Overview – What Exactly Is “Investing”?
Investing: this word sometimes conjures up images of sharply dressed businesspeople sitting in front of several monitors for hours on end, watching myriad charts fluctuate while their wealth increases with every passing moment. Sounds too good to be true, huh. So, what is investing anyways?
Benjamin Graham, Warren Buffett’s professor and mentor at Columbia University and widely considered the “father of value investing”, put forth the following definition of investing in the classic investment book he co-authored with his colleague David Dodd, Security Analysis:
“An investment operation is one which, upon thorough analysis promises safety of principal and a satisfactory return. Operations not meeting these requirements are speculative.”
Security Analysis, Sixth Edition. page 106.
This definition, though simple, contains three major elements. Let’s go over each one:
Thorough Analysis
Investing isn’t the act of picking a popular asset (stocks, bonds, crypto, real estate, etc.), notice its price has been trending upwards, then proceed to bet your entire life savings. Nor is it the act of buying a popular financial instrument simply because you got a hot tip from a stranger telling you to do so.
You wouldn’t buy a house simply because you liked how it looked or just because someone told you to buy it. Chances are, before buying a house you would go on a house tour, evaluate the build quality, and make sure the neighbourhood is safe, among other things. Any sensible person would perform the appropriate due diligence before deciding whether they want to call a house they’re interested in their new home.
Investing is no different. Before pursuing any sort of prospective investment operation, whether it’s buying shares or purchasing real estate, a thorough analysis needs to be performed to ascertain that the prospect is indeed worth putting your money into.
Safety of Principal
“Principal” is simply the money initially put up for investment. A thorough analysis of a prospective investment operation must ensure the money you put down does suddenly not vanish.
Now you may be asking “surely my money won’t just disappear into thin air”, but there are instances when this can happen: stocks can be de-listed, companies and governments can default on bonds, a market crash may render your real estate or crypto holdings worthless – the list goes on.
There’s always the possibility of losing your money on an investment operation, but some possibilities are greater than others – it’s an investor’s job to determine those possibilities based on the facts they’re presented.
Satisfactory Return
For something to be considered an investment, there needs to be some sort of financial return. After all, what’s the point of giving up your money in the first place if you don’t expect to receive more in the future? If that’s the case, how much money should an investor expect to receive?
Notice the use of the word “satisfactory”. Benjamin Graham did not choose words such as “large”, “superior”, or “outsized”.
There’s nothing wrong with going after investments that offer very strong returns, but obsessing over returns no matter what is the danger Graham warns of. This is because an investor’s greed may cause them to take on more risk than they can reasonably handle, thereby jeopardizing their money in the process.
Beating the market – the term used when an investment portfolio outperforms key indices such as the NASDAQ or S&P 500 – is possible. However, getting too caught up trying to outperform thousands of other investors on a consistent basis is much easier said than done, and may even cause you to lose more money in the long run.
The whole point of investing is to give up some money today in hopes of getting more in the future. A 1% return on a “boring” government bond is much better than a 0% return on a popular stock that ultimately de-lists.
Am I Investing, or Speculating?
In the preceding section, investing was strictly defined and each of the three key points was analyzed. When thorough analysis is not performed, safety of principal is not assured, and adequate returns are not to be expected – you are no longer investing, you are now speculating.
Speculating is the exact opposite of investing. Investing is a disciplined, systematic, and careful act. Speculating is the reckless act of putting money into ventures with the hopes of making a quick profit, without stopping to check if you’ll make money from such a venture in the first place.
In the investing world, any time you are presented with an opportunity to make money fast, you should be equally as fast to turn it down. If it sounds too good to be true, then it probably is.
There are instances where money can be made from speculative ventures, but do not expect it to be sustainable. If speculation is something that you would like to try, allocate a specific amount of funds, and keep speculative investments in a separate portfolio.
If the speculative portfolio increases in value, good for you. Do not allocate more funds than the previously determined amount you have set. Some people get lucky with their speculations, but “sheer luck” isn’t a valid investment strategy, and is certainly not something that can be sustained year after year.
Types of Marketable Securities
There exists a wide variety of marketable securities for investors to purchase. Some common ones that new and young investors are likely to come across are the following:
Stocks
Publicly traded companies issue stock to raise capital. An investor can buy a portion of a company’s stock by purchasing individual units of ownership called shares. Therefore, investors that own a company’s stock are called shareholders and subsequently become partial owners of the business.
Money can be made from a company’s stock by selling the shares at a higher price than the initial purchase price (capital appreciation) or by being periodically paid a portion of the company’s profits (dividends).
(For more on stocks, read about it here).
Bonds
Bonds are pieces of debt that are sold to the public. For example, let’s say a company or government has $1,000 of debt. They can choose to divvy up the debt into ten pieces worth $100 each and put these ten portions up for sale. A single $100 portion of debt in this example is a bond.
Investors can buy bonds from a variety of institutions such as governments, corporations, and municipalities. All debts must be repaid, so every bond has an “expiry date”: a date when the institution that issued the bond must pay back the money the investor initially paid to purchase the bond.
Expiry dates can range from a few months to more than 30 years, sometimes longer. A bond investor is also entitled to periodic interest payments from the bond during the bond’s lifetime called coupon payments.
Like any sort of debt, there’s a corresponding interest rate that the lender charges. In the case of bonds, each bond has a corresponding “coupon rate”: a percentage of the bond’s price that determines how much money in interest payments the investor will receive at a set interval (once a year, twice a year, etc.).
At the expiry date, an investor gets to keep all the interest paid to them and receives their initial investment back.
(For more on bonds, read about it here).
Funds
Funds are a type of investment instrument where several investors put their money into a common money pool, and this money pool is managed by fund managers.
The three most common funds are mutual funds, exchange-traded funds (ETFs), and index funds (although index funds are usually a type of mutual fund or an ETF).
A mutual fund is an investment vehicle that pools together the money of many other investors. This “pot” of money is then invested into a variety of investment products such as stocks, bonds, and other asset classes.
ETFs are investment products that contain a collection of different asset classes (stocks, bonds, etc.). ETFs are, in many ways, like mutual funds, but they can be purchased on an exchange during normal trading hours, as opposed to mutual funds which can only be purchased after normal trading hours.
(For more on funds, read about them here).
Some Misconceptions About Investing
Individuals become investors for many reasons, but many individuals start to invest with a few false beliefs in mind, putting themselves at a disadvantage right from the get-go. Let’s go over what some of those false beliefs are:
Myth: Investing Is a Guaranteed Path to Wealth
Many individuals turn to investing with grand dreams of achieving seven or eight-figure net worths overnight.
For those who focus solely on the stock market, some investors believe that all you need to do is pick a handful of popular stocks, buy some more when money becomes available, then sit back and watch your net worth go to the moon.
If becoming wealthy was that easy, then everyone would be an investor. Clearly, that isn’t the case.
Let’s dispel this false belief right now: investing is not a sure-fire way to accumulate wealth.
Now, many people may turn to some high-profile investors such as Warren Buffett, Bill Gates, and Ray Dalio, and point out that these individuals are not only investors but are all billionaires.
This “so and so is an investor and is super-wealthy” finger-pointing is made worse when Warren Buffett is used as an example, since he is heralded as one of the greatest investors of all time and people immediately assume that all they need to do is invest to become a billionaire.
These three individuals all share one thing in common: they are all entrepreneurs and have built large and successful businesses. Investing definitely played a role in obtaining their wealth, but investing is secondary to their entrepreneurial/business activities.
Myth: Investing Is Too Risky
Many individuals choose not to invest by citing the high risk of potentially losing their money. These individuals have a valid reason to be concerned: high profile events such as the 2001 dot-com bubble, the 2007-2008 financial crisis, and, at the time of this writing, the continued market effects of COVID-19.
These market events have resulted in financial ruin for many investors, some of who previously thought their portfolios were bulletproof.
Some people shy away from investing by citing the oft repeated: “high risk, high reward”. This pushes the false notion that the only way to achieve excellent investment returns is to constantly live on the brink of collapse, and that safer investment options aren’t worth looking at since a false dichotomy of “low risk, low reward” is created.
Investing can be risky, but so is driving, weightlifting, and going on a hike. Why do people still perform these activities despite the risk? It’s because people who perform these tasks have the skills, knowledge, and preparation needed to keep the risk as low as possible. Investing is no different.
Some Truths About Investing
There are many, many more investing myths, and listing all of them would require a separate article (a lengthy one at that). Now, we will turn the previously mentioned misconceptions upside down, and discuss some investing truths.
Truth: Investing Is a Key Component to Building Wealth
More than half of the world’s billionaires are self-made. Many of these individuals didn’t even start off as millionaires: almost all of them started and built their own businesses, some also chose to build up an investment portfolio over a long period of time, and eventually both their businesses and portfolios grew, leading to their astronomical net worth.
Investing may not guarantee wealth, but it certainly increases your chances of becoming wealthy.
Investors who achieve seven and eight-figure net worths are the ones who consistently work on their portfolios, adhere to a strict set of strategies, and continually reassess their portfolios to make sure everything is in order.
The investors who grow their portfolios bit by bit for years on end are the ones who ultimately achieve great wealth from investing. Consistency is just as important, if not more, than an investor’s intelligence.
Investment portfolios take time and effort to grow. So, if an investor is willing to put in the time and effort to build up their portfolios, then the likelihood of one day having a lucrative portfolio becomes more and more of a reality.
Truth: Investing Is Risky if You Don’t Know What You’re Doing and Fail to Manage the Risks
“High risk, high reward” is arguably one of the most misleading statements when describing investing.
The myth that “the only way to achieve outsized investment gains is to take on a commensurate amount of risk” is a very damaging belief that turns many people away from investing.
Risk primarily comes from not knowing what you’re doing. If your approach to investing is simply to buy the hot investment instruments of the day and sell at the first sign of trouble without performing any analysis beforehand, then your money is most definitely at risk.
However, if you take the time to properly invest, which was defined as performing thorough analysis to ensure your money is safe and you receive an adequate return, then the risk of losing your money is greatly reduced.
Risk, which can greatly be reduced, cannot be totally eliminated – there are some factors that contribute to risk which are beyond an investor’s control. Therefore, the best an investor can do is to try and keep risk as low as they possibly can. Countless investors are able to do this on a regular basis without much hassle.
Truth: Successful Investing Involves a Lot of Patience and Hard Work
After reading the preceding sections, you’ve probably pieced together that investing isn’t as easy as it seems, and you’d be correct.
A lot of work is involved when you first come across a prospective investment all the way to making a final investment decision. To make matters worse, sometimes after performing all that work you may ultimately decide that a prospect isn’t worth pursuing after all.
Excellent investment opportunities are difficult to come across, so it should come as no surprise that a lot of work is involved when trying to uncover them.
Investing isn’t an activity where your IQ determines your success. Yes, you need some degree of intelligence to be an investor, but none of that brainpower will matter if you aren’t willing to work hard and patiently go through all the necessary loops.
Wrapping Up
The learning curve new investors face is a very steep one, but don’t let this discourage you! Anything worthwhile takes time to learn and master – investing is no different.
Every investor’s journey will have its fair share of challenges, successes, moments of triumph, and occasional moments of disappointment, but that’s to be expected for any endeavor worth undertaking. Welcome to the world of investing!
