Despite what people may believe, there is no single best way to invest your money. Knowing what you want to get out of investing will help you determine the right mix of investments. Some investors find that more liquid investments--such as stocks--offer the best return. Others are more suited to longer-term strategies. Familiarizing yourself with the types of investments available and examining your personal situation will help you build a diversified portfolio.
Risk tolerance is the term given to an investor's unique attitude concerning risks. Investors who are looking to make quick profits using money they can afford to lose generally have a higher tolerance for risk, and they will favor more risky--yet more lucrative--investment options. Investors who wish primarily to keep their money safe while earning some kind of return will likely favor less risky investments.
Ask yourself how losing your original investment would affect your financial situation; this will help determine your risk tolerance. If losing your investment would be devastating, consider seeking less risky investments.
The length of time that individuals have to invest their money also plays a role in determining the types of investments they favor. Young couples investing for their retirement years, for example, may have forty years before they tap into their investment income.
Investors with short time horizons tend to favor trading stocks and bonds for quick profits, whereas investors with long-time horizons tend to favor long-term growth stocks, bond interest income and mutual funds with reputations for steady, continual growth.
Investors have different reasons for wanting to earn money through investment, and their individual objectives play a hand in choosing the investments they favor. Parents saving for a child's college expenses, for example, are likely to choose a conservative mutual fund, such as a 403(b) plan. Entrepreneurs looking to open their own investment company, as another example, are likely to choose from a range of products to hedge against each investment's risks. Individuals looking to invest in a very hands-off way, without spending hours monitoring investments, may favor mutual funds or annuities.
Hedging refers to holding different types of investments that go up or down in value at different times. Hedging against risk is an important concept for all investors. Regardless of the investment instruments that you choose to favor, always put money in instruments whose value shifts are not related. If something happens to decrease the value one, it will not necessarily affect the other. For example, if you hold a large number stocks for short-term profit, consider holding a few bonds with ten-year maturities. This way, if the stock market takes a plunge, for example, you will have long-term, conservative investments to fall back on.
- Jupiterimages/BananaStock/Getty Images