How to Evaluate Investments

Unfortunately, all investments are not created equal.  But for those people who would like to be able to retire because of investments the ability to discern the difference between good and bad investments is paramount.

There are many types of investments out there.  Stocks, Bonds, Savings, Real Estate, Mutual Funds, Commodities and Derivatives are the major form of investment opportunities that are often offered.  Investments can go even farther than that.  Even a baseball card, comic book collection or a works of art can be considered an investment.

There are many ways to evaluate an investment. 

The most basic method is a simple risk/reward scenario.  This is simply figuring how much risk you are willing to take to achieve a certain level of success. 

Putting all you money on “Black” in Roulette is high reward.  You have a 49% chance of doubling your money, in a few seconds.  On the other hand you have a 51% chance of losing it all, so this is also as “risky” as it is possible to get.  

Good investments will rarely have those sort of returns, but usually they will also not have nearly that level of risk either.

Here is some more great info on how to evaluate investments:

♦  Amount Committed to the Investment

The first important factor for evaluating an investment is how much of a percentage of your wealth is being committed to the investment.  “Don’t put all your eggs in one basket” is a common saying and very true when it comes to evaluating investment opportunities.  The amount of the investment does not matter, but the percentage of your wealth that is invested in one area is huge.  Just look at the housing market.  Someone who had every single penny tied up in housing four years ago is still likely a very unhappy person, but someone who had 5% of his wealth in real estate may have taken a hit, but it would be minor.

♦  Evaluate the Risk of Investments

Risk is a factor in almost all investments.  Savings and government bonds are considered to be the “safest” investments, but even these would fail if the “government” collapsed.  Even with this investment it could be wise to have SOME money in a tangible investment (like gold or silver).  No need to fear though, up to FDIC insured limits Savings and Bonds should be very safe.

♦  Understand the Factor Time Plays on Investments: 

The time it will take you to see a return is another important factor.  If you get a .5% profit on your money but you get it back in 10 days; that could be a great investment.  You made money and can reinvest it quickly.  Many investment opportunities are good because they are “liquid”.  You can get your money out fast, with no penalties.  Other investments are tied to a long time span, leave you money long enough and you will profit, but it will take time to see those profits.

♦  Understand the Reward 

You have likely heard the phrase ROI.  It stands for “Return on Investment” and is also known as ROR (Rate of Return).  ROI is generally represented as percentage and usually shown for a set period, such as monthly ROI or yearly ROI.  Many investments that have higher possible ROI’s or have a longer period when you money will not be liquid will subsequently have larger possible ROIs.  These investments also have the chance for low ROI and even negative ROIs. 

When evaluating investments it is easy to see the potential profit but not be cognizant of the possible risk.  Remember that reward must always be compared to risk and then considered against other investments that are similar and the amount of time the money will be tied up in the investment.

Everything boils down to maintaining control of your own personal finance planning and getting the investments that are right for your on the risk/reward matrix.