Ever wondered how wealthy you would be at this minute, if the money that you saved in your modest piggy bank, as a child, compounded itself every year, till you turn 21? The best gift any young adult could possibly give to their future self is a sizeable portfolio that has exponentially grown over the years; thus providing financial independence in the years of retirement.
Certainly, it’s easier said than done. The crucial question here being, is saving money enough to become financially independent in the long run? The answer is clearly No. ‘Investing’ your money, and not just ‘saving’ it, will assist you in achieving your financial goals. But duhh, isn’t it the same thing?
There’s a fine but key difference between both these activities in terms of the risk/return tradeoff involved. Both of them require you to keep aside money, in order to meet future needs. However, saved money will be accessible quickly, with little or no risk involved; thus generating lower returns. Money can be saved in a bank account or any liquid money market fund/asset. Invested money, on the other hand, is the one with which productive assets are bought, with an expectation that such assets will attract more money, over time. However, it involves higher risk and offers higher returns. Thus, the right balance between both these strategies shall help us build long-term financial wealth. Simply, the difference can be portrayed as given in the picture.
Now that we have understood the importance of investing money in order to achieve personal financial goals, we cannot deny the fact that investments form a crucial aspect even for businesses, small or big, new or old. Since investments are always linked to the uncertainty factor, choosing the right productive asset is of epoch-making significance to any individual/entrepreneur. These decisions are considered to be a ‘once in a lifetime opportunity’ and therefore, we should thoroughly evaluate every option and learn from others’ mistakes before weaving our own fortune!
The most popular investment lessons would not be new to us: diversify, make time work for you and clutch stocks. But here are some superlative investing lessons for every individual (as well as entrepreneur), coming from some of the most revered investors of all times, to guide us, in making some spot-on investment decisions. These lessons not only commend a different perspective by highlighting the most important investment considerations, but also subsume some mistakes that we should be cautious about.
1. Dope out your ‘Risk Profile’
Every individual can categorise themselves as, either a ‘Risk Embracer’ or a ‘Risk Avoider’, depending upon their ability or preference of undertaking risks. Investment decisions should always be taken in line with one’s unique risk profile, thus avoiding herd-mentality.
It is to be noted that entrepreneurs would naturally categorise themselves as risk-embracers. They already assume high levels of risks in their business. Therefore, they should adopt a conservative approach while taking investment decisions. They should prefer safer strategies like hedging and investing in low-risk bonds.
2. Buy into conviction stocks not fads
It is advisable to approach an investment as if you’re buying the whole company, not just it’s shares. Thorough fundamental analysis and research will provide deeper understanding of the long-term philosophy of the company. Great investors only buy into conviction stocks, where they are 100% convinced with the core business principles and activities. They consider derivatives and cryptocurrency to be ‘fads’ as they do not attain 100% conviction in the same. Fads may appear to be attractive, but are equally speculative. According to Peter Lynch and Warren Buffet, fads only lead to wealth depletion in the long run.
3. The sooner you start, the better it is
The best way to harness the power of compound interest, is to start investing early. Compound interest is considered to be the most powerful force in investment finance. Here is an example to understand how the power of compounding can generate unimaginable returns, when time is on our side.
Three individuals, X, Y and Z, invested ₹2000, per month, for a period of 10 years, and left the money in their investment account, to accrue interest @7%, till they turn 65 years old. However, X invested from the age of 25 years till he turned 35 years old, Y invested between the age of 35 to 45 years and Z started investing at 45 years and stopped when he turned 55 years old. Each individual invested a principal amount of ₹2,40,000 within 10 years. At the age of 65 years, the difference in maturity values for each one of them were mind-boggling! X earned a maturity value of ₹26,35,131.36 , Y earned ₹13,39,567.16 and Z earned a maturity value of ₹6,80,968.02; as shown in the graph below.
Thus, combining the power of compounding with longer time durations will produce a synergetic effect on our investments. However, if we look at the downside, the same force can produce appalling values in case of outstanding expenses. For example, if credit card balances remain unpaid for a longer time duration, the interest gets compounded overtime, only to result in horrifying outstanding values. Young investors are highly recommended to tread cautiously and use this power, to make the best out of it.
Harnessing the power of compounding in businesses
The principle of compounding is not just restricted to personal finance. When applied to any business, this concept can help multiply business results, by focusing on the right business elements. Some examples would be, providing higher value to customers, thus attracting new customers and capitalising on the existing ones, cutting down on excessive cash flows, balancing the retained earnings, etc. The most important prerequisite to enjoy the fruits of compounding, in the future, is to remain patient in the present.
4. While investing in stocks, the most crucial organ is not the brain, it’s the stomach!
Before investing even a penny, ask yourself, ‘Do you have the stomach to digest a 60% portfolio erosion, in the short term?’ If you have the appetite to handle the same, the market is for you! Great investors always prefer making informed decisions rather than playing the market for short term gains. This is because, if short term gambles provide an opportunity to double the wealth, they also bear an unsaid risk of eroding all the money, within the same time duration.
5. Diversification can be dangerous
Diversification is considered to be a full-proof method to mitigate the risk of loss. However, experienced investors agree that one only needs numbered quality stocks to create wealth. Warren Buffet himself questions the need to invest in the 4th or 5th best option when our 2nd or 3rd preferences are already so much better. If we have researched and picked 4 to 5 best companies, we should place all our bets in those companies and not diversify into companies we are not thoroughly aware about. In his words, Diversification is only required when you don’t know what you are doing.
6. Timing the market is futile
Experts recommend that waiting for a black swan event to start your investing journey is fruitless. A black swan event means an unpredictable and rare occurrence, something similar to the Global Financial Crisis of 2008 or the Market Crash of March 2020. Thus, investors should not count days till such an event occurs; when they can invest money to make profits. The best strategy is to target and invest into lucrative investment opportunities in the present.
7. Build a cushion
Every investor/entrepreneur should have an emergency fund which they can fall back on, in the most pessimistic scenarios. Amount equivalent to 6 months’ expenses should be accumulated and invested in liquid assets, to help in times of crisis. The best asset to hold as an emergency fund, which will also help in accumulating wealth over time, is gold. Gold should make up at least 5 to 10% of any portfolio.
Lastly, a golden piece of advice for every investor would be to trust only those, who have their own skin in the game. One should not react to every passing news in the markets, as most news is just noise.
Oscar Wilde once gorgeously quoted, “What a pity in life, we only get our lessons when they are of no use to us.” Let that not be true for once, if you are someone who is awaiting an opportunity to kickstart investing. Remember these lessons and make the most of the upcoming ‘World Savings Day’. Stay tuned for more investment-related buzz, as we launch our exciting podcast!