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Over time, equities have fared quite well in terms of total returns. However, that doesn't necessarily mean every investor should purchase or be invested in equities. Along the same lines, many junk bonds have the potential to deliver sizable incomes to their holders, but there are people who should never have junk bonds in their portfolios. So how can investors determine what types of investments are right for them?
An individual's resources or funds available may dictate what type of investment he or she should make. For example, some mutual funds require a $2,500 initial deposit. Similarly, a person's ability to sustain a loss may affect the types of securities he or she chooses. So, options and futures might not be sensible investments for an individual with limited resources or for someone facing retirement. There's no point in wiping out your whole nest egg in one fell swoop, right?
However, these aren't the only considerations when choosing which investments to add to your portfolio. A person's personality - and how it can influence investment decision-making - is actually a bigger factor in the risk/reward equation than purchasing power. Let's take a look at how your personality can shape your investing prowess, and how trusting your instincts can often lead you to the best decision.
How Personality Factors in
The ups and downs of the market have the potential to be stomach-churning to say the least, and to throw in a rocky or tumultuous market will only make things more nauseating. After all, what good is making money if you can't sleep at night? Buying investments that fit your mindset and personality is key.
So, how do you go about determining what type of investment fits your personality?
One way is to consider the characteristics of the various types of investments that are available to you, and then determine which characteristics suits you best. Let's take a look at four of the most common investments. By looking at the characteristics, you can get a sense of whether they will make you shiver with anticipation or fear.
Note: Remember, that you can find high risk, high excitement investments and low risk, low excitement investments in almost every category, but for the average investor with the average investments, these rules generally apply.
1. Stocks (High Risk, High Excitement)
Although these can be volatile, generally they are considered less so than options and futures contracts. Historically speaking, stocks have a strong track record of creating large increases or large decreases for individual investments. A quick look at a chart reveals that in spite of several recessions, a World War and other national and international crisis situations, the ASX Average has risen over time, and markedly. (Of course, the path wasn't straight up, and future performance is never guaranteed.) Those that jumped on the ASX and held on through the rough patches got an exciting reward for their passion.
As such, stocks are an attractive investment to investors who are willing to accept risk and who have the patience to hold an investment during periods of volatility.
Those with a somewhat conservative personality might be attracted to stocks in some circumstances too. Large corporations with a long operating history and that pay consistent dividends often attract these risk-averse investors.
The Animal Instinct in You
If you start to add shorting into your stock portfolio to ramp up the excitement, you might identify more with the bear investor. This animal enjoys a pessimistic view of the market, and can make money on the downturn of the market. Risk and market turmoil does not turn off this animal. However, if you're investing in long-term value stocks and you're expecting an even return over time, then you have a bull investor attitude. These bull investors make money on the optimistic hope that their investments will be worth more as the market rises, which may not always be the case, and that adds to the excitement of these investments.
2. Bonds (Low Risk, Low Excitement)
These investments are known for their consistency. Large swings in price have been known to occur as interest rates fluctuate or during downturns in the health of the issuer, but they are not the norm.
Bonds have a place in the portfolios of various types of investors. After all, the income that bonds kick off can be an attractive feature that might help pick up the slack of other under-performing holdings. That said, many people who are attracted to debt or make it a substantial portion of their portfolios are more risk-averse than their stock-holding or option-buying counterparts. A bond investor may also be a little more even-keeled in terms of demeanor in that they may not be looking to make a killing in the market, but to merely generate an attractive rate of return.
The Animal Instinct in You
The problem with investing only in bonds is that you run the chance of earning less than inflation over time and turning into an investing ostrich, scared of the market at every turn and hiding your head in the sand to avoid market news.
3. Options and Futures (High Risk, High Excitement)
People who purchase options and futures tend to be more prone to risk-taking, because these are inherently higher risk investments. These types of high-risk investors want to make money, and make it fast. They often can accept (or often think that they can accept) the high-pricing volatility that can accompany these instruments. Those who frequently invest in naked options have short-term investment horizons and are looking to make their money anywhere from a couple of minutes to a couple of months.
Naked option positions are generally not for the faint of heart or for people with limited means who cannot afford to take a loss or deal with a high rate of volatility.
Many people think of options only as a risky investment because of the pricing volatility usually associated with them. However, if used correctly, options can actually help to limit risk in some circumstances.
The Animal Instinct in You
If you're a glutton for punishment, and greed is your only goal, you run the chance of becoming a pig. To free yourself of this muddy fate, avoid overindulging; the only pig you'll see will be your overflowing piggy bank.
4. Mutual funds (Medium- to Low-Risk, Medium Excitement)
These investments can be comprised of traditional stocks, bonds, or other instruments, and can be owned by various types of investors including those who like to take risks and seek capital appreciation, and those who seek income and invest in more reserved bond funds.
The typical mutual fund investor is often one who isn't looking to do his or her own in-depth company-specific research. This doesn't mean that mutual fund investors aren't capable, just that they are often looking to either rely on a portfolio manager or on the prospects for a given index. Mutual fund holders also frequently understand the benefits of diversification, and that's why they might have gotten themselves involved in the first place - so they can purchase a basket of securities and perhaps mitigate risk.
The Animal Instinct in You
If you'd rather have someone else direct your funds, or if you're swayed by the news in the media, you may be a sheep. These investors risk losing control of their investments, and that can either add or take away from the excitement of these funds.
The Bottom Line
An investor should be mindful of the resources or funds available when looking to purchase a particular security. However, your temperament and instincts may point you in a whole new direction. Only you will know what's best for your own portfolio, so go with your gut on this one.