You invest your hard-earned money to watch it grow, but there is more to evaluating an investment than the net profit when you sell it. In this article, Adam Ferrari discusses some essential but often overlooked aspects of evaluating investments, the nature of risk, and the role of repeatability.
Evaluating your investments.
The primary reason you make investments is to hold them as they contribute an increase to your net worth. But there’s more to properly evaluating an asset than whether or not it increases in value.
When evaluating assets, people often overlook two areas: how much time and effort they expend nurturing and developing the investment and how the asset fits with their personal life goals and values.
An example of an investment that may consume too much time and effort even though it returns a profit for you is real estate flipping. A 10% increase in value over six months may be acceptable, even an excellent return for many types of investments. Still, if that investment was a home and the labor required to get it ready to resell consumed a large part of your time during that period, it might be a poor return.
An example of an investment that may not fit well with your values is cannabis. Although legal, investments in this sector may run contrary to the values and ethics of some investors. If you can’t feel good about a potential investment, pass on that opportunity.
The nature of risk.
Much has been written about the many aspects of risk, but the one unavoidable and universally acknowledged aspect of risk is the potential for loss. There is always risk involved in investing, and for many investment types, it is your willingness to assume the possibility of loss that earns you the reward if the asset increases in value.
As an investor, you must understand your risk appetite, which, as the term is used for investing, is your willingness and ability to take risks. If you are risk-averse, avoid investments that include a potential loss that you are unwilling to accept. Staying within your acceptable risk limits will make investing a much more enjoyable experience.
To be a successful investor, you must accept a level of uncertainty. Regardless of how well you research investment, there is still a chance it will fail. If you’ve done your due diligence, this is not a reflection of your investing ability; it just means that unforeseeable influences eliminated the prospect of profit in that particular case. Likewise, reaping even a huge gain should not be interpreted as meaning that you have a magic touch.
Is the investment repeatable?
An important metric to track while investing is the repeatability of your investments. Some investments are wholly dependent on unique events or factors that may not be repeatable. It is critical to understand these factors, so you don’t make assumptions about the repeatability of the investment and lose money the next time around.
Let’s say, as an example, you invest in a retail building materials outlet. You’ve done your research, and it has a good location and not too much competition. It seems like a safe and sane investment.
Then comes a significant drop in bank interest rates due to an unrelated circumstance. As interest rates drop, new home loans go up, and there is a building boom. Your investment pays off much better than anticipated, but is it repeatable? The building boom was the result of an unforeseeable and unrelated event. You’re lucky, but don’t misread the results to mean something that it doesn’t.
About Adam Ferrari
Adam Ferrari was born and raised in the south suburbs of Chicago, IL. He is the grandson of an Italian immigrant coal miner who worked in the mines of Coal City, IL. From an early age, Adam was taught the value and dignity achieved through a hard day’s work. The oil and gas industry provides good-paying jobs for millions of blue-collar men and women across America. This is one of many reasons Adam and his company, Ferrari Energy, are such staunch supporters of the oil and gas industry. Blue-collar men and women built America, and the modern oil and gas industry keeps America moving forward.