Recently I was having a conversation with someone. I highlighted different investment options available and the person goes “so which is the most profitable amongst all?”
That’s quite a legitimate question to ask and it’s a question I might have asked in any circumstance as well. Who doesn’t want huge investment returns after all? I do.
As honest and innocent as that question is though, letting it solely guide your investment decisions can be catastrophic. Not only that, it often results in premium tears. Yes, you see when you go for the best option based on returns, you likely left other considerations on the table.
Considerations like your risk appetite, your expectations of the future, the nature of your capital (patience or impatience), your time horizon, and many more.
In my answer to the person, I said “Investment decisions are best made based on your expectations of the future and your risk appetite.
There will always be an investment opportunity that is more profitable than the one you are into. But which one fits you is always the question.”
Talking about fit, instead of relying only on the potential ROI on investment decisions, here’s how you should also think about other considerations.
Your risk appetite
This about what gives you great sleep at night vs what takes it away. Volatility often gives room for high returns but it does open up potential downsides as well. And when it gets too much, it may cost you your peace of mind.
We are attached to money and only handle what our appetite can per time. So it’s important to check how volatile the asset is as well, just as it is important to know about the potential returns.
This is not in terms of the expected ROI as much as it is about what you intend to do with the capital in the future.
Are you setting the money aside to build long-term wealth or to get wedded with the money or to buy a car? Or the money even has no purpose.
Depending on your answer to this, you need to check the features of the asset you want to invest in if it aligns with what your future expectations are. Otherwise, it may not end well.
A good example here will be money that is expected to be used to purchase a car. However, imagine the scenario is such that the car might come anytime and you are to pay immediately or it will be sold to another. If you have your money invested in a fixed-term asset like a bond, you will either won’t be able to access such a fund or have to pay a premium for accessing it earlier than the maturity date. That’s what I mean here.
Patience or impatience capital
Related to future expectations but deserves a class of its own.
And here’s a rule of thumb:
- Patience capital is best suited for high-risk high-return assets, e.g. Stocks, Crypto, and High Growth Business Ventures.
- Impatience capital is best suited for assets with relatively predictable ROI and features, e.g. Bonds, Index Funds, and Stable Business Ventures.
A capital is patience when it is not needed to settle an expense in the immediate future. Say from 2 years and above. Capital will be impatience otherwise. Meaning you could need it on short notice and that has a way of getting in the path of good returns on asset classes that are best suited for patience capital.
Investing patience capital in assets best suited for impatience capital is also less optimal. You will be leaving gains on the table. But this is even allowed if it is what gives great sleep at night.
all the points so far have touched on this point one way or another. However, I will say just a thing.
Your time horizon is far more important when making investment decisions even above the potential returns. Understanding your time horizon is fundamental. There are even some investments you should never do at all just based on the consideration of the time horizon.
Some investments won’t materialize to any outcome until 5-10 years. Angel investing will qualify for this. And some are only to be attempted if you understand how a huge difference 10 mins or 1 hour can make on your success or failure. Cryptocurrency is good for an example here.
So I ask again, should you invest in the most profitable investment? Your answer by now should be”it depends” rather than Yes.