Mon | Nov 30, 2020

What influences investment decisions

Published:Sunday | November 18, 2012 | 12:00 AM

When making an investment decision, the first consideration should be your goal.

The investment goal determines the strategy that will be used. It will dictate the time and the funds you are prepared to commit as well as the risk you are willing to take.

Although there are short- and medium-term goals that an investment programme will help to achieve, investing is primarily long term.

It is imprudent, therefore, to apply the same strategy to all goals.

Long-term strategies must be used to achieve long-term goals and short-term strategies to achieve short-term goals, and whereas riskier instruments fit well into a long-term strategy, they are less suitable for a short-term strategy.

If a steady stream of income is required to meet a short-term goal, the most suitable instrument would be one that pays a guaranteed income and offers security of principal.

To do otherwise would be to risk serious loss or not be able to convert to cash when it is needed. So although investing for capital appreciation in the short term may result in significant gains, this should not be seen as normal.

Your financial resources also affect your investment decisions. If your financial resources are small, you will be limited in the options you can exercise. Certain investments will be ruled out and the thought that one mistake can bring financial ruin could temper your actions.

Not having a relatively large pool of investible resources severely restricts the ability to spread risk except in the case where unit trusts, mutual funds, and other forms of pooled investments are employed.

It may also be relatively more costly to make small investments than large investments.

Past experience also influences investment decisions. Past successes build confidence, sometimes overconfidence. Bad experiences and lack of experience tend to lead to extreme caution and risk aversion.

Age is also a factor in making investment decisions. The younger you are, the more time there is to recover from financial mistakes but youth is the time when there is less to invest. On the other hand, while the pool of investible resources is likely to be more at a more advanced age, more caution is required as the time to recover from a bad decision is limited.

Family commitments also affect the investment decision. Although having many such commitments would suggest that there is a need to have more money, there is the reality that more caution is required so as to secure what there is.

Time also influences investment decisions. If the capital being invested is required in the short-term, the prudent course would be to avoid investments that are more risky in favour of safer instruments, which tend to give lower returns.

Along with this are your cash flow requirements. Where there is a need for a regular flow of income, the prudent course is to invest in income-generating instruments. The major risk associated with them is the loss of purchasing power due to inflation.

Investment knowledge has a place in investment decision-making. It is useful to understand the features and nature of available investment instruments as well as how the investment markets operate.

It is very important to know the kind of portfolio that is suitable for you. The major influence on portfolio performance is asset allocation, the proportion of invested funds in each type of asset so you should have an idea of how these ratios should change depending on your age and your goals.

detached position

While investment professionals are available to give guidance, the final decision should generally be yours so you should read, watch and listen to as much as you can about investments. If you prefer to take a detached position from your investments, put them in the hands of people you can trust.

It is critical to understand your own self, that is, your level of sophistication in investment matters, your knowledge of investments, the time available to invest and to monitor the portfolio, your attitude to risk, your ability to bear risk, the level of investible resources available and what you expect from your investment portfolio.

Oran A. Hall, a member of the Caribbean Financial Planning Association and principal author of "The Handbook of Personal Financial Planning", offers free counsel and advice on personal financial planning. Send feedback to finviser.jm@gmail.com