Define an Optimal Financial Strategy
An optimal financial strategy provides the greatest amount of returns from investment possible at the time that a person or organization plans to use the money. There is no single optimal financial strategy that is best for every individual. The optimal financial strategy in one year may be different from the optimal financial strategy in the next year.
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Expected Returns
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The optimal financial strategy uses expected returns because many investments are risky. For example, an investor may be able to purchase $100,000 of Treasury bonds that will return $4,000 in interest or corporate bonds that will return $5,000, but the corporation may default on these bonds. The investor multiplies the probability that each event will happen by the payout if each event occurs. If the corporation has a 25-percent risk of defaulting, then the expected return on its bonds is 25 percent times a payout of 0 plus 75 percent times a payout of $5,000, or $3,750, so the expected payout is lower.
Diversification
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An investor can reduce the risk of a catastrophic event by investing in several types of assets. For example, an investor can leave some money in a checking account, purchase some stocks, purchase some bonds and purchase gold and silver. If the stock market suddenly crashes, the investor will still have gold and bonds that are valuable. The optimal financial strategy for a portfolio depends on an investor's age. A younger investor can invest more of her portfolio in riskier assets such as stocks.
Income Timing
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Some investments do not earn income according to a well-defined schedule. The value of a share of stock may increase 50 percent over a ten-year period, but the stock may lose 10 percent of its value in one year and then rally to a higher price the next year. This stock is a good long-term investment, but the investor risks having to sell the stock at a loss if he needs to sell the stock to cover his other expenses.
Taxes
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An optimal financial strategy also includes the tax consequences of investment decisions. A business can deduct interest payments as an expense, and a homeowner can deduct mortgage interest payments. These deductions reduce the cost of borrowing, so an investor can purchase an asset that returns less than the stated rate on a loan and still earn a profit. Some financial instruments provide tax advantages. Many city and county bonds are tax-exempt, so an investor can earn a greater return by buying these municipal bonds even if their stated rate is lower than the rate on a corporate bond.
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