What Is a Good Investment?
It’s all about boosting your net worth
If you're like everyone else, you've been told you should invest in your future. But investing can be intimidating and confusing, and there are risks. There are countless ways to invest your money; however, there are so many choices that it is easy to become overwhelmed by them. It can be tough to choose, and every investor has an investment they recommend.
Here's the key—one person's good investment may be another person's bad investment. Investing is all about what you can do with what you have, your comfort with the risks, and what works for you.
To find a good investment, you should first identify your goals, take inventory of your assets, and determine an investing budget. Work to identify investments that are within your budget and have the potential to grow. Then, compare them using performance measurements and tools that have become standard for professionals. If you have the time, you could also look into an investing simulator to help you view their potential.
Define Your Investment Goals
Decide what you want to invest in. You have plenty to choose from choices—real estate, bonds, mutual funds, stocks, currency, and commodities are only a few of the available choices. You can make money from any of the investment opportunities out there, but you have to know what you want to do first.
You can invest your money for retirement, to build a family fortune, to buy a house, or pay for your children's college. There are as many reasons to invest as there are investments.
Take Inventory and Budget
Once you know what you want to do, it helps to know what you can do. It takes money to make money, as the saying goes, so you should have enough to play with and not lose your shirt. You should have an income that can support your lifestyle and expenses, and work to build up a separate account that is large enough to handle the minimum investment required for your choices, plus an additional buffer.
Many investors use the 10% of income rule when investing.
A good rule of thumb is to invest no more than 10% of your income. As you are starting out, you may want to allow for less than 10%, grow your holdings and initial worth, then work up to 10% over time. Budgeting for your investing activities can keep you from overspending on your investments, and keep the rest of your life on track.
Identify Growth Investments
There is no way to know for sure whether an investment will rise in value, as risk is part of the investing game. But there are many indicators that can give you a good sense of whether something will become more valuable over time. The market continues to be thoroughly analyzed by professionals and academics, providing many insights into the performance of different instruments.
Much of the work has been done for you by professional financial and investment advisors and fund managers. Companies like Charles Schwab provide investment opportunities designed for different goals. They maintain thoroughly researched and analyzed funds that provide short- and long-term growth opportunities, making your investment search much easier.
Choosing to use an investment manager can help you realize gains faster than conducting the research yourself if you are not 100% confident in your investing abilities.
If you prefer to go it alone, you can make educated guesses about the future value of a company’s shares of stock by reviewing its finances, industry, history, and market performance. When examining a company to determine whether its shares will rise in value, you should take a look at some key factors.
Consistent Revenue and Earnings Growth
How much money did the company earn in the last quarter and the last year? How did that compare to previous periods? If the 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.
It is important when considering revenue and growth that you take into consideration 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.
A Competitive Advantage
Does this company have a sizable edge over its competitors? Is there something about its products or processes that can allow it to withstand market downturns? Warren Buffett has often referred to this as a “moat” because it serves as protection against competition and volatile markets. Companies with competitive advantages, such as Apple, have historically shown steady growth over the long term.
Even the most successful companies may borrow money to fund operations. Debt, by itself, isn’t necessarily bad. 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 can be an indication of 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 dividing their total debt by their total equity reveals a result of more than one, it means that they have one dollar of debt for every dollar of shareholder equity.
Total Debt ÷ Total Shareholder's Equity = Debt-to-Equity
A company's debt ratio indicates the manner in which a company funds its assets. Dividing the company's total debt by its total assets reveals the percentage of assets funded by debt. A higher percentage can indicate problems if their debt-to-equity is high as well.
Keep in mind that some industries require higher amounts of debt—if you are looking at a company with a debt-to-equity ratio of 1.6, look at the industry average or similar companies to see if the one you are interested in is comparable.
Total Debt ÷ Total Assets = Debt Ratio
It can be tough to find industry averages and performance without subscriptions to specific websites. There are some free online libraries you can use with a library card, such as the Free Library of Philadelphia, who offers access to Business Insights Essentials, Mergent Online, Moody's, and Morningstar's Library.
If you live in Pennsylvania, all you need is a library card. Many states have similar online libraries. If you attended a university or college, and have access to an alumni university, you may have access to these tools also.
Does It Provide Income?
If steady, passive income is one of your goals, investing is capable of providing it to supplement your normal paycheck.
Real estate, for example, 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. Shares of stock can also be income producers, as many companies are known to pay out portions of their earnings to shareholders in the form of quarterly dividend payments.
Other potential income-producing investments can include bonds or certificates of deposits.
For shares to equate to enough income to be meaningful, an investor needs to own a large number of shares or have a large amount invested. Generally, dividends are provided on a per-share basis, at set intervals throughout a year (generally semi-annually, annually, or quarterly). If a company declares dividends of $1.50, and you own 100 shares, you will receive $150.
Is It Priced Fairly?
Even if something meets all of the above criteria, it still may not be a good investment. This may happen when an investment is overpriced (this is usually called overvalue). Consider, for example, a piece of real estate selling for $1 million. Imagine that the real estate market overall is very depressed, and comparable properties are selling for $400,000. In theory, that piece of real estate might eventually sell for more than $1 million and earn you a profit. But why overpay for it now?
In many cases, it may be worth waiting for an investment’s price to come down before making a purchase.
When investing in stocks, you can determine whether a company’s shares are overvalued by examining its finances, the price of competitors, 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 are anticipating growing returns, while a lower ratio indicates the opposite.
Current Market Price Per Share ÷ Fully Diluted Earnings Per Share = Price to Earnings Ratio
Many companies provide this information on the income statements filed with the Securities and Exchange Commission. However, this is not current information so you'll need to rely on online reports such as Yahoo! Finance or MarketWatch.com for up-to-date information.
What Is the Total Cost of Ownership?
When you buy an investment, you must remember that your overall expenses may be more than the purchase price alone. For example, a rental property may rise in value and generate income for you, but you may also spend thousands of dollars in maintenance, taxes, utilities, and other costs.
Some funds come with management fees, load fees, transaction or other fees. These should all be taken into consideration when looking for a good investment.
When evaluating an investment, be sure to take into account all the expenses you would incur during the time you might own it. You want the return on that investment to exceed not only your purchase price but the expenses you incur along the way.
Can It Diversify Your Investment Portfolio?
Often, an investment can 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 takes a dive.
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.
You can diversify your portfolio by mixing investments in varying industries and sectors, and by investing in companies of different sizes.
Weigh All of the Influences When Deciding
Ultimately, any investment should be evaluated 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. Also, it’s important to understand the dynamics of supply and demand, the economy, and take into account the total cost of ownership with any investment.
Berkshire Hathaway. "Berkshire’s Corporate Performance vs. the S&P 500." Accessed Feb. 4, 2020.
Steven Bragg. "Business Ratios Guidebook." Page 77. AccountingTools, Inc., 2017