Weighting your Investment Return

If the investor has two investment options as following, which will the investor choose?

  • Option 1 - Invest in Fixed Deposit or Time Deposit which will guarantee 4% return yearly.
  • Option 2 - Invest in Bond or Trust Fund which will guarantee 6% return yearly.
Assuming both are facing the same investment risks, with no doubt, the investor and everyone will choose for Option 2 because

Option 2 will earn more 2% of return yearly. Obviously, this is very simple comparison between investment opportunities which most investors won't see in real environment. Some more, seldom to have two different investment products that will face same investment risks.

 

Let's have another more complicated investment options. In this case, let's assume that the investor has $10,000 extra money.

  • Option 1 - Assuming the investor owe a $10,000 study loan, which will need to pay 3% interest yearly. Use this extra money to clear the debt.
  • Option 2 - Assuming the investor owe a $10,000 study loan, which will need to pay 18% interest yearly.
  • Use this extra money to clear the debt.
  • Option 3 - Invest this extra moneyin Fixed Deposit or Time Deposit which will guarantee 4% return daily.

If you will the investor, what is the best option, second best option and worst option?

Some of the people will choose that Option 3 is the best option as it is only option 3 is earning money while the rest is just reduce the spending.In fact, it is totally WRONG.

When talk about investment opportunities, the best analogy is to imagine whether this investment option is putting money into your pocket or take money out from your pocket. Let's evaluate all these three options one by one s following.

  • For Option 1, the amount of interest needs to pay for a year is $300. If the investor uses the extra money to clear the debt, he will save $300 per year.
  • For Option 2, the amount of interest needs to pay for a year is $1800.If the investor uses the extra money to clear the debt, he will save $ 1800 per year.
  • For Option 3, the amount of interest that will earn for a year is $400. If the investor invest the extra money in Fixed Deposit or Time Deposit, he will earn $400 per year.

After evaluate all these three options, the investor can put everything together and try to analyze the investment opportunities.

  • If the investor invests in option 1, he will be able to save $300 study loan interest, but yet need to pay $1800 credit card interest while losing the chance to earn $400 Fixed Deposit interest.
    • Total = +300 - 1800 -400 = -1900
  • If the investor invests in option 2, he will be able to save $1800 credit card interest, but yet need to pay $300 study loan interest while losing the chance to earn $400 Fixed Deposit interest.
    • Total = +1800 - 300 - 400 = 1000
  • if the investor invests in option 3, he will be able to earn $400 Fixed Deposit interest, but yet need to pay $300 study loan interest and $1800 credit card interest.
    • Total = +400 - 300 - 1800 = -1700
Based the analysis, Option 2 is the best option as option 2 are putting $1000 into investor's pocket while another two are taking money out from the investor's pocket.