Is there really such a thing as the perfect investment? If you could build the perfect investment, what characteristics would it have? For me, that investment would essentially eliminate any or all of the risks that investors face. Conceptually, the ultimate investment would have four key characteristics.
- An investment that protects against investment risk
What is investment risk? Investment risk is simply the possibility of losing money while investing. For example, if you invest $10,000, what are the chances that you could lose some or all of that $10,000? Unfortunately investors are quite familiar with the concept of investment risk over the last 5 years. We all hate losing money even if we know we are going to recoup those losses over time. It is pretty safe to assume that the ultimate investment is one that would never lose money.
- An investment that protects against inflation
Let's face it; we need an investment that accumulates faster than our costs. Inflation simply means that the costs we face go up each and every year. Let's look at stamps as a simple example. Today, to mail a standard piece of mail to anywhere in Canada, the cost is 50 cents. Thirty five years ago, the cost to send that same letter was a mere 5 cents. Inflation caused the price to rise 10 fold over the last 35 years.
A great investment is one that helps us to maintain our purchasing power and fight inflation. In other words, the ultimate will give us a positive real rate of return. The returns that we make on the investment are greater than the rising cost of living or inflation.
- An investment that protects against tax
I have often said that it is not what you make that is important. Rather it is what you keep that counts. When investing in Canada, this saying hits close to home because the government taxes you on what you make on your investments (unless in a RRSP).
Because taxation can have such a significant impact on investing in Canada, it is very important for investors to be tax aware or tax smart. When evaluating whether an investment makes sense, it is important to find investments that eliminate, minimize or defer tax into the future.
- An investment that provides consistent returns.
There is no question that the main reason we invest money it to get a return on our investments and the higher the returns the better. The problem is that high returning investments typically require higher risks. So maybe the key characteristic in for a perfect investment is consistent returns. In my experience consistency is really what investors want. The bottom line is a good investment provides returns and preferably higher more consistent returns.
Does the Perfect investment really exist?
Unfortunately the answer is no. There is no such thing as the perfect investment because the investment industry is an imperfect one. If there were such a thing as the perfect investment, then we would have a lot fewer choices than we have today.
The point of this article is to give you some important guidelines when evaluating investments. When you are looking at an investment, ask yourself at least four important questions? Will the investment keep up with inflation? Will the investment avoid or at least minimize investment risk? Will the investment protect against taxes? And what kind of return potential does this investment provide.
Far too often, there is too much emphasis on performance and little to no consideration given to risk, inflation and taxation. Yet these are essential characteristics to determine investment merit and investment suitability. Don't get too carried away on one single characteristic because every investment has tradeoffs. An investment that has great tax merits may carry lots of investment risk. Or an investment that protects against investment risk and guarantees your capital might be a very poor inflation fighter. While there may not be the one single perfect investment out there, there are investments that are appropriate for you. Just make sure you take the time to research them given these guidelines.