In today's world, there are so many opportunities to invest that it can be hard to decide what to invest in. The first step to figuring out where to invest your hard earned dollars, is to define your investment criteria.
A few points to consider when determining your personal investment criteria are:
- What are your investment goals?
- How much money do you have available to invest?
- How long is the time period you have to invest?
- Do you have any specific areas of expertise?
- Are you looking for income or capital appreciation?
- What is your risk tolerance?
- What is the minimum rate of return your are seeking?
- Are you looking to make a debt or equity investment?
What are your investment goals?
The very first question you must ask yourself is, why am I investing?
For many that answer will be retirement. For others it can be for your child's college education, to create enough income to live off of, to start a business, to buy a nice toy at some point in the future, or simply to beat inflation.
It may be possible that you have more than one goal for investing and have to allocate your investment dollars accordingly.
How much money do you have available to invest?
The amount of capital you have available to invest will also play a significant role in defining your investment criteria.
Do you have a large lump sum of money you saved, inherited, or otherwise accumulated? Will you be able to make regular contributions to your investment account overtime?
The amount of money you have to invest will also determine the minimum size investment you are willing to make. If you have $10,000,000 to invest you may only consider only consider making investments of $500,000 or more. Anything less might be a waste of your time.
On the flip side, if you only have $10,000 or $25,000 to invest then you may be more limited in the investments you have access to. Also, with many alternative investments, you can only make an investment in a lump sum, unlike the stock market where you can invest in increments overtime.
How long is the time period you have to invest?
If you're investing for retirement then your time horizon may be pretty long (10,20,40 years) and you can take a long term approach when choosing your investments. This approach will likely give you the most flexibility when determining your investment criteria.
If you're saving for your child's college education, you may have 17 or 18 years to invest. You would have to choose an investment that would allow you to exit the investment or would be able to throw off sufficient cash flow to fund the expenses of a college education by the time your child is college age.
If you are looking to open a business in 5 years then your time horizon is much shorter and your criteria will likely vary significantly than it would under a long term approach.
Also, you want to ask yourself before making an investment, will I need this money before the investment matures?
If you choose a strategy that will tie your money up for 5 years but in year 2 all of a sudden you need the money, you may be in a bad situation. In many cases such as a loan or an equity investment in an alternative asset, you will won't be able to pull your money out so easily, and if you can, there might be some penalty for doing so. Even if you are in a more liquid asset such as a stock, if you planned to be invested for 5 years but pull out in year 2, you may have to sell at a loss.
Do you have any specific areas of expertise?
We all don't have the same skill sets or industry experience. Your specific knowledge of a certain industry may make it advantageous for you to invest in that industry over others.
For example, If you're in the pharmaceutical industry, you may see trends developing that allow you to choose the right pharma stocks to invest in for the future.
If you're a successful restaurant owner, your expertise may allow you to understand what makes a successful restaurant and therefore allow you to see investment opportunities that those not in the restaurant business don't see. Not only that, but your wisdom and connections may even allow you to make suggestions and recommendations that can improve the restaurant you invest in.
As you can see, your specific knowledge and expertise may give a leg up in a certain area, making it a better area than others for you to invest.
Are you looking for income or capital appreciation?
As you already know, not all investments have the same type of returns. Some are purely income based such as an annuity or loan, others are purely capital appreciation such as a growth stock (i.e. Amazon), and others have a combination of both.
If you are looking to grow your seed capital to start a business in 5 years, then choosing an investment with high potential for capital appreciation over 5 years may be a great choice for you.
If you have a large amount of inheritance or savings that you are looking to live off of, then choosing a more conservative investment that pays out a regular and reliable stream of income (i.e. distribution, interest payment, dividend), that may or may not a capital appreciation component, might be the better choice for you.
What is your risk tolerance?
Generally speaking, there is a positive correlation between risk and reward. The lower the risk, the lower the potential return. The higher the risk, the higher the potential return. If you are willing to take a higher risk then you should be compensated with a higher return.
Everybody's risk tolerance is different and your investment goals may also have an effect on your appetite for risk. If you are looking to buy a Ferrari in 5 years then you may be willing to invest in an investment with higher risk than if you were investing for your child's college education.
What is your minimum rate of return your are seeking?
As you become more sophisticated in understanding your investment objectives and begin investing, you may eventually choose to make investments with a minimum rate of return. For some that is 6%, and for others its 15%+. This will be determined by your investment goals, risk tolerance, and other factors discussed here.
Are you looking to make a debt or equity investment?
Again, the factors discussed here will determine weather you choose to make debt or equity investments, or consider a combination.
Typically, debt investments pay a fixed interest rate, such as 8%, over the term of the loan. If the underlying business or asset performs well then you will not participate in any upside, and if it performs poorly you still have the right to collect 8% interest over term of the loan. Sometimes the loan is secured by collateral such as real property, other times it is not. Usually with an unsecured loan you can demand a higher interest rate in return the added risk. Debt is often considered less risky than equity.
With equity, your are buying a piece of the business and are exposed to both the upside potential and downside risk. If the underlying business or asset performs well then you will participate in the upside returns. If it performs poorly then you will also participate in the losses. In many cases being an equity investor has more tax advantages than being a debt investor, but it comes at a higher risk.
The Bottom Line
By asking yourself these questions you will be able to better define your personal investment criteria. Having a well defined investment criteria will allow you to choose the type of investments that are inline with your investment goals and avoid investments that are not, which may be most important of all.
You may also discover that the cookie cutter advice given by Wall Street and financial advisers may not be the best option for you, and that your expertise or connections allow you to invest in alternative investments such as real estate.
Babylon Property Group, LLC provides FREE consultations to those who are interested in real estate investments. To schedule your free consulation, please contact us by phone at (631) 253-1609 or email at firstname.lastname@example.org.