What To Consider Before Investing
Welcome to a detailed write-up on things that you may wish to consider before investing. It begins by giving a brief definition of investments. The guide then explains some of the factors that can be important in making investment choices.
Perhaps you have some savings and have always wanted to invest, but you are not sure how to go about it. Maybe you don’t know where to start when it comes to investing your money, or you are here to gain more information and possibly invest in the future. Whatever the case, this guide can help you maximize your investment knowledge.
It is important to note that this is a contributed article that is not financial advice under any circumstances. It is purely for educational purposes.
What are investments?
Investments in any form refer to the purchase of assets using a capital sum(money) with the expectation that they will generate profits/income flow and possibly (in the case of property and shares) growth in the future. Simply put, investing usually means trying to increase your money at a rate that is faster than putting it in a savings account.
What to consider before investing?
It may be prudent to consider some of the following factors which can contribute to your decision to invest.
1. Investment Purpose
Financial experts believe that it is important to know why you are investing since this guides all other investment decisions. Having a purpose can prevent you from being sidetracked and may enable you to maneuver through tough times.
Not having an investment purpose or investing merely to get the greatest potential return on your money may lead you to a bad situation. Sometimes, it can be considered better to focus on getting a return of your money and not a return on your money. However, different people have different investment objectives, which means that an investment that is suitable for one person may be unsuitable for another.
2. Investment Capital
This refers to the amount of money that is available to you for investment purposes. Capital investment is usually a major factor since it has a major role to play in the size, investment type and whether the investment is sustainable for your situation.
A common misconception is that investment is for the wealthy folks. However, this is false. Whilst there are investments to match everyone’s financial ability, financial institutions offer loans to give individuals the support they need. If you choose this route, you may want to ensure that you can meet the terms of the loan.
3. Risk Vs Reward
In finance, risk refers to the possibility of losing money due to unforeseen circumstances. Every type of investment has a certain degree of risk associated with it. The risk/reward ratio is often used to compare the expected return of an investment to the amount of risk undertaken. This ratio is calculated by dividing the potential risk by the potential profit to be generated from the investment. It is often used by investors as an indicator of whether to proceed with investment plans.
Being aware of your risk tolerance can be essential in avoiding future stress that may be caused by the risk associated with your investment. The purpose of investments is to increase the quality of your life and not decrease it by adding unwanted stress. Some people believe that stocks tend to be relatively riskier investments than bonds. Therefore, one may need to take a calculated risk when investing in stocks. One way of doing this could be to check the performance of various stock markets on some of the best stock picking websites.
As a general rule in business, many have said that the higher the risk of investment, the more potential there can be for a higher return. For those who are skeptical about undertaking risk, Robert Arnott states “In investing, what is comfortable is rarely profitable.” Of course, this is juts one person’s opinion and we are all entitled to our own.
4. Return on Investment
Return on Investment (ROI) is a measure used to indicate the profitability or success of an investment. In some cases, it is used to compare the performance and efficiency of different investments. To calculate this ratio, divide the benefits(returns) by the cost of the investment.
The result is usually indicated as a percentage or ratio.
If an investment’s ROI is net positive, it could produce results. Consequently, investments with negative ROI may have a net loss. It is worth noting that ROI does not take into account the holding period or passage of time. Therefore, opportunity costs of investing elsewhere can be missed.
5. Time Horizon
Due to varied investment goals, the time required for cashing out on investment also varies. Someone who invests for retirement probably has a longer time frame than someone who wants to invest to buy a home. This could ultimately affect the choice of investment. The investment period mainly depends on the personal needs of the investor.
An investment can be short, medium, or long. Long-term investments are normally held for more than a year while short-term investments can be held for one year or less.
Some investments may also attract penalties if surrendered or redeemed before a holding period. In this case, you may want to ensure you might not want to exit before the stipulated redemption period.
6. Inflation Rate
As the prices of commodities such as petroleum products or metals increase, so does the price of most goods and services. This is referred to as inflation which usually leads to a decrease in the value of money. The Inflation rate is usually expressed as a percentage calculated annually to estimate the price of goods and services in the economy.
According to trading economics, as of April 2021, the annual inflation rate in the US soared to 4.2%. Bearing this in mind, an investment could aim to generate interest of 6% or more to beat inflation. Some people believe that an investment worth considering can be one whose ROI is higher than the inflation rate. Ultimately, inflation is sometimes a motivation to invest since investors can be unlikely to see returns high enough to fend off inflation when they hold money as cash in a bank account.
Some investments such as property and shares can be positively influenced by inflation. Their value may increase as inflation rises, but not always.
After going through the factors above and considering your own needs and objectives, hopefully you can have an idea of what you would like to do moving forward. There is no ideal time for everyone. Just ensure that the time and conditions are right for you.
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