As noted in yesterday’s post you can use your money to make money (generally called investing).  Of course, you need some money to start.  You can engage in money making activities and save some money to use for investing ( basically working for others or working for yourself at activities that generate cash).  Or you can borrow money from others to invest (using others money to make money is often called leverage and results in higher rates of return, but more risk).

What’s the best way to invest my money?

Unless you are engaging in money laundering (which has a slightly different objective, although similar) the object of investing for most people is to earn the greatest return over the shortest time with the lowest risk of incurring losses.

Unfortunately such a generic objective is too high level to measure and thus difficult for ongoing management (i.e., determining how you are doing and modifying approaches accordingly on an ongoing basis).  The best first step is to define the underlying goals with a little more specificity.  The second step is to use these goals to select investments that match to the goals (more on that in future posts)

Here are the three key things to consider:

1. ) Target Return –  Ask yourself what level of return on investment would satisfy your needs.  Many Corporations I have worked for in the past set this bar at various levels (known as the hurdle rate)  usually somewhere between 22% and 40 %, but for the individual investor this is probably unrealistic and the current economic environment needs to be considered when determining your goal.

   Many use the performance of stock market indexes over time as benchmarks.  I consider this a useful influence but personally also include my personal needs;  amount of effort I intend to expend, my level of competitiveness and other factors like these that are largely personal to me.  Taken all together I come up with my personal target – this is the annual return I am shooting for.  I revisit this goal once a year.

2. ) Time Frame –  Determine the duration you expect for your investments to continue to perform.  For example this could be until I die or for a specified time frame.   You might select to invest for ten years after which you are okay spending the capital and reducing investment return, even down to nil.  The latter case would usually apply when you calculate after spending starts the capital won’t run out before you still need it.

   In some cases you may engage in a specific investment you only expect to produce income for X number of years (e.g., a diamond mine with limited reserves of say 10 years) and this goal should be understood at the start of the investment to avoid surprise.

3. Appetite for Risk –  This is the most complex considerations.  Libraries of books exist on this topic and I do not intend to fully explore it in this post (I have written some posts in the past just about managing risk and will be writing others in the future).

   For this summary of key factors, the main point is really the importance of understanding and defining your risk tolerance in conjunction with the other two factors (target return and duration) before investing.  Overtime the amount of risk acceptable to you will change and the risk events you actually encounter with ongoing investments will be one key influence on these changes (bit once, shy twice).

   Remember, as a general rule lower risk tolerance over leads to lower returns and most stable long term performance.