INDIVIDUALS & FAMILIES
The nine basic rules of investing
There is no magic to making money by investing. It requires discipline, determination, perseverance, and hard work. In deciding what investments are suitable for you, you must first understand the nine basic rules of investing.
- Risk versus return.The greater the risk that you will lose not only the return on your investment but your original investment as well, the greater the potential rate of return. An individual investor should always try to get the highest rate of return without going beyond the risk level that he or she finds comfortable.
- Inflation.If inflation is higher than the return on your investments, you are losing future purchasing power. If, for example, you have $1,000 earning 3% after tax, and inflation is 4%, your $1,030 will purchase only $990 of goods one year later.
- Liquidity and marketability.A liquid investment can be readily converted to cash; a marketable investment can be readily sold for cash. A savings account, for example, is highly liquid, and blue chip stocks are readily marketable. A piece of real estate, on the other hand, may take time to sell and convert to cash. Often, yields run conversely with liquidity and marketability.
- Tax aspects.An investor’s return should always be computed after taxes. Some investments have tax advantages that increase their relative after-tax yield. Tax-exempt bonds, for example, carry a lower return rate than taxable securities. However, your after-tax return may be higher with the tax-free investment than with a taxable one.
- Income versus appreciation.Some investments provide current income (such as high-dividend stocks); others have little current income but appreciate over time. The best investments provide both income and appreciation.
- Management.Some investors enjoy managing their own portfolios. Others lack either the time or knowledge to be effective managers. Your desired degree of involvement will help determine the kinds of investments best for you.
- OPM.Using “other people’s money” and leveraging into investments allows you to get a higher return on your own invested dollars; however, the risk is also higher. Again, you’ll have to decide your own comfort level.
- Diversification.Those investors seeking safety count on diversification. Diversification is simply investing in two or more kinds of investments. Then if one investment goes sour, you do not lose everything.
- Your goals.In your own investment program, it is your goals that are important, not the goals of your broker or financial advisor. Never invest in anything that you do not understand or with which you are not comfortable. Decide what your objectives are and what your risk-tolerance level is, and go for the highest return within those boundaries.