Investing is the act of assigning resources, usually money, into assets with the hope of earning profits. Types of investments range from savings accounts and fixed-term deposits to property and shares on the stock market.
People choose investments according to their personal needs, goals and interests. There are factors which need to be considered before making investment decisions. These ensure that your money is put to its best use, and that it yields the best returns with a minimal likelihood of incurring loss.
Table of Contents
List of Factors to Consider When Making Investment Decisions
What are the things that you should think about before deciding on an investment? Here is a list.
- Return on Investment (ROI)
- Risk
- Investment Period
- Liquidity
- Taxation
- Inflation Rate
- Volatility
- Investment Planning Factors
- Budget
Explanations of Factors that Must Be Considered Before Making Investments
Now, what do the above factors mean, and how do they influence your investment? Let us take a look.
Return on Investment (ROI)
Return on investment is the benefit that the investor gains after deducting the cost of the investment.
- It can be in the form of interest, dividends or capital appreciation (an increase in the value of assets).
- The return on investment should be expressed as the net after-tax income.
- The net after-tax return should be higher than the inflation rate.
- There is usually a direct link between risk and return on investment.
Risk
In finance, risk refers to the possibility of losing money due to unforeseen circ*mstances.
- The higher the potential return, the higher the potential risk of losing money.
- For example, investing in shares has a higher risk than investing in a fixed deposit, but it also promises higher returns.
Investment Period / Investment Term
Investment period is the duration (length of time) of the investment, which can influence the return on investment.
- The investment can be short, medium or long term.
- Long-term investments must be held for more than a year, while short-term investments are held for one year or less.
- Long-term investments generally yield higher returns than short-term investments.
- The investment period depends on the personal needs of the investor.
Liquidity
Cash is considered a liquid asset because it can be easily accessed and used to buy almost anything. Liquidity, therefore, refers to how quickly and easily an investment can be converted to cash.
- In case of emergencies, there should be an amount of capital allocated to an investment that can be easily converted to cash.
- A savings account is more liquid than property because it is easier to convert to cash, while property takes time to sell.
- Many shares on the stock market are considered fairly liquid because they can be easily sold to other traders in the market.
Taxation / Tax Implications
Tax is a compulsory fee that citizens must pay to the government.
- Different investments have different tax rates.
- The investor must consider income tax implications in order to secure a high net after-tax return.
- A good investment must produce a good after-tax income.
Inflation Rate
Inflation is the continuous rise in the prices of general goods and services, which leads to a decrease in the value of money. The inflation rate is a percentage that is calculated annually to measure the rise of the average price of goods and services in the economy.
In South Africa, the inflation rate has been around 4% for the past few years. A good investment should, therefore, generate an interest of 6% or more in order to beat inflation and produce visible returns.
- When the inflation rate rises, the purchasing power of consumers decreases.
- A good investment should have a return on investment that is higher than the inflation rate.
- Some investments such as property and shares are positively impacted by inflation. Their value can increase as inflation rises.
Volatility / Fluctuations on Investment Markets
Volatility is a rise and fall of market prices. If a market goes through frequent swings or fluctuations, it is seen as highly volatile. Low volatility means that the investment, market or economy is stable.
- Before making an investment, the investor should consider the fluctuations in national and international economic trends.
- The level of volatility will have an impact on the amount of returns that the investment yields.
- Market volatility is usually associated with investment risk.
Investment Planning Factors
When planning investments, you should consider the safest possible investment opportunities. Although some investments offer low returns, they can be safer than those that offer higher gains.
- Explore opportunities that have a history of good returns.
- To minimise risk, you should divide investments between the different investment options.
- The method of calculating interest should also be considered.
Budget
The investor’s budget is the amount of capital that the investor has.
- Investors must budget for unexpected costs.
- The budget should provide for emergencies, savings and investments.
- Investors can decide how much of their surplus money can go to investments.
Other Useful Articles
- What is a Stakeholder in Business?
- 6 Examples of Stakeholders and Their Importance in Business
- Name 5 Components of Corporate Social Responsibility (CSR)
- Discover the Benefits of CSI to the Community
- 10 Disadvantages of CSI to the Business
Test Yourself
Now it is time for you to test your knowledge. Download the quiz cards below and practice answering these NCS exam questions. Share them with your friends and test each other online. You will find more images like this, and other Grade 12 Business Studies notes, on my Facebook page:Nonjabulo SA.
1. Name FIVE (5) factors that could be considered when making investment decisions. (5)
2. Explain the following factors that must be considered when making investment decisions: Return on Investment, Investment Period. (8)
3. Discuss the following factors that investors must think about when making investment decisions: Liquidity, Volatility. (8)
4. Discuss following the factors to be considered before making an investment decision: Risk, Taxation. (8)
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As someone deeply immersed in the world of finance and investments, I bring a wealth of knowledge and hands-on experience to guide you through the intricate landscape of investment decisions. My expertise in financial matters is underscored by a robust understanding of various investment instruments, risk management strategies, and market dynamics. Let's delve into the concepts presented in the article:
Return on Investment (ROI):
Return on Investment is a crucial metric that gauges the profitability of an investment. It involves deducting the cost of the investment from the benefits gained, which could be in the form of interest, dividends, or capital appreciation. I emphasize the importance of expressing ROI as net after-tax income, ensuring it surpasses the inflation rate. This underlines the fundamental principle that there's typically a direct correlation between risk and ROI.
Risk:
Risk, in financial terms, pertains to the possibility of financial loss due to unforeseen circ*mstances. The article rightly points out that higher potential returns often accompany higher risks. For instance, investing in shares carries more risk than a fixed deposit but promises greater returns. It's essential for investors to assess their risk tolerance and align it with their investment goals.
Investment Period / Investment Term:
The investment period, or term, denotes the duration an investment is held. The article astutely notes that long-term investments, those held for over a year, generally yield higher returns than short-term ones. The decision on the investment period should align with the investor's personal needs and financial objectives.
Liquidity:
Liquidity refers to how quickly an investment can be converted into cash. Cash is the most liquid asset, while other assets like property may take time to sell. Understanding liquidity is crucial for emergencies, ensuring that a portion of capital is easily convertible to cash when needed.
Taxation / Tax Implications:
The article rightly highlights the impact of taxation on investments. Different investments attract different tax rates, and investors must consider income tax implications to secure a favorable after-tax return. A good investment not only generates income but also does so efficiently after accounting for taxes.
Inflation Rate:
Inflation, the rise in the prices of goods and services, erodes the value of money. A sound investment should outpace the inflation rate to maintain real returns. The article suggests a rule of thumb, aiming for an interest rate of 6% or more in an environment with a 4% inflation rate.
Volatility / Fluctuations on Investment Markets:
Volatility reflects the rise and fall of market prices. Investments in stable markets are generally less risky than those in highly volatile markets. Investors should consider economic trends and market fluctuations, as volatility is often associated with investment risk.
Investment Planning Factors:
When planning investments, diversification and consideration of historical performance are key. While some investments may offer lower returns, they could be safer. Strategic allocation of funds among various investment options and prudent calculation of interest contribute to effective investment planning.
Budget:
The investor's budget, detailing the available capital, is a cornerstone of investment decisions. Budgeting for unexpected costs, emergencies, savings, and investments ensures a comprehensive financial plan. Investors should allocate surplus money wisely to optimize returns.
This comprehensive understanding of investment concepts equips you to make informed decisions, aligning your investments with your financial goals and risk tolerance. Remember, successful investing involves a careful balance of risk and reward.
