Classification of Investments

Investments can be categorized on quite a few bases like significance, size, functional activity, cost and revenue management, etc. On all the above, most appropriate way of classification is on the basis of correlation between investments.

The probable correlation between investments are listed below:
1. Prerequisite
2. Complement
3. Independent
4. Substitute
5. Mutually Exclusive

1. Prerequisite: One investment might be a prerequisite for the other. In other words, an initial investment is required for further investment.
For example: Investment in land is prerequisite for construction company

2. Complement: If secondary investment increases the expected returns from the primary (or decreases cost), then the secondary investment is said to be a complement of the primary investment.
For example, Erection of new plant to enjoy the cost advantage due to mass production.

3. Independent: Investments are said to be independent, if the cash flows from primary investment would be the same despite of whether the secondary investment is undertaken or not.
For example, Buying a lathe for the plant and computerizing administration activities are independent investments.

4. Substitutes: If secondary investment decreases the returns generated from the first investment (or increases costs), then the secondary investment is said to be a substitute of the first. This kind of investment are inversely correlated to complement investment.
For example, Producing air-coolers and fans for the same market may lead to product cannibalization and erode profitability.

5. Mutually Exclusive: In the extreme situation, the benefits from the primary investment may totally disappear if further investment is accepted or it may be technically impossible to undertake both. Such investments are called mutually exclusive investments.
For example, it is not possible to build a plant in two different locations. Accepting one will result in involuntary rejection of the other.