What Is a Good Investment?

Definition & Examples of a Good Investment

A good investment is one that fits your financial goals, risk tolerance, and makes money. Investing is all about what you can do with what you have, your comfort with the risks, and what works for you. One person's good investment may be another person's bad investment.

Learn more about recognizing your financial goals and determining what type of investments put you in a position to accomplish them.

What Is a Good Investment?

Regardless of the type of investment, they all exist for one reason: to make money. A good investment can accomplish this while also fitting into a person's risk tolerance and overall financial plan. To find a good investment, you should first identify your goals, determine an investing budget, and work to identify assets that have the potential to grow.

An investment can often be worthwhile because of its ability to balance out other investments in your portfolio. For example, let's say you are invested almost exclusively in U.S.-based companies. While these stocks may be good performers for you, they may also leave you exposed to bad results if the U.S. economy downturns. You can diversify your portfolio by mixing investments in varying industries and sectors, investing in foreign companies, or investing in various types of assets.

Portfolio diversity has been a staple in the investment community for a long time. It helps you mitigate the risks of losing all of your invested capital.

Ultimately, you should evaluate investments with one thing in mind: boosting your net worth and helping you achieve financial security. Investing comes with risk, and it is possible to predict whether you have found a good investment or not by considering all the factors that influence them.

Remember that successful businesses often make for successful investments, so you may benefit from learning how to examine a company's business plan and finances. It's also important to understand the dynamics of supply and demand, the economy, and take into account the total cost of ownership with any investment.

How Good Investments Work

There is no way to know whether an investment will rise in value, as risk is part of the investing game. But many indicators can give you a good sense of whether something will become more valuable over time. The market continues to be thoroughly analyzed by professionals, providing many insights into different instruments' performance. Here are a few characteristics you should look for in a company before investing:

  • Consistent revenue and earnings growth
  • Competitive advantage
  • Manageable debt
  • Income-producing
  • Fairly priced

If a company has boosted sales throughout its lifetime, it's reasonable to assume that its shares have the potential to increase in value over time, all else being equal. When considering revenue and growth, consider the economic circumstances surrounding the performance. A solid performer in a period of economic expansion may not be as solid in a period of shrinkage. A holistic view of performance is beneficial when considering growth.

You also want to ensure the company has a competitive advantage over its competition; there should be something about its products or processes that can allow it to withstand pressure from other businesses and volatile markets.

New investors often overlook a company's debt, but it's important to examine. Debt by itself isn't necessarily bad, but a high level of debt can be a red flag, depending on the company and its financial model. Too much debt can be burdensome to a company's ability to grow and indicate some broader financial problems. In some cases, it can even indicate a failing company. The debt-to-equity ratio provides some insights into a company's financial structure. 

If you divide a company's total debt by its total equity and get a result of more than one, it means they have more than $1 of debt for every $1 of shareholder equity.

If steady, passive income is one of your goals, specific investments will suit you better. For example, real estate can be a great investment if you own a property and rent it out for monthly payments from tenants that help cover the monthly expenses. In some cases, stocks can be income producers if the companies pay out dividends. However, if you're looking for steady income, investing exclusively in growth stocks that don't pay out dividends wouldn't fit well into your financial goals.

Even if something meets all of the above criteria, it still may not be a good investment because it's overpriced or overvalued. The main purpose of investing is to make money and overpaying for investments cuts into your potential profits and returns.

When investing in stocks, you can determine whether a company's shares are overvalued by examining its finances, competitors' price, and its price-to-earnings ratio (P/E ratio). This ratio compares a company's price per share to its earnings per share. A high P/E ratio suggests that investors anticipate growing returns, while a lower ratio indicates the opposite.

Key Takeaways

  • A good investment is one that fits your financial goals, risk tolerance, and grows in value.
  • Some investments' main purpose is to provide diversification to your portfolio.
  • You can't identify whether an investment is good for you if you don't know your financial goals.