Investment is the placement of capital in the expectation of deriving income or profit. Each investment is different and requires a different approach, but the general process is essentially the same regardless of the type of investment you are considering.
Understand the Investment
Do not rush into an investment, especially when it is of a “can’t miss” or “limited time” variety. Take the time to thoroughly understand it before you part with your hard-earned money. If you can’t understand an investment, do not go through with it, no matter how good it sounds. If you don’t understand it now, you won’t know when something has gone wrong.
Estimate the Upside
Nobody knows what the future holds but you can still reasonably assess the best-case scenario. For example, if you are considering purchasing a bond, you know the exact amount you will get back at maturity -- its face value -- so your upside is the amount of income you will receive annually. If you are considering a stock, you must establish some basis for believing how high its price can go.
Consider the Downside
Most investors do not give enough consideration to the downside, simply hoping their investment will do all right, or expecting that their adviser has looked into the risks. But, you must consider the worst-case scenario. For example, a bond may default resulting in a total loss for you. Any stock can also go down to zero at any time for any reason and take your money with it.
Assess Possibility vs. Probability
If the worst-case scenario for many investments is a total loss, consider how likely it is to happen and what you can do to minimize or mitigate the risks. For example, U.S. government and some insured bonds do not default, and the possibility of default is less for short-term bonds and bonds issued by leading American corporations such as Wal-Mart or Boeing.
The Time Factor
We all know the saying that “time is money” but few give it adequate consideration in investing. For example, if an investment can double, how soon? If you must wait 10 years, it may not be such a good opportunity. On the other hand, making just 3 percent per month on an investment could amount to more than 30 percent per year if you are able to replicate the success.
How Easy is it to Sell?
Most investments these days are easy to get into -- it’s getting out that may be a problem, especially if something goes wrong. Most stocks are very liquid: they can be sold in an instant. Bonds are liquid as well, but real estate, venture capital or private equity are not.
- “24 Essential Lessons for Investment Success”; William O’Neill; 2000
- “The Alchemy of Finance”; George Soros; 1994
- “The Battle for Investment Survival”; Gerald M. Loeb; 2009