What is a Good Investment?

It’s all about boosting your net worth

Couple looking at their investment portfolio on a laptop.

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You have probably been told that it’s a good idea to invest your money. But investing can be intimidating, and it comes with risk. There are countless ways to invest your money, but it’s not always obvious what is a good investment. Luckily, good investments can be relatively easy to spot when you know what to look for.

 The goal of investing can be seen as simply growing your net worth. Your net worth is your total assets after subtracting your total liabilities. With a larger net worth, you may have more financial security. Any investment that does not assist you in pursuing financial security may not be worth going after. 

 This concept seems simple enough, but it can be challenging to know in advance whether an investment will actually boost your net worth and help you achieve financial security, or result in a loss.

 For example, a new car, which usually depreciates in value once you begin driving it, may not be a good investment. On the other hand, a piece of property that rises in value over time and allows you to sell for more than you paid for it is a sound investment.

In a given period of time, not all properties will rise in value.

 It gets even harder when it comes to investing in companies. The value of a stock or bond can rise or fall in any given day—and whether or not it has gained value in the past has no bearing on whether it will do so in the future.

 Given these factors, how can you assess that an investment is good? The answers to the following questions can help.

Will It Grow in Value?

There is no way to know for sure whether an investment will rise in value. All investing comes with risk. But there are many indicators that can give you a good sense of whether something will become more valuable over time. 

 The first thing to examine is supply versus demand. Quite simply, if the supply of an asset is low but demand for it is high, that asset will likely rise in value. 

 You can make educated guesses about the future value of a company’s shares of stock by reviewing its business operations and finances. When examining a company to determine whether its shares will rise in value, take a look at these key factors below.  

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 quarter after quarter, and year after year, it’s reasonable to assume that its shares have the potential to increase in value over time.

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 wide competitive advantages, such as Apple, have historically shown steady growth over the long term.

 “A truly great business must have an enduring ‘moat’ that protects excellent returns on invested capital.” - Warren Buffett, Berkshire Hathaway.

Manageable debt

Even the most successful companies may borrow money to fund operations. Debt, by itself, isn’t necessarily bad. It’s a high level of debt that can be a red flag. Eventually, debt can be burdensome to a company’s ability to grow, and is an indication of some broader financial problems. In some cases, it can even cause a firm to declare bankruptcy. 

Does It Provide Income?

Investing can also increase your income in a passive way, supplementing the money you might get from your job.

 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 cost of your mortgage and more. Shares of stock can also be great income producers, as many companies are known to pay out portions of its earnings to shareholders in the form of quarterly dividend payments

Other potential income-producing investments can include bonds or certificates of deposits.

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. 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 simply compares a company’s price per share to its earnings per share. A high P/E ratio suggests that a company’s shares may be too expensive.  

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. A piece of vintage artwork may fetch a high price if you ever sell it, but in the meantime you must pay to preserve and insure it. 

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. Adding international investments, such as European, Asian, or emerging markets stocks, can reduce risk in your portfolio and potentially lead to better results over time.

 In addition to investing across different geographies, you can diversify your portfolio by mixing investments in varying industries and sectors, and by investing in companies of different sizes.

The Bottom Line

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’s impossible to predict if something is a “good” investment or not. But there are ways of evaluating investments to determine whether or not they are likely to be profitable. 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, and take into account the total cost of ownership with any investment. 

Article Sources

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