The Basics of Making Good Investments
Its All About Risk
Whether you intend to invest your life savings or make monthly contributions you need to know what you are getting yourself into. In the investment world risk is the key factor in earning returns on your money. But as the word would suggest nothing is certain when it comes to risk. In a perfect world low risk means low returns and high risk should mean higher returns. A better way too look at risk is to substitute returns in the previous sentence with the potential of returns, thus high risk investment has the potential to reward investors with high returns - this is by no means guaranteed and often this won't be the case. So the first thing for investors to do is to find the amount of risk that they are happy with being exposed to. An investors goals and needs will play a big part in determining their appetite for risk.
Know your appetite for risk
Knowing your appetite for risk is the most important step in making good investments. There are 3 main categories when it comes to investment risk - conservative, moderate and high. Depending on your goals and funds you will fall into one of these categories. Lets's take a look at these three categories and see which one best suits your needs.
If you want to conserve your capital and can't stand to lose money then this is usually the best option for you. Conservative investments are there to protect what you have. The downside to this is that you won't really be making any money and for long term investments you could see your actual money shrink if your investment doesn't keep up with inflation. For example if you put $1000 dollar into a savings account for a year with a yearly interest rate of 5% you will have $1050 at the end of the year. Now lets say inflation ( which simply put is the rise in costs of goods - food, clothes, electricity etc - year on year) was at 10% for that year, thus resulting in a -5% move. Then in effect although your money increased with $50 for that year your buying power actually shrunk - thus it would cost you $1100 to buy the same products you bought a year ago for $1000 and you effectively lost $50 in buying power. So if you want to play it safe with your capital at least make sure that you are at worst earning the same as inflation otherwise you are actually losing money. Many investors use conservative products as a parking vehicle for their cash, while they are looking for another more long term investment opportunity. If you are looking to make a conservative investment you can look at a fixed deposit, money market products from your bank and government bonds.
The moderate risk level is for for people who want to earn a return better than inflation on their investments. When you are exposed to moderate risk should understand that there is a chance that your capital or investment can shrink, or more simply put that you can lose money and are not as safe as conservative investments. The risk of losing money is usually outweighed by the steady returns these investments can provide and here a bit of research will go a long away to getting peace of mind. For instance property is seen as moderate risk investment around the world. This is however very dependant on the area where the property is located. Looking into past property sales, valuations and average rental income will give you a good idea of whether or not the property concerned is a good investment. Some more examples of moderate investments are company bonds, certain shares and mutual funds.
High risk investment could potentially be the most profitable, but the journey to those returns will be up and down. If would be wise to only invest money that you can afford to lose or money that you can afford to be without for a longer period of time in high risk investments. Shares is a good example of a high risk investment, depending on what the markets are doing you can make or lose a lot of money. One thing to remember with shares is that although you might see losses in the short term over the long term share prices usually goes up. This makes shares a great investment if you plan to keep investing for periods of up to 5 - 20 years. Other than shares, certain mutual funds and foreign exchange fall in to the high risk category.
In short we all want high returns on our investment with the lowest possible risk. Unfortunately that doesn't happen very often in the real world. There are however a few of ways in which you can minimise your risk and still get good returns. Lets take a look :
As I have mentioned before, doing your research before investing is a great way to minimise your risk. Research will help you to identify whether the product you want to invest in does indeed suit your appetite for risk. if you are looking to invest in a company, take a look at the company's financial statements and goals. These will show you where the company is financially and where they are aiming to go. If you are considering investing in a mutual fund then look a the year on year returns that the fund have been delivering in the past. The more information you have before making an investment the better.
By spreading your money over a few investments you are able to mitigate investment risk very effectively. Thus if one or two of your investments have negative earnings the other might have positive earnings thus off setting your loss. One can diversify through investing in different risk categories and/or by investing in different products within a specific risk category. For instance if you like to invest in shares, then diversify by investing the different business sectors, like industrial ( Gold, oil etc.) and financials (banks and insurance companies). Then even if one goes down in the market the others could go up and help you get positive returns. In short its better not to have all your eggs in one basket.
The duration that you plan to invest for influences you risk in a couple of ways. Firstly the longer you invest the longer you have to recoup losses in the short term. Most investment products have good and bad cycles in the market place, and unless you are able to spot these bad cycles and move your money before they appear you will have to ride out the bad cycle or move your money and take a loss. If you can afford to wait then in time the good cycle will come along and your investment will return to its previous higher levels.
Secondly, by keeping your money invested for longer you should get higher returns. One very important term in investing is compound interest/returns. This means earning money of your previous interest/returns and the longer you invest the bigger your compound interest/returns will be.
Bringing it all together
So before making an investment determine which risk category best suits your goals and needs. Ask yourself what the goal of your investment is. This will help you determine for how long you plan to invest and what sort of returns you would prefer. Secondly do some research on the investments products that you are interested in. This will ensure you that you make an informed investment decision. Lastly remember to diversify. The wider you spread your investments the better your chances of making good returns and not losing money. In the end you have to decide whether an investment opportunity is a good fit to your needs. By doing so you will ensure that you make a good investment.