The following are some of the traits of good investments. 8 Characteristics of a good investment. An investment does not need to have all these traits, but there should be an acceptable reason for the absence of any one of them. For example, an investment does not need to provide income, if it is expected to grow in value. If it does neither, there is no point owning it.
- Fairly valued
If you overpay for an investment, you are putting yourself at a disadvantage. Good investments are usually bought at a good price. With equity investing, valuation relative to future growth is key. Market timing may have its limits, but stock valuation plays a big part in determining future returns. Buying at a fair price is not necessarily the same as value investing, but the price should always be reasonable and based on reasonable growth assumptions.
The same applies to other asset classes too. Real estate investments should be based on yield and not just on the assumption that the price will increase. Cyclical assets like commodities should be purchased after a down cycle when fundamentals begin to improve.
- Underlying value will increase over time
The best investments are more often than not assets that increase in value over the long term. Whether it’s a company or real estate, this occurs when the asset owns or produces something that is in demand. Company values increase when they reinvest profits to increase capacity. Property values increase because real estate is limited while demand is not. While the stock market as whole has increased in value, the same is not true for all companies.
Contrary to some popular investing myths, this doesn’t mean you should only buy blue chip stocks or those of well-known companies. Any company that can grow market share within a growing market can be a good investment – provided you buy it at the right price. On the other hand, some blue-chip companies are in industries in terminal decline.
It’s not only stocks that can accrue value over time. Compound interest enables bonds and real estate investments to grow in value too. The value of commodities is a little bit more difficult to assess. Demand for commodities does rise, and supply is to an extent finite. However, the price of a commodity typically accounts for future demand. Commodities are more likely to rise in price when supply has fallen, and demand is beginning to increase.
- It is diversified
Diversification is a key element of successful investment portfolios. To diversify when buying stocks, bonds and other assets you need to build a portfolio of securities. When it comes to products like mutual funds or exchange traded funds (ETFs), the products themselves offer various levels of diversification.
Funds that are spread across several sectors will offer better diversification over the long run. Investors are often tempted to invest in funds that concentrate on industries or sectors that are performing well at the time. These funds may not perform well when investors move on to other sectors.
- It is liquid
Different types of investments have varying levels of liquidity. Large cap stocks and ETFs can be sold very quickly. Some funds, like hedge funds can only be redeemed monthly or quarterly. Real estate and investments in small businesses are even less liquid.
There are several advantages to illiquid investments. Most investments that are not listed on an exchange do not have real time, or even daily pricing and so their values are less volatile. Illiquid investments can also prevent you from making impulsive decisions. In aggregate your portfolio should have a good level of liquidity. Whenever you consider a new investment you should consider whether it will make your entire portfolio more or less liquid.
- It generates income
If an investment is not expected to grow in value, it should generate a yield. Many of the best long-term investments turn out to be those that have a steady, continuous yield. This can come in the form of stock dividends, bond coupons or rental income from properties.
Not only does a yield give you a passive income, but the ability of an investment to generate cash proves it is profitable. There is often a danger that growth investments can be speculative. Investment products, companies and properties that can generate cash are less likely to be speculative investments.
However, an investment with a yield will only make a good long-term investment if the cash flow is sustainable. It often pays to focus on sustainable cash flows rather than chasing the highest interest rate or yield.
- You understand the product and the risks?
A good investment for an experienced hedge fund manager may not be a good investment for the average retail investor. If you cannot understand how an investment will grow, or create value or generate profits, it should be avoided. This goes for companies, funds or any other structure.
Complexity is often used to mask a flaw in the business model. This applies particularly to complex trading and investments strategies and to derivatives. Risks comes with any investment, but if you do not understand what you are investing in, you won’t know how much risk you are really taking. The following are some of the types of investments that are best avoided unless you really know what you are doing:
- It is regulated or protected
The way any investment product is structured and regulated should offer investors protection. This applies to companies, investment products, intermediaries and strategies. How your investments will be protected against fraud, insolvencies and other potential risks must be considered when weighing up investment options. Companies listed on major exchanges are subject to oversights that offers shareholders a certain amount of protection. Unlisted companies and those traded on OTC markets are not subject to the same oversight.
Not all asset classes and investments can be regulated to this extent. In this case it’s important to do as much due diligence as possible to make sure you understand the risks.
