The Fundamentals of Investment Decision Making

 Key Takeaways

• At its core, investing entails applying the proper financial resources to suitable opportunities.

• The overriding goal of any investment decision should be to maximize returns in accordance with the investor’s objectives.

• Among the primary considerations should be the nature of the returns on investments and their frequency, balanced against the associated risks.

The overriding goal of any investment decision should be to maximize returns in accordance with the investor’s objectives. To that end, the primary considerations should be the nature of the returns and their frequency, balanced against the associated risks. The methodologies employed to manage these concerns are the fundamentals of investment decision-making. 

The Basics

At its core, investing entails applying the proper financial resources to a suitable opportunity. Giving the proper consideration to the key financial management parameters of risk and return should be foremost to the process. After all, investment decisions can be irreversible, and their ramifications are often exacted over the long term.

Depending upon their overall investment objectives, investors must usually choose between traditional investment options such as publicly traded equities, securities, and fixed income products such as bonds, and so-called alternative assets such as commodities, real estate, and private equity and the like. 

An investor’s time horizon should also figure prominently in any investment decisions. Some assets are better suited to long-term objectives, while others are more effective when applied to short-term needs. Taken together, these considerations will help an investor determine their appropriate investment style. 

The Process

Emergency Fund Establishment – This should be a priority before embarking upon any investment strategy. In most cases, six months or more of living expenses invested in a savings product should be enough to cover unexpected expenses or job loss without incurring debt or requiring an investor to liquidate a potentially profitable position.

High Interest Debt Elimination – Paying off credit card debt should also be a priority as the associated interest charges almost always outpace investment gains. Diverting capital into stock market investments while carrying a large high- interest debt load is counter productive. 

Financial Analysis – Every investment strategy should begin with an analysis of the investor’s financial position. Establishing goals, which should, in part, be informed by the tolerance for risk, is the first step. It’s important to recognize that all investments involve a degree of risk and it is possible to lose money. Neither the Federal Deposit Insurance Corporation nor the National Credit Union Association insures securities investments. The Securities and Exchange Commission does regulate publicly traded securities, but they do not refund losses.

In exchange for taking on the risks is the possibility of a greater investment return. Those who have a long time horizon have the potential to earn more substantial returns through carefully placed investments in asset categories like stocks and bonds, as opposed to cash-equivalent assets. Conversely, the latter could serve a short time horizon better because they tend to experience less volatility—however, they can be outpaced by inflation, which could minimize the value of returns over time. 

Moreover, solid due diligence should be conducted before investing capital into any opportunity. Ask questions about financial professionals as well as recommended products before agreeing to place capital.

Asset Allocation – In accordance with their investment goals, time horizon and tolerance for risk, the next step for investors is choosing assets into which to invest. Diversification is a good tactic to employ in this regard. The idea is to choose assets with returns that respond under varying market conditions to balance losses. Generally, the three main asset categories — publicly traded equity, fixed income products such as bonds, and cash equivalents such as money market funds — have not moved in concert with one another. 

Circumstances capable of feeding growth in one category can potentially render others inert. Spreading investment capital over a variety of categories can smooth the returns of a portfolio. The idea is that a failure in one class may be counteracted by better returns from a different one.  

Another aspect to consider regarding asset allocation is ensuring that the chosen risk profile leaves enough room to achieve the desired amount of growth within the time frame in which it is needed. 

Above all, however, heavy investments in a single stock — even that of an investor’s employer — should be avoided. Should that company go under, all the investor’s capital will likely go with it, as well as their employment situation.

Dollar Cost Averaging – Making regularly scheduled investments of the same amount over a long period minimizes the risk of placing outsized investments at inopportune times. Because prices rise and fall over the course of their generally upward trending trajectories, this technique (also known as DCA) enables investors to average the overall costs of their investments more so than investing a lump sum all at once. 

Take Free Money – Many employers offer retirement plans in which they will match employee contributions to a retirement fund — up to a pre-set amount. This is basically free money and those contributions should be maximized to get as much of it as possible. Failing to do so is tantamount to refusing an offer of free money. 

Portfolio Rebalancing – Seasoned investors make sure their portfolios remain balanced by ensuring that asset categories are not overrepresented. This helps ensure that holdings remain reflective of the investor’s risk tolerance profile. Reviewing holdings every six to 12 months is usually sufficient in this regard.

In some cases, selling to ensure asset allocations remain within the specified percentages can mean moving capital away from a high-performing asset in favor of one that seems to be struggling. While this might appear to be counterintuitive, it is in keeping with the idea of selling high and buying low.  

Primary Factors to Consider

When executing the above steps, investors would do well to keep the following factors top of mind.

• Objectives should inform the choice of long-term or short-term allocations. Investors have a wide variety of needs and priorities. It is important to ensure that the chosen allocations are reflective of those goals.

• Returns on investment should be as high as possible, within the prescribed risk profile. It is important to recognize that the potential return is usually accompanied by a commensurate degree of risk. 

• Frequency of returns can also vary depending upon need. An investor seeking to build retirement income is likely to be more concerned about growth early on, then shift to a high return strategy in retirement. 

• Risk factors should always be a consideration as well. The risk/reward ratio should always be carefully matched to investment objectives. 

• Market volatility must be factored into an investment strategy as well. Fluctuations in the market can have a significant impact on returns, which underscores the importance of portfolio diversification.

• Liquidity requirements must also match investment choices. Different assets have varying levels of liquidity. Your portfolio’s liquidity profile should align with your potential cash needs.

• Investment costs and fees can have a significant impact on long-term returns. Consider expense ratios, transaction costs, and management fees when you select investments. Even small differences in fees can compound to substantial amounts over years.

Portfolio Diversification and Alternative Assets

As mentioned above portfolio diversification is generally agreed upon to be a smart investment strategy. Alternative investments can be a good way to help accomplish this. Traditional portfolio asset allocation envisages a 60% public stock and 40% fixed income allocation. However, a more balanced 60/20/20 or 50/30/20 split, incorporating alternative assets, may make a portfolio less sensitive to public market short-term swings. 

Real estate, private equity, venture capital, digital assets, precious metals and collectibles are among the asset classes deemed “alternative investments.” Broadly speaking, such investments tend to be less connected to public equity, and thus offer potential for diversification. Of course, like traditional investments, it is important to remember that alternatives also entail a degree of risk. 

In some cases, this risk can be greater than that of traditional investments.

This is why these asset classes were traditionally accessible only to an exclusive base of wealthy individuals and institutional investors buying in at very high minimums — often between $500,000 and $1 million.  These people were considered to be more capable of weathering losses of that magnitude, should the investments underperform.

However, platforms like Willow Wealth provide curated access to private markets for individual investors.   

Investors can get started with minimum investments as low as $5,000 for their first investment (subject to certain exceptions). Willow Wealth offers a curated selection of opportunities across multiple asset classes, ranging from individual investments to diversified funds and automated portfolio solutions. While these investments carry risk, they open the door to opportunities across real estate, private credit, private equity, and more.  

Join more than 500,000 members and start investing in private markets today at willowwealth.com. 

In Summary

Sound investment decision-making is fundamental to ensuring growth and profitability. It is important to recognize that “do-overs” generally do not exist when it comes to investing. However, carefully considered portfolio asset allocation can serve to minimize risk and help achieve the desired objectives.

All securities involve risk and may result in significant losses. Alternative investments involve specific risks that may be greater than those associated with traditional investments; are not suitable for all clients; and intended for experienced and sophisticated investors who meet specific suitability requirements and are willing to bear the high economic risks of the investment. Investments of this type may engage in speculative investment practices; carry additional risk of loss, including possibility of partial or total loss of invested capital, due to the nature and volatility of the underlying investments; and are generally considered to be illiquid due to restrictive repurchase procedures. These investments may also involve different regulatory and reporting requirements, complex tax structures, and delays in distributing important tax information.