What is utility value?
Earnings value is a value assigned to an investment based on its anticipated return. Individual investors use their own methods to determine the utility value of potential investments. People can come up with different estimates of utility value based on how they weight the variable involved, so one person might say an investment is sound, while another might say just the opposite. When considering a new investment, taking the time to determine the utility value can be an important part of the process.
Two things are balanced when determining the utility value of a potential investment. The first is the expected return. People may use certain market information to make predictions about performance, or they may rely on information provided with the investment. For example, a certificate of deposit with an interest rate of four percent has a clear expected return. Individuals can also consider the length of time needed to hold the investment and what types of factors could result in a decrease in expected returns.
Next, the investor analyzes the expected risk. Risk can mean different things to different investors. Some investors prefer to take a very conservative approach and limit their risk as much as possible, while others are willing to take high-risk investments, especially short-term ones, in exchange for the possibility of large returns. Different investors have varying risk tolerances that must be considered when considering an investment to decide whether the anticipated return is worth the risk.
With this information in mind, the investor can determine the utility value and decide whether or not the investment is a smart choice. Someone with a low risk tolerance might opt for a low-risk, low-return investment for most of their assets, while an investor with a high risk tolerance might be willing to weigh a portfolio with more high-risk assets. Your decision may also be based on factors such as market volatility and projections.
Investors can and do make mistakes because the future cannot be perfectly predicted. This must also be considered and balanced when evaluating potential investments to determine whether or not they will be wise choices. This is one reason investors diversify their portfolios as much as possible; it's possible to make one bad prediction, but less likely to make 20 bad predictions. Therefore, an investor can afford to lose in one area of a portfolio because the other areas are likely to survive intact.