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.
1. 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.
2. 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.
3. 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.
4. 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.
5. 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.
6. 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.
7. 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.
8. 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.
9. 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.
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