The ability to weigh up risk and reward is a crucial skill for successful investors. Even though investors may be presented with exactly the same information, they may come to completely different conclusions about whether or not it’s a good idea to make the investment. The reason for this is that each investment has to be viewed in the light of an individual’s personal situation and goals and hence an investment which is perfect for one person may be a really bad choice for another. Here are some key questions to ask when deciding whether or not an investment is right for you?
What is my investing horizon? – This is really a better question to ask than the traditional “What is my age?”. You may be a young person who, for whatever reason, can only tie up their money for a short period, or an older person working on the assumption that you may still have decades left to live and even if you don’t, you would like to leave a legacy for your heirs.
How easy would it be to monetise this investment? – Some investments can be monetised fairly quickly and easily, many shares for example, although you do have to accept that you may do so at a loss, particularly if exiting the investment early triggers a penalty and/or a tax liability (such as capital gains tax). Some investments, however, such as property, have much slower transaction times.
How much risk is appropriate for me right now? – In addition to looking at the balance of risk and reward for the particular investment, you need to look at where you stand in general. For example, if the investment is fairly high risk but high reward and all your other investments are very low risk and low reward, then you may feel that you would benefit from taking a bit of a gamble, at least with a small portion of your investment funds, to try to improve your overall return. If, however, you already have a number of high-risk/high-reward investments in your portfolio, then you may be better to stand pat.
How diversified is my portfolio? – Generally, you want to achieve enough diversification so that your portfolio always performs well overall, regardless of the specific economic climate, although some investments may do better than others, depending on market conditions. At the same time, over-diversification can make a portfolio overly complex and challenging to manage.
Does this investment have tax-benefits? – For example, can you put it in an ISA or does it qualify for business relief to help with your estate planning? Tax benefits in and of themselves are unlikely to turn an inappropriate investment into an appropriate one (or vice versa), but when you have the choice between two appropriate investments, remember to take tax into account when calculating which one could offer the better returns.
What is my field of knowledge? – You need to be able to understand potential investments to be able to judge if they are right for you, since, ultimately, control of your financial destiny lies with you and you alone. At the same time, however, the best decision-makers generally know when to get advice, choose their advisers carefully and pay close attention to what they say. With this in mind, it can be worth giving strong consideration to getting professional help from a financial adviser, who can look at your specific situation, make suggestions as to what investments could be right for you personally and explain to you what they mean in actual, practical terms, thus empowering you to make the right decisions for your particular circumstances.