Question: My business has extra cash in the bank that does not earn enough interest. I was offered several options where to invest my cash by the bank but I do not know which one is the right. Can you advise me? – Arianna G by email
Answer: There is no one right strategy to invest because every investment plan depends on what works with the investor. Are you the type who follows what everyone is investing? Or are you the type who makes your own decision after doing some research?
Choosing where to invest your money is not something that you can just decide arbitrarily based on what your emotions tell you. You need to decide carefully because you need to invest strategically, taking into account all the possible risks that your investment may lose money. How do you make the right investment decision?
Here are five considerations you need to bear in mind when making an investment:
1. How much risk can you afford?
In general, a typical investor is risk averse. Ideally, you would not want to take any risk when you invest but at the same time you want to make as much money as you can from your investment.
But this does not work this way in the investment world. If you want higher returns from your investment, you need to take higher risk. If you are scared of losing your money, you will have to take the lower risk route but your returns on investment will be lower too.
How much risk can you handle? How much money can you afford to lose? Finding your risk tolerance level can guide you on what kind of investment you should go into.
2. How soon do you need to get back your investments?
Let us say you want to take the conservative approach. If you just need to park your excess cash temporarily, you can look for short-term, low-risk investment instrument that can assure you that your money will be protected with small income.
If you think your business will not need it in the near future, you can invest it in a long-term investment instrument that can give you relatively higher yield and at the same time offers your small risk of loss.
But if you want higher returns, you can take more risks and invest according to your time horizon objectives. For example, you can park your money temporarily in mutual funds or equities. Or if you want long-term with high risk high return approach, you can invest in startup business.
3. How easy will it be for you to liquidate your investment?
There are good investments that can generate decent returns but may be difficult to sell when you need to get back your money. For example, investing in real estate can give you good rental income but depending on the marketability of your unit, it may take some time for you to find a buyer who will be willing to pay the price you want.
There are also investments that are highly liquid and allow you to get back your money instantly. For example, if you have invested in the stock market, you can always sell your stocks when you need money for something. You can sell at the price you want and get the money back in few days.
4. What are the tax considerations?
It is important that you have to consider also the income tax implications on your investments. There are profits that you don’t have to include in your income tax return when you file every April because it has been taxed already.
For example, the interest profits that you earned from money market instruments or gains from trading in the stock market are no longer subject to income tax. Your interest income is taxed by 20% at gross so what you will receive will be only 80% of the promised interest. If you earn dividends from stocks, you will be taxed 10% at gross so your net will be 90% of the dividends due to you.
Understanding how taxes will affect your returns is critical because it helps you determine how much income you will actually receive after taxes are paid. This will also guide you in developing your overall investment strategy later on when you are building your portfolio.
5. How do you control your risks without sacrificing too much return?
The key to making good investment decision depends on your ability to maximize returns while minimizing risks. Managing investment is all about managing risk. You can control your risk by knowing how to spread it across your investment assets.
For example, how much do you intend to allocate your excess cash to mutual fund, stocks, money market, real estate, and startup businesses? You can allocate your investment according to your risk appetite. If you are conservative type of investor, you can devote majority of your investment in money market, or if you are the risk aggressive type, you can invest more in startup businesses and stocks compared to other asset classes.
For each asset class, you can further manage your risk by diversifying it. For example, if you have invested a portion of your money in stocks, you can further lower your risk by allocating your money between blue chips and second rated stocks.
Planning your investment carefully can help you achieve your financial goals with high probability. You may need to equip yourself with the right skills and knowledge by educating yourself. Or you can hire a financial adviser, preferably a Registered Financial Planner (RFP) to guide and advise you in crafting your investment plan.