We all know the benefits of investing. Investing allows your money to grow. But most people only focus on the positive side of things in investing. What about the things that you need to look out for in an investment before you commit to it?
To help you be better positioned to make the right investments, here are 5 crucial things you must consider before investing.
1. Investment horizon
Before you plunge into any investment, take a deep breath. First, consider how long can you keep your investment capital vested in the investment. Anticipating your investment horizon at the start of any investment is important. Your investment horizon will determine your desired risk exposure, which in turn helps you to select the right investment assets.
For example, if you are saving up to buy your dream home in the next six months, investment in stocks might not be suitable for you. This is due to the volatile nature of stock investing. Thus, there is a potential risk of making losses in closing your stock investment in such a short time period. If you have a longer investment horizon, you have the flexibility of riding out the volatility as volatility is smoothed out over the long term.
2. Investment capital
There is a need to look out for your investment capital because it can affect your choice of investment. The amount of spare cash you can afford will determine the types of investments you can invest in. For example, property investing requires substantial free cash to pay for the down payment. You need to ensure that you have enough spare cash to meet the minimum investment criteria and also to pay for at least six months of mortgage payment.
In the past, investments like stocks and bonds also required a sizeable investment capital before you could invest in one. However, as financial instruments like Exchange Traded Funds (ETFs) and the shrinking of a lot size (from 1000 to 100), the barrier to investing has been partially removed. Nowadays, investment capital is no longer as important as it used to be for stock and bond investing.
3. Liquidity of your investment
Liquidity refers to how easy it is to sell your investment and convert it into cash. While some investments have the potential to generate significant returns, it might not be easy to convert them into cash. One common example is property.
Historically, investing in property can yield around 6% in annual returns since the 1980s. However, most Singaporeans face difficulty in translating those returns into cash. This is because a property is a less liquid investment compared to stocks or bonds. To find a buyer who is willing to pay your asking price, it can take months or even years. Even after agreeing to the right price, there is still a gap between signing the agreement and eventually getting the money.
You need to consider the liquidity of your investment and see if it fits into the greater scheme of things (i.e. your financial goal). If there is a mismatch, it is an early warning signal that the investment is not the right one for you.
4. Investment returns
Return is the essence of every investment. After all, why bother investing if not for the potential of growing your money? Before committing to an investment, find out the historical performance of the investment. While historical return isn’t indicative of future return, it can give you an estimate of the kind of return to expect. Then, compare that historical performance against your desired investment return to see if the investment fits your needs.
Imagine this: You need your portfolio to grow at 8% p.a. in order to achieve your goal of retiring by age 40. However, the investments that you are considering can only return 4% p.a. This will double the time to your goal of retiring. It can even be more than double if you realized this too late.
5. Investment risks
The last thing to look out for is investment risks. As with all investments, they come with risks. You need to consider whether the risks are within your personal risk appetite. Investing in investment instruments that only fall within your risk appetite will help you sleep soundly at night. It will also help you avoid making novice mistakes like buying high and selling low due to panic.
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