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There are four factors in your investment profile:
1. Duration – How long do you want to invest for?
2. Returns – Do you want income or growth?
3. Liquidity – Do you need to get to your money easily?
4. Risk – Understanding the nature of risk involved in different forms of investment and taking account of your views on risk.
There’s little point investing in something offering returns of 12% or more if you end up losing some or all of your money.
It might be that you have a couple of different investment goals. You might be saving for an overseas holiday, and saving for your retirement at the same time. You’d have separate investment profiles to match each goal, and the best investments for you will be different in each case.
Duration means how long you want to invest for.
Short term – 1 to 3 years
Medium term – 3 to 7 years
Long term – over 7 years
Money you are saving to go overseas in two years time is a short term investment.
So you need to make sure you’ll be able to get it when you need it. Money you are putting away for your retirement can be a long term investment. Over a longer period of time you’ll be more interested in capital growth.
It’s common to have different investments of different durations.
To work out the type of returns that will suit you, ask yourself if you’re more interested in income or growth.
a. Do you want to use the money your investment earns as income to live off during the duration of the investment?
b. Do you want to reinvest it with the original lump sum, and grow your lump sum as much as possible?
If you need short term income from your investment, it’s probably best to put your money where you can guarantee how much money it will earn – such as a bank deposit paying a fixed amount of interest for a set period.
If, on the other hand, you don’t need the income in the short term and you want to grow your lump sum as much as possible, you could consider investments that don’t guarantee the return from year to year, such as shares.
Liquidity means the speed you can convert your investment into money before the end of your investment period, without taking a loss.
High liquidity investments mean you can get at your investment anytime, without losing any of your investment. A bank savings account is the classic example of a high liquidity investment.
In a low liquidity investment, it may take time to find a buyer at a price which is acceptable to you. Property is usually a low liquidity investment. Shares in public companies generally have a reasonable liquidity. An interest in a forestry syndicate will probably have low liquidity.
Some investments maybe illiquid – you can’t get your money until a certain date or event (e.g. retirement). It is important you understand and are comfortable with the risk.
Risk and reward is the classic investor’s balancing act.
The higher the risk you take, the higher returns you could receive, but the more chance you have of taking a loss.
With a low risk investment, you generally know the return you will receive right up front. A low risk investment would be a bank savings account – you know the return (the interest rate), but compared to riskier investments, like shares, it isn’t great.
Higher returns are only available with higher risk. The risks come in two types, volatility, which is the possibility that the value of your investment will go up and down, and performance, which is the possibility that the investment could be a flop and you lose all or part of your money. Or, the investment gives you a lower return than you expected or needed.
If you are considering high risk investments, you can balance your risks with other investments in lower risk areas, like short term deposits or cash and bonds.
You can generally recognise high risk investments because the potential returns are also sky high (the promise of too-good-to-be-true returns is probably just that, not true.)