Making Investment Decisions: The Groundwork

Answering the question ‘What should I invest in?’ can be as complicated or as straightforward as you want it to be.  Because of this ambiguity, the wealth of information (pardon the pun) and competing opinions on where you should put your money can be hard to sift through.  WTF Money has a simple framework which can help you test an idea, collect relevant information to help you make a well thought out investment decision, which you can revisit and re-evaluate sometime in the future.  Chances are you have one big investment in mind right now (like buying real estate) and maybe something sometime in the future (preparing for retirement).

When making a personal investment decision, you won’t often need to look at the whole investment universe (in fact, it’s impossible to do so).  For example, at work you may look at very specific transactions.  It may help you to know that even in the investment industry, while there are many models which can be used to analyse various investments, decision makers often have to rely on their own knowledge to make the final choice.

At school, university or business school you may be taught tools to compare and choose investments: return on investment, return on equity, weighted average cost of capital, payback period – I could go on and on.  But in real life it is very rare that you will get two investment opportunities which come up the same time, with the same information, which you can compare perfectly.  And there’s the rub – textbooks teach how to make a decision with perfect information and complete detachment.  But you have imperfect information and you are very very emotionally invested in where your money goes.  Such a decision can be far harder than any exam question.

When making a business decision, funds may not be the limiting factor (happy days – it’s somebody else’s dime!) so your choices can be made in terms of ‘return’.  But personally, your choice is more likely to be limited by ‘affordability’.

Great – I hear you say – we’re 400 words in already, and you haven’t shown me how you can make this any easier.  Cut to the chase!

It’s useful to define your proposed investment with what I would call an ‘investment framework’ – the parameters of the investment that you want – so that you can

* Test if what you want is reasonable;

* Find what investment instrument(s)* fits your framework;

* Evaluate what fits, and choose your investment;

* Re-evaluate your investment (when the time comes).

This also gives you what professionals would call ‘a bit of rigour’ to your investment decision.  If you are constantly trying to tweak your parameters – ask yourself ‘why?’.  Are they too rigid?  Too limited? Does your investment theory actually suck?  Is your investment theory awesome, but the instrument doesn’t exist yet?  Do you need to change your ideas?

Read on for the WTF Investment Framework.

* An investment instrument could be just about anything: buying shares, buying units in a fund, giving a loan, buying a business, investing in bonds, angel investing, buying a house, buying a rental property, buying commercial property.  Read my blog post to find out what is not an investment.

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