Investors are increasingly forced to choose from a proliferation of investment options. They also have to deal with contradictory advice on how to achieve their financial goals and how to invest the savings they have accumulated during their lifetime. If you consider that there are more than 7000 mutual funds available in the United States alone, and thousands of insurance products worldwide, making the choice that will satisfy them ever after is daunting, to say the least.
No wonder people so often ask the rather general question: Which investment is best? The first part of the answer is easy: No single investment is ‘the best’ under all circumstances for all investors. Personal circumstances, goals and different people’s needs differ, as do the characteristics of different investments. Secondly, one asset class’s strength in certain circumstances could be another’s weakness. It is therefore important to compare investments according to relevant criteria. The art is to find the appropriate investment for each objective and need.
The following are the most important criteria:
the goal of the investment
the risk the investor can handle
taxability of the investment
the period until the financial goal is reached
last but not least, the cost of the investment.
Goals determine the characteristics sought in an investment. You will be in a position to choose the most appropriate investment only when you have decided on your short-, medium- and long-term goals. The following generic goals are normally involved:
Emergency fund money should be readily available when needed, and the value of the fund should be equal to about six months’ income. Money market funds are excellent for this purpose. While these funds do not perform much higher than inflation, their benefit is that capital is saved and is easily accessible.
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If you already have a ready emergency fund covering more than six months’ income, you could consider a more aggressive mutual fund
If your primary aim is capital protection, you will have to be satisfied with a lower growth rate on the investment. Those above 50 are normally advised to be conservative in their investment approach. While this may for the most part be sound advice, you should also keep an eye on the risk of inflation, so that the purchasing power of your money does not depreciate. It is not the nominal value of the capital that should be protected, but the inflation-adjusted one. At an annual inflation rate of 6%, $1 million today will buy the same as $174 110 in 30 years’ time. A 50 year-old with $1 million would therefore have to lower his living standard substantially if he only retains the $1 million until he was 80.
Conservative investments like those listed above should form the normal basis for providing an income. Because of inflation risk, investments should be structured so that they can at least keep up with inflation. This means that at least a percentage of the investment source providing the income should be made up of other asset classes like property and equity mutual funds. The percentage would differ according to individual and economic circumstances.