Utility value is a value assigned to an investment on the basis of anticipated performance. Individual investors use their own methods for determining utility value of potential investments. People can arrive at different estimations of utility value depending on how they weight the variable involved, which is why one person may say that an investment is sound while another may 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 utility value of a prospective investment. The first is the expected return. People can use given market information to make predictions about the return or they can rely upon information furnished with the investment. For example, a certificate of deposit with an interest rate of four percent has a clear expected return. People may also consider the length of time required to hold the investment, and which kinds of factors might result in a decline of expected returns.
Next, the investor looks at 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 on high risk investments, especially if they are short term, in exchange for the chance of big returns. Different investors have varying risk tolerance which must be weighed when considering an investment to decide if 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 return, low risk investment for the bulk of his or her assets, while an investor with high risk tolerance might be willing to weight a portfolio with more high risk assets. Her or his decision may also be based on factors like market volatility and projections.
Investors can and do make mistakes, because it is not possible to perfectly predict the future. This must also be considered and balanced when evaluating potential investments to determine whether or not they will be sound choices. This is one reason why investors diversify their portfolios as much as possible; it's possible to make one bad prediction, but less likely to make 20 bad predictions. Thus, an investor can afford to lose in one area of a portfolio because the other areas will likely survive intact.
