Let us do some simple mathematics here. Assuming we start work at 25 years old and retire at 55 years old. We have an average income of $5000 a month and we can save $2500 a month. Without investing and parking our money in a bank, we will achieve approximately $968,400 at 0.5% rate of investment (ROI). If we invest our savings over long term at a modest 7% ROI, we will achieve $2,833,823 as our retirement funds. Is there a big difference between $968,400 and $2,833,823? I bet there is! Now that is the magic of the law of compounding in investments.
Rule of 72
The Rule of 72 simply states the number of year it takes to double our invested money at a given rate of interest. For example, if we invest our $10,000 at 2% ROI, it will take 72/2, that is 36 years, to become $20,000. If we invest it at 4% ROI, it will take 72/4, only 18 years to become $20,000. So on as so forth. This is another illustration of the magic of compounding.
Establishing your Investment Philosophy
Investment Philosophy (IP) is a set of beliefs that you adhere to as you make your investment decisions. It is a style of investing that is very personal to the investor and is different from investor to investor. If we do not have an IP, whenever a investment situations arises, we will not know what to do and may make unwise investment decisions. An IP will suit the investor’s risk profile, personality, goals, personal beliefs, etc. For example, if people around you say that oil prices will increase because of an impending war, will you take advantage of the situation and buy oil futures? One investor may feel that it is a tremendous opportunity because he is an aggressive investor to be able to tolerate the risk inherent in derivatives instrument (with leverage) and he is a short term opportunist. On other hand, you may feel that futures is too risky for you and you prefer stocks that are more stable and has a longer time horizon. Also, you may feel that profiting from a war, which usually results in the loss of innocent lives, is not ethical. With a clear IP, you will not chase after profits and be lead by them, which will leave you frustrated and even cost you money. But you will be a stable investor, knowing exactly what to do in the ever changing capital markets.
A good financial advisor is supposed to help you discover your personality type and establish your personal IP. He can share with you his IP, and you may want to adopt his IP if it suits you, but it is important to understand the IP that you undertake which underlines your investment decisions.
My Personal Investment Philosophy
1. Have at least 6 months of income saved in my bank account. This acts as an emergency fund in the event of retrenchment, emergency medical bills, etc.
2. Differentiate my ‘needs’ from my ‘wants’. I do need a flat for me to get married and start a family. I do need money to fund my children through a formal education and I do need money for a comfortable retirement of about $3,000 expenses per month in today’s dollars. However, I want to own a Ferrari sport car. I want to live in a bungalow. I want to own a private jet. I want to set up a charitable foundation. We need to prioritize our needs from our wants and provide for our needs first.
3. Open different ‘accounts’ for different goals. Each goal has a different time frame and different amounts. With that in mind, we can then undertake the most effective investment strategy for each goal. For example, if your goal is to hold a wedding one year later, the wedding funds should be held in a conservative portfolio, consisting of bank deposits or money market instruments. However, if the goal is to be financially independent in 20 years time, we can undertake an aggressive portfolio to achieve our target amount for retirement.
4. With our budget set up, we are able to allocate our savings per month towards our goals. For a start, I will recommend savers to construct a portfolio that can withstand market shocks. This can be achieved by diversifying our money amongst different companies, industries, and countries. Unit trusts (mutual funds), exchange traded funds (ETFs), real estate investment trusts (REITs) are effective instruments to accumulate wealth over the medium to long term. These instruments also allow us to contribute periodically. A regular savings program (RSP) is a powerful way to accumulate wealth by a strategy called dollar cost averaging, which means lowering our investment cost over time when we invest regularly with discipline. This strategy should enable us to comfortably achieve our ‘needs’ goals in life.
5. When we have accumulated a certain sum of money, eg $50,000; we can then proceed to explore shares of companies which are of long term value. In this exercise, we will be putting on our thinking caps and perspective of a business owner. A good business sense and acumen will be of great help to identify companies with profitable long term prospects. We may even start a new venture and invest in the growth of the company. Being a shareholder of a profitable company that is sustainable over long term will exponentially increase our wealth. We can then start to dream of achieving all our ‘wants’ in life, given time.
6. Properties will be the next investment vehicle I will be keen to invest. A property will either require a huge capital investment, or a loan from the bank to finance the mortgage. In both cases, having a large pool of funds to invest or sustain the loan financing will be a prudent way to start investing in properties. Of course, there are other creative measures to use leverage in property investments, and it depends on our risk profile and personality type when it comes to investing. And believe me, a tremendous amount of wealth can be amassed if we understand and invest in properties wisely. By this time, I presume we are all living in our dream lifestyle, with profitable investments, passive income, dream house, dream car, country club memberships, etc. The list goes on and on. However, I would like to quote a passage from the Bible. “What good does it profit a man, if he gains the whole world, and yet loses his own soul?” To me, having good health in the spirit, soul and body, with a warm family, is still the greatest treasure of all.
7. Finally, if we have the courage and the appetite for risk, we can venture into the ever complex capital markets for trading and speculation. The financial markets are usually responsible for the rise and fall of many millionaires, even billionaires. Like one of my trader friend said, “The financial market is the greatest mystery of all time.” No one can ever predict with 100% accuracy the next move of Mr. Market. Trading and speculation in the financial markets require a great amount of study and emotional tenacity. Thus it is the final area of investing sphere that I will recommend to investors due to its complexity and sophistication. I believe when we have done the above 6 steps correctly, we will have amassed great wealth and have all the time in the world to explore the mysterious world of capital markets. The capital market instruments include stocks, bonds, currency, futures, options, warrants, etc. There are also numerous strategies that we can adopt and every trader/speculator has their own strategy of profiting in the markets. But beware, even though trading in the markets may sound exciting, or even sexy… it has still caused many to laugh, cry or even die, as a result of great rise and decline of their wealth. Are you prepared for the challenge?
In conclusion, a journey of a thousand miles begins with a single step. After knowing how powerful investing can be in amassing our wealth and achieving our life goals, and knowing our own investment philosophy, it is time to start putting our first dollar to work. Don’t procrastinate. Start saving. Start investing NOW.
Aaron Graham Tay, CFP
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