What Makes a Good Investment? 6 Things to Look For
Last Updated on May 11, 2021
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A 2019 study by GOBankingRates found that 55% of adults in America aren’t investing. Investing is important for so many reasons because it:
- Provides you with the opportunity to gain higher returns
- Is an effective way to help you save for retirement
- Can offer tax benefits
- Helps you beat inflation
So, why are so many Americans choosing not to invest their money? Here are the top two reasons reported in the study:
- They don’t have enough money, or feel that they have enough money to invest
- They have money to invest, but don’t know how or what to invest in
Fortunately, both of those barriers can be overcome.
If you don’t think you have enough money to invest:
If you don’t think you have enough money to invest, you’re probably lying to yourself. More often than not, people who think they don’t have enough money to invest have simply prioritized the present over the future. There are a number of quality investing platforms that allow you to invest in fractional shares for as little as $1. Some personal favorites here at The Ambitious Dollar include:
- M1 Finance (read a beginner guide here)
- Acorns (read a full review here)
All of these platforms allow you to purchase fractional shares, provide informative content, have low minimum balances, and low fees.
If you can find $1 in your budget, you have enough money to invest. Of course, finding more than just $1 in your budget would be better, but it’s a good place to start.
If you don’t know how or what to invest in:
First things first, give yourself a pat on the back. Reading articles like this will help you increase your financial literacy so you can continue to make smart financial decisions. It’s crucial to do your research when it comes to investing, because all investments come with a degree of risk. But, it’s also important to understand that there are risks to not investing.
The key is to make sure you understand the risks associated with each investment you consider. Then you’ll want to evaluate whether or not that level of risk is tolerable, if it can be mitigated, or if it’s in your best interest to avoid that investment opportunity altogether.
Ensuring you are educated about your investments is vital, but it is also a great idea to enlist the help of a professional. If you decide this is the best route for you, make sure you take the time to find an individual you trust, who is certified, and that they take the time to truly understand your goals.
What are the qualities of a good investment?
Knowing the qualities of a good investment can also help you determine how to invest. While there are a number of different asset types that you can invest in (securities, real estate, etc), good investments of all types tend to have a few qualities in common that you should look out for.
1. It’s fairly valued
It’s common for new investors to want to jump on the bandwagon for a stock that is soaring in value. No one can blame you for wanting a piece of that pie. However, it’s important to take a long term perspective when choosing investments. If you buy an asset that’s overvalued, you may wind up overpaying and losing money after the valuation levels out.
Good asset prices should be based on reasonable growth expectations. As long as you anticipate an asset to increase in value over time, it’s much better to invest while it’s undervalued or fairly valued.
If you’re a new investor, you might be thinking, how am I supposed to know if an asset is fairly valued? Two good places to start are:
- Checking historical data
- Performing stock ratio analyses
2. You expect the value to increase over time
For new investors, it’s likely best to stay away from trying to short stocks (i.e. betting on stocks you expect to decrease in value). Short selling is a complicated process which can get inexperienced investors into trouble.
Instead, it’s a good idea to invest in assets that you expect to increase in value over time. How might you determine whether or not it’s likely that an asset will increase in value? Just as you did your research for fair valuation, looking at historical data and ratio analyses will help paint a good picture of what you can expect in the future. Additionally, it’s smart to consider the forces of supply and demand for the asset you’re evaluating. If the asset owns or creates a product or service in demand, that’s a good sign for the future.
3. It diversifies your portfolio
Concentration risk is the risk that you incur from being too heavily invested in a particular sector or industry. It’s important to choose assets that will help diversity your portfolio – balance is key. By having investments in different asset classes, time horizons, and industries, your whole portfolio won’t go down if one investment area declines.
4. It aligns with your risk tolerance
You should only consider investments whose level of risk aligns with your risk tolerance. Think of investing as a marathon, not a sprint. If you invest in something that is too risky for your liking, it will most certainly cause you stress and possibly push you to make decisions that aren’t in your best interest.
5. It aligns with your expectations for returns
There’s typically a tradeoff between risk and reward. It’s important to find an investment that considers both sides of the equation. If you’re wary of risk, you still need to consider the fact the purpose of an investment is to grow your money. Returns from extremely low risk investments may not even keep up with the rate of inflation, and thus wouldn’t be worth your time and hard earned money.
A good benchmark to consider your investment against is the S&P 500 index. The average annual return from 1926-2018 was 10-11%. Of course, the S&P 500 certainly had some down years. But, with minimal fees and high returns, it’s easy to see why this index serves as such a good investment benchmark.
6. It aligns with your investment horizon
Your investment time horizon is also necessary to consider when evaluating an investment opportunity. Your investment horizon is how long you plan to keep your funds invested before cashing out.
Your investment horizon will likely influence what level of risk and return makes the most sense. For example, if you’re close to retirement, you may not want to invest in something too risky, because you won’t have time at your disposal to overcome any unanticipated losses. But if you plan to stay invested for the next few decades, you can leverage time to your advantage and seek out riskier investments that may provide you with higher returns.
What investment gives the highest return?
A common FAQ of new investors is, “What investment will give me the highest return?”. Well, as we just discussed, typically risk and returns go hand in hand. So, some of the highest returns will be offered by the riskiest investments.
Historically speaking though, the US Stock market has been the greatest source of returns for investors. Over the last century, it has outperformed other investment avenues, including the housing market.
The bottom line
Figuring out how and what to invest in can be an intimidating process, especially for new investors. But if you keep in mind the above 6 qualities of good investments, you’ll be on track to make smarter investment decisions.
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