The aim of investing is to make money, but sometimes investments lose value. The principal considerations for planning an investment strategy are ways to reduce the risk that your investment portfolio will not perform as you expected. You must look at your financial situation, the types of investments available, and the historical performance of various kinds of investment. You may then choose investments that combine key characteristics to deliver the performance you want at a risk you can tolerate.
Purpose is a key consideration. You must decide whether your objective is the generation of immediate income or long-term capital growth.
Government or corporate bonds pay interest and generate a regular income. Investing in these income-producing securities is a way of using any existing savings to supplement your regular income. You may expect a slow but steady return of several percent, and your original investment is still there when the bond matures.
Retirees often generate income from bonds to supplement their pension. Younger investors more often are looking for growth. They want to make money by investing spare cash and making it grow. Growth investors buy stocks that they think will increase in value and sell them when they do. More exotic investment options offering growth include futures, through which you purchase the right to buy or sell a stock in the future; commodities, with which you speculate on the prices of materials such as grains, oil or metals; and foreign exchange, through which you bet on the value of foreign currencies.
Another consideration before you invest is the liquidity of your investments. If you have savings and are sure you will not need the money for the next five years, you can tie up your funds for that period and you may get a higher return. If something unexpected happens and you need the money, however, you may have to pay substantial penalties. The alternative is to invest in liquid securities that you can sell at any time. You must balance your personal situation with your requirements for income, growth and liquidity and select your investments accordingly.
A key variable affecting the amount of money you will make with your investments is the amount of risk you are willing to take. Risk consists of two components: the amount of money you might lose and the likelihood of the loss occurring. Higher risk means greater income or more growth.
One way to address the different considerations when investing is to buy securities with different characteristics. Many people are not sure whether they will need liquidity, and some might like growth even as they hope for a bit of extra income. Diversification lets you buy some securities for income and some for growth. Some will be locked in and some you will be able to sell at any time. A few will have high risks, most will be somewhere in the middle and a few will be very safe.
Because you are interested in how much money you will have left over after paying your taxes, you must look at the tax implications before you invest.
Different types of investments may give widely varying results after taxes. Your individual tax situation has so many variables that you either have to actually calculate your taxes using different scenarios or consult a financial adviser to get professional help.
- Comstock/Comstock/Getty Images