Starting off your investment journey can be tough if you don’t have enough resources and knowledge about what it takes to become an investor and the factors that come into play. Knowing the requirements of investing and which elements influence returns will make it easier for you to make the right decisions that will suit your investment goals and capabilities.
This article will take you through the different investment decision-making factors to consider in order to become a successful trader.
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Risk is any investment-related uncertainty that can harm your trading position and financial returns. All investments involve some level of risk. If market circumstances deteriorate, investments such as stocks, bonds, mutual funds, and exchange-traded funds are likely to lose value.
A particular investment’s or asset class risk level and potential return rate are often, positively correlated. The rationale behind this relationship is the notion that investors who are willing to make risky bets and possibly lose more money ought to be compensated more for their risk and vice versa.
Here is a simple comparison of risk versus potential return for some asset classes:
While the financial market offers a large pool of investment options, you must weigh the inherent risks before making investment decisions.
2. Period of Investment
The investment term is the amount of time the investment is made, which can impact the return on the investment.
The duration of the investment can be immediate-, short-, medium-, or long-term. The term period for holding these investments can be categorized as follows:
- Immediate-term: 0-2 years, e.g. high-yield savings accounts, money market
- Short-term: 3-5 years, e.g. short-term debts, equity investments, stocks, bonds
- Medium-term: 6-10 years, e.g. stocks, bonds
- Long-term: Above 10 years, e.g. retirement savings, stocks
Investments made for the long run typically provide more significant returns than investing in the short term.
The length of the investment depends on the investor’s needs, such as the type of investment, and risk appetite. Thus, consider your budget, goals, and risk tolerance before making investment decisions. It is advisable to start with simple investments that expire in the immediate- to medium-term, then incrementally expand your portfolio.
3. Return on Investment (ROI)
ROI is a measure of the profitability of a given investment. ROI is determined by the loss or gain of the investment in relation to its cost, i.e.;
ROI = Net Return on Investment / Investment Cost * 100%
Most investment managers and financial advisors consider the return on investment of a project since this metric predicts the success rate of a given asset class.
No one wants to make an investment that would result in losses. For instance, you can review an organization’s performance history to make a wise choice before investing in stocks.
ROI can be in the form of dividends, interest, or capital gains. The net after-tax income is used to calculate the ROI and must be higher than the inflation rate for an asset to be worth your investment.
4. Tax Implications
Taxes on investments vary. Income tax is levied on interest earned from investing in savings accounts or share dividends. On the other hand, capital gain tax (CGT) is charged on profits made from the sale of an investment asset.
You should also research the various tax rates applicable per investment income; in some countries, the tax rate is progressive, meaning that the higher the investment income, the higher the tax rate and vice versa.
As an investor, you must consider the tax implications to ensure reasonable after-tax returns.
Also Read: Top 10 Basic Rules of Investing For Beginners
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Ensure to plan your finances in order to have enough money to allocate towards an investment.
You should also plan for unforeseen expenses. An emergency fund, savings, and investments should all be included in your budget.
For more tips on how to set a budget and propel yourself into a successful investor, read me.
There are numerous asset classes you can invest in, including real estate, hedge funds, private equity funds, stocks, and commodities. However, gaining substantial returns from these asset classes will require you to make sound investment decisions.
Be sure to take your time to understand the various requirements that go into investing, such as risk, period of investment, ROI, tax obligations, and budgeting. Talking to your investment manager about these factors will greatly improve your investment decision-making skills, and remember, anyone online trying to sell you quick ways to make money is probably a scammer.
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