largest acquisition at the time.

Sixteen years later, in just 2022, YouTube’s revenue reached $29.2 billion, almost 18 times higher than the purchase price. As the sole owner, Google receives 100% of the profits from this project. This direct investment is considered one of the best investments the company has ever made and remains one of the primary drivers of its growth to this day.

Another example: suppose you own a property worth $5,000. Your acquaintance proposes transferring the property to the ownership of his chain of coffee shops in exchange for a share in the company. The current value of the business is $20,000.

After the transfer, you become a co-owner of the coffee shop chain with a 20% share. From now on, you are entitled to 20% of the profits from the coffee shop and can propose management decisions that will be considered among other owners of the chain, who must have at least 20% support. Thus, you are a direct investor in the coffee shop.

Summary:

• Direct investments involve placing funds into a company with the goal of obtaining partial or full control over it.
• Direct investments can be made in any company and in various forms.
• Direct investments are low-liquidity and non-diversified, which makes them high-risk.
• Direct investors expect higher long-term profits due to their significant participation and the ability to influence the company’s operations.

What Are Portfolio Investments?

Unlike direct investments, portfolio investors do not aim to control the company. The primary goal of such investments is to increase capital through stock price appreciation and dividend payments. Most likely, you are either already a portfolio investor or plan to become one.

Portfolio investments are the placement of funds in securities, derivatives, and other financial assets on the stock market, where the investor does not acquire direct control over the company or project but does so exclusively to earn income in the form of dividends and capital gains over time.

Portfolio investments have no specific requirements for the amount, ownership share, or other factors. Each portfolio investor selects parameters that suit them, focusing on creating an investment portfolio to diversify and optimize risks. These can include both short-term trades and long-term investments, as discussed in this article.

Portfolio investments can consist of:

• Company stocks and ETFs (Exchange Traded Funds);
• Corporate and government bonds;
• Investment funds (REITs, mutual funds, hedge funds, etc.);
• Derivatives (options, futures, warrants, etc.).

Portfolio investments are a critical component of financial stability and have become a popular phenomenon in the finance sector. Their popularity has led to the emergence of investment funds and financial advisors—specialists who are ready to build and manage your portfolio investments for a fee. This greatly simplifies the process and helps those starting in this field with minimal skills.

For example, you can get a portfolio of the 500 largest companies in the U.S. stock market by buying shares of just one fund – SPY. Alternatively, you can work with a fund that has professional management strategies. Fondexx offers both of these options, and you can learn more about each at a meeting with a manager.

Summary:

• Portfolio investments involve forming a diversified portfolio of assets with the goal of earning financial benefits through price appreciation and dividend payments.
• Portfolio investments can only be made on the stock market.
• They are diversified and relatively less risky than direct investments.
• The process of creating and managing portfolio investments can be entrusted to an investment fund or financial advisor.

Direct or Portfolio Investments – Which to Choose?

It’s impossible to answer this question definitively because each type of investment suits different situations. However, we can describe which type of investment is more suitable depending on the goals and characteristics.

Who will find direct investments interesting?

• Individuals or organizations with large financial resources seeking significant control over other companies or projects;
• Venture investors and business angels investing in startups and small businesses to help them grow;
• Corporations and conglomerates seeking to expand their operations or acquire competitors;
• Investment funds specializing in specific industries and looking to invest in companies within those industries.

Who will find portfolio investments interesting?

• Financially literate individuals consciously planning their financial future.

In short, direct investments require more expertise and involvement in the process. It’s a complex process with numerous legal aspects and requires significant investments. On the other hand, portfolio investments can be simplified and still remain effective.

By considering each aspect, you can start your actions with more confidence. To help with this, we’ve prepared a comprehensive comparison table where you can review the pros and cons of each investment type:

Summary

Globally, portfolio investments cannot be considered the counterbalance to direct ones. Direct investments complement the opportunities an investor gains within the framework of portfolio investments. While they differ in goals, risks, and execution strategies, all investments primarily aim to preserve and grow capital by distributing and controlling risks.