Each and every day, more people become aware of the importance of investing. They know that investing is a great way to create wealth and prepare themselves for the future however, only a few people know the right way to invest successfully.
To be successful as an investor, you need to understand certain elements. There are risks involved in investing and a good investor wants to minimize the risk and make more profit. That is why I want to share with you the four keys to successful investing. Let’s get into it!
Key #1: Investment Returns
What is an investment return? This is the profit you make at the end of the day on any investment. It is important to understand this if you want to succeed when investing. It is also known as the Return On Investment or ROI. It is either expressed as a percentage or ratio of the profit to the investment cost. That is the ratio of the total amount of money you gained to the original amount you invested. It is calculated to show whether you are gaining or losing on an investment.
When you invest your money you give up certain benefits of using the money right now hoping to get benefits from it later. The profit you get from investing is your reward for not spending it but instead placing it into a growth vehicle. Therefore, you need to understand some concepts of investing to make the maximum profit at the end of the day.
You should take note that a successful investment should generate a high return. At the same time, the risk and the investment cost should not be too high. Remember that the first reason why you want to invest in the first place is to make a profit. If the risks are too high it is possible to lose all your money.
The profit you make from an investment is a function of the risk that is involved in the investment. Investment with low risk usually generates low investment returns while investment that comes with a higher risk has the potential for more profit. For example, treasury bills are usually safe and have less risk. But the return on investment of treasury bills is low when you compare it to other investments with high risk such as stocks. Stocks have a higher average return and also come with higher risk.
Investment returns are paid as either interest or dividend. You can receive interest if you invest in a high-yield savings account or certificates of deposits popularly known as CDs. Dividends are paid when you own stocks. Another way to make money on your investment is to give it time for the investment to appreciate then sell it for a profit called a capital gain. Now, it is very easy to calculate the return on investment and the result provides useful information to measure the profitability of any investment.
For example, if you invest $10,000 into a business, and after 2 years your investment now worth $15,000, we can calculate the investment return.
To do that, we subtract the $10,000 (which is the investment cost) from the $15,000 current value. The answer is $5,000. The profit after 2 years is now $5,000. To calculate the percentage, divide the profit by the investment cost and multiply the result by 100. In this case, it will be $5,000 divided by $10,000. And the result multiplied by 100. The answer is 50%. That means that this investment generated a 50% profit in 2 years.
Key #2: Investment Cost
The next element you need to understand to succeed when investing is the investment cost. You indeed have to spend money to make more money. However, when it comes to investing, more money spent does not always mean more profit. You have to be careful when it comes to considering how to spend your money on an investment. Your goal should be how to spend the least amount of money to get the maximum profit.
The investment cost is the total amount of money you use on a particular investment. The profit you make from an investment is not always related to the amount of money you invest. The amount of profit you will realize at the end of the day will be related to the type of investment and the risk involved. Generally, an investment with higher risk has the potential for higher profits while investment with little risk offers lower returns.
Each time you spend more money than you are supposed to spend, you reduce your potential profit. Sometimes you don’t realize that you are making this mistake. Most people think more money spent is what makes the profit bigger. That is why you need to understand what investment cost is to know how to make the right investment decisions. It is important to take note of every amount you spend on an investment no matter how little to know the amount of profit you made.
Here are some investment costs that you may incur when investing beyond your initial outlay.
For example, investing in mutual funds may cause you to incur an expense ratio. This is like a management cost for the fund and it is expressed as a ratio. This is also an investment cost and it is debited from the investment return. That is, if your expense ratio is 0.7%, you are going to spend $7 on every $1,000 you invest annually.
This may not look like a big deal until you study it carefully. You will realize that they add up to become a big number at the end of the day. This money doesn’t get lost only as an investment cost. They are also lost as they should have the potential of contributing to your return but they end up reducing it instead.
For example, investing $100,000 at an interest rate of 6% per annum will generate about $430,000 in 25 years. But if you need to pay just 2% of the money per annum as investment cost, you will end up losing $170,000 and be left with $160,000 as profit. That is, about half of the profit you are supposed to earn has been lost to investment cost.
Another cost you may spend when investing can include maintenance and repair costs. For example, if you invest in real estate, you may need to spend some amount of money on repairs and more on the maintenance of the property.
You also need to understand that part of the investment income you earn will be lost to the advisory fee that you pay. It is another place where you spend more money and it can reduce the total return on investment. For example, if your investment advisor charges just 1% of every $100,000 you invest, that is about $1,000 every year paid to the investor advisor which is also removed directly from your investment returns. Some brokers charge you transaction fees when you want to buy and sell shares. These fees are usually fixed and the disadvantage becomes more obvious when you are transacting with a higher amount of money.
Key #3: Investment Risk
Risk is part of everyday life and it also comes into play when investing. Simply put, there are risks involved when investing. Jim Cramer once said:
“every once in a while, the market does something so stupid it takes your breath away.”
It is therefore important that you know what investment risk is all about so that you will understand how to avoid them and also learn how to solve them when you encounter them. Generally, investments with higher risk often have the potential for higher returns. Your goal is to invest in things that will give you the maximum profit with the lowest risk. Therefore, you should consider the risks that are involved in an investment before moving your money into it.
There are different types of risks you may come across when investing. The first one you need to understand if you want to succeed when investing is liquidity risk. Liquidity risk explains how easy it is for you to convert your investment to cash whenever you need it. All investments do not have the same liquidity. You should consider how easy it will be for you to remove your money when you need it.
While it is easier to sell things like stocks and shares, it may take a longer time to convert assets like real estate to cash. Location is also a risk factor in real estate investment. You may lose your investment return on real estate if the location is not favorable for the market. Your location can make or break the returns you realize on your investment.
There are also market risks involved in investing. You can invest in a company that may go out of business. This is a real risk when investing and one that you should aim to avoid. There is also an investment risk for inflation which is when the rate of increase on your investment is lower than the inflation rate on the asset you own. When this happens, the purchasing power of the amount you invest is actually lower than you what you might expect to receive.
Then, there’s the risk that exists when you invest in very few stocks. If any of the few investments should take a wrong turn, you can quickly lose all your money. The best practice is to diversify your portfolio and put your money in both high and low risk investments. Finally, there is financial literacy risk. If you don’t know enough about an investment, you may end up making the wrong choices and spending more money than you should. To be successful when investing, you have to consider the risks involved before making your decision. Sometimes, as an investor, you have to act immediately or wait till you get more knowledge about the investment at hand. As an investor, you want to understand how investment risk works. Warren Buffett said that “risk comes from not knowing what you’re doing.” And he also advised that you should invest in what you understand.
Key #4: Analyzing the cost-benefit trade-off
The last element you need to know to be successful when investing is to analyze the cost-benefit of the investment. Analyzing the cost-benefit trade-off of an investment is how you decide whether to invest in a venture or not. You do this by comparing the potential benefits that an investment will have to the risks involved in such investment. It is used to determine which particular investment will make more profit and this activity is typically done with a long-term view in mind.
To calculate this, you must assign a monetary value for all the risk factors involved in the investment. Then, you must list all the investment costs involved in the investment. You will also need to give a value to the investment return you expect at the end of the investment year. The proposed benefit or profit is calculated as a net present value. In essence, it is adjusted to know what the profit will worth now when adjusted for inflation.
The cost-benefit is calculated as a ratio of the benefits to cost. The total monetary value of the benefits and the cost is then compared. If the ratio is greater than one, it means the investment is profitable.
The aim of this is to spend less money on investment costs and also expect more money as investment returns. It will allow you to decide which risk you are willing to take to make the maximum profit.
So there you have it. These are the 4 keys to succeeding when investing!