When it comes to financial investments, we have many options. We can put our savings in a bank account, we can buy bonds, stocks, real state or cryptocurrencies, to name just a few options. So given this many choices, how can we decide? Each options will have its own characteristics that we should examine carefully. But in my opinion, when it comes to factors to consider when making investment decisions, there are only 5 main components. And in this post, I’m going to talk about them.
Suggestion: Reading guide to financial lifestyle and learning about its different aspects can also help in these kinds of situations.
1. Rate of Return
This is usually the first thing people look at, when evaluating an investment option or making investment decisions. It is often stated as an annual percentage, like 10 percent per year. And obviously, a higher rate of return would be more desirable for any investor.
Some investment options will have a more or less fixed rate of return. And some will experience big fluctuations each year. For example, banks will have a nominal rate of interest and cryptocurrencies and stocks will be more volatile in terms of actual returns.
We all have some idea of what a risk is. But in financial terms, risk is the probability and the extent by which the actual result could be different from the expected result. In other words, risk is the amount by which the return for an investment could be higher or lower than its average expected value.
Too much risk is not a good thing. And you should always pay attention to the amount of risk you’re taking by choosing an investment option.
Professional investors use sophisticated models to calculate risk. You can use these models, if you know how they work, or you can use more simplified models to compare the amount of risk you would take by investing in different options.
Crypto is a relatively risky option, stock market is also risky. But government issued bonds and saving accounts are usually considered safer, depending on where you live and how its financial system works.
Note: Rate of return and risk will have an inverse relationship. Meaning higher rate of return will usually be accompanied by higher risk.
The higher the liquidity, the easier it is to sell your investment any time you want. For example, regular bank accounts and large-cap cryptocurrencies will have more liquidity because you can sell or exchange them practically any time you want. And real state will have very little liquidity because it can take months to sell a property and get the whole price for it.
4. Tax Cuts
Government will issue tax cuts for certain kinds of investments. And you should consider them when choosing between different investment options. People usually prefer to pay less tax when possible. For examples of this, see your local and national rules and regulations.
5. Age and Time Frame
There are always trade-offs between the characteristics that we defined above. So the final factor to consider when making investment decisions, should be age and time frame.
For example, when you are in your 20s or 30s, you can tolerate more risk. And especially if you think long-term (like a few decades), you can prioritize rate of return to maximize your wealth over time. You should also consider any available tax cut. The opposite is true for when you’re in your 70s for example.
The question of liquidity is also very dependent on the time frame. If you’re investing for the short term (a few months for example) you should only consider the more liquid options.
Note: If you’re going to need your money to pay rent or tuition or to buy food, don’t think about any investment options that has risk or doesn’t have much liquidity. Better yet, don’t think about these things at all. Save money first.
What are your factors to consider when making investment decisions? Comment below with your thoughts.
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***Last Updated on 1 April 2022 by Hamed Derakhshani (Guy with a Wallet)