One thing the modern investor is never short of is data and information. We are bombarded with data from various sources: share prices, earnings reports, economic forecasts, national statistics. A lot of this can be useful. But for many of us, it can be overwhelming. We have so much data we can’t understand what’s going on. The only way to cope is by focusing on the key things you need to understand about any investment. Here is the list of the six questions you need to answer before investment.
1. How does investment make money?
I think this is the simplest possible question that comes to your mind. What have you invested for and what do you expect in return? Investing in share means buying part of a business so that you will receive some profits in the future.
Have you lent money to a business or financial company that will invest it to make money and pay you back with interest? (This is an example of corporate or government bonds or simply put money on deposit.)
Have you bought something in the expectation that it will go up in value so as to sell it for a profit? (This is what happens if you invest in gold or land or real-estate)
Understanding this will allow you to sensibly analyze your investments, the kinds of risks they have and how they might be affected by changes in the economy. You might also want to understand the different factors that explain the return you get on your investment.
2. What could you lose?
No one likes to think about the downsides of their investments, but understanding risks is a crucial tool in managing your portfolio and ensuring you won’t end up completely broke.
With investments, your capital is at risk. If you buy shares of a risky company, then when it goes bankrupt, you will get little or nothing back. Similarly with corporate bonds, in case of defaults, you may not get back as much as you invested in.
If you properly study before buying the stock, you can justify your investment. And to ensure you won’t end up broke, make sure to diversify your portfolio in a way it can cover the losses.
Deposit accounts are less risky – your main risk is on missing out on bigger return opportunities. Even then there is a risk that the bank or other institution will go bankrupt and unable to give your money back.
3. How does Investment payout?
The reason we invest is to gain more money from the initial investment i.e to make a return on our investments. There are two ways you make a return on an investment – income and capital gains.
The distinction between the two isn’t always obvious. Income is money or additional shares declared to you by the company you invested in. You’re liable for income return if you hold the shares. While capital gains are what you will get when you sell some or all of the investments in profit.
Both are related to the performance of the company, although the dividend distribution is under the companies control (assuming they are running in profit) whereas the capital gain is determined by the volatility of the market.
It will depend on where your priority lies in. Different sorts of return might suit different kinds of investors at different stages of life. This will depend on the goal of the investment. Whether the investment is long term or for trading purpose, the main idea is to generate income with little efforts.
4. How liquidate the investment is?
You make lots of money in an investment, but what if you need that money urgently and can’t get it? Some investments are easier to turn into cash easily. This is known in the technical term as “liquidity”.
How sellable that is will depend on whether there are enough ready buyers. Sometimes circumstances may require you to sell in a hurry then you may have to accept a lower price (and hence a lower return or loss).
For others, such as some deposit accounts, there are explicit charges or time limits or day limits that apply before you can get your required money back.
Generally, you get a higher return if you are willing to accept less liquidity but you may want to make sure you have extra savings in an easily accessible form. This will avoid losing money when cashing investments.
5. Is it worth the risk to get the unknown return?
It is broadly known fact in investing: higher the risk, higher the return. But, It’s not always true tho. Many have fallen prey to these risks. And if you want to reduce your risks then you must be willing to accept a lower return.
Frankly speaking, there is no such thing as a free lunch. So make sure your investment will get good value or return for what you spend. You need to study various data carefully to make sure that you will be getting the full reward for the risks you are bearing.
6. Does it suit your needs?
This is a crucial question. It’s all depends on your priorities. Once you understand your investments and the possible scenarios for them, you can use that to decide whether they are working for you as per your requirements.
There are some stages in your life when you might need stability and security. At other times you might be able to afford risks in exchange for better long-term growth. Some people prefer taking risks and winning (or losing) big. Others prefer to go slow with patience even if it means missing out on a few great opportunities.
The answers to these questions depend on you and your circumstances.
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