Investment opportunities are everywhere these days, but if you’re going to shell out some of your hard-earned money, you want to make sure that it’ll pay out in the end. When you’re deciding how to invest and what to invest in—whether it’s a start-up business, cryptocurrency, or something else—ask yourself the following questions and use growth rate, capital, and return on investment calculators so you can make smarter financial decisions.
Do You Understand the Idea?
Don’t base your investments on ideas that simply seem “trendy” or like they could be “the next big thing.” If you’re going to back an idea with money, then you need to have some understanding of how it works, especially how it makes money, so you can better project its profitability.
For example, if you don’t have any specific knowledge about software, then you might want to steer clear of Software-as-a-Service (SAAS) companies when planning your investments. Sure, the SAAS industry is on the rise, but without comprehending how your company compares to its competitors or how exactly it drives income, then you’ll be at a disadvantage when investing.
With so many investment options out there, you don’t need to resign yourself to putting money in a company that’s too complicated to grasp.
Do You Know the People Behind It?
Along with assessing the company or product you’re considering investing in, take a close look at the people behind the idea as well. Do they have experience in the field they’re in? Have their other projects resulted in success or failure? Remember: It’s one thing to have a good idea. It’s another to have the skill and knowledge to make it a reality.
Aside from looking at the people running the show, see who else has vouched for the investment as well. Maybe you have a friend in the same industry who can testify to the idea’s potential and give you tips on investing in such a company. Perhaps an investment icon like Warren Buffet himself has expressed interest. You may not be an expert, but you can use other reputable people’s knowledge to make wiser decisions.
What Will Be the Return or Interest on Your Investment?
You don’t have to be a business whiz to know that you want to invest in something that makes money. But,what exactly does that mean? In general, you want to see that the investment is consistently earning income and has a healthy return on assets.
If you’re new to investing, it can seem particularly daunting to calculate interest on an investment and other fundamental financials. Luckily, there are a couple of online calculators out there that can help you make such projections:
- Compound Annual Growth Rate (CAGR) Calculator: Enter the initial investment amount or business revenue, the current investment amount or business revenue, and the period between these two values to see the growth rate (CAGR) as a percentage and dollar amount.
- Return on Invested Capital (ROIC) Calculator: See how well a company uses its capital to generate returns by looking at its tax rate, assets, liabilities, and cash.
- Internal Rate of Return (IRR) Calculator: Determine an investment’s profitability through the discount rate that makes the net present value of all cash flows equal to zero.
- Weighted Average Cost of Capital (WACC) Calculator: Figure how much it would cost to raise capital for a business by looking at equity, debt, and corporate tax rate.
Total Return vs. Rate of Return
Most people new to investing often focus too much on the total expected return from it. E.g. if an investment of $100,000 is expected to make them $50,000 this is the number a new investor would focus on, forgetting about the time to get these $50,000. Time value of money is a complex topic, but in short, one would be happier if they were able to make these $50,000 in two years instead of in ten, and even happier if this return was realized in half a year. This is where rate of return and rate of growth come into play.
Typically one calculates the average growth rate of an investment, annualized, hence why CAGR or the Compound annual growth rate of an investment is abundantly used. It makes it easy to compare vastly different investments in terms of starting value and period since by its nature CAGR is normalized on these two dimensions.
Returning to the above example scenarios, the CAGR of a ten year investment of $100,00 returning $50,000 compounded is just 4.1%, whereas it is 22.45% for a two-year return of the same size. All else being equal, an investment with a higher CAGR should be preferred.
Do You Have Other Financial Responsibilities?
Even if you’ve found an investment idea that you understand and seems profitable, consider any other financial responsibilities you currently have before taking the plunge. If you’re saddled with a lot of student debt, it might be better for you to pay that off first before using your extra cash for investments. Some high-interest loans may end up costing you more than any potential investment earnings you make, so it’s better to get rid of those as soon as possible.
How Much Are You Hoping to Invest?
You may have plans to invest a lot so you can enjoy bigger returns, but don’t forget to plan for emergencies. Since there’s always a measure of unpredictability with investments, no matter how much research you do, make sure you have enough savings to hold you over in case something goes wrong. About three to six months of savings is a solid amount. Essentially, an investment that will leave you with nothing during an emergency is not a good one.
Remember, investing doesn’t have to be a huge financial commitment. The bigger the investment doesn’t mean the better the investment. You can always change the amount you invest as time goes on and your cash flow situation changes.
When weighing whether or not something is a good investment, there are many things to consider. As you make your investment decisions, utilize a return on investment calculator and other free online financial calculators so you can choose opportunities that will be profitable. Happy investing!
Cindy is a freelance writer and editor with previous experience in marketing as well as book publishing. Along with her content writing for a diverse portfolio of clients, Cindy’s work has been featured in Thrillist, The Points Guy, Forbes, and more.