Every single investor wants his or her investments to be successful – that goal is the common thread that binds all investors together. Isn’t this the general belief that most of us have? The problem with that common belief is that the definition of “successful investments” or “good investments” may be drastically different for different investors.
Surprised? Don’t be! Let us understand this concept quickly through a smart example. Andy, a 23-year old college graduate, has just joined his first job. He is an intelligent and responsible guy and he wants to get an MBA 5 years from now. He knows that MBA degrees from good b-schools can cost quite a lot. So, he wants to invest his money during the next 5 years in order to be able to pay for his MBA degree without relying on expensive student loans. Andy’s mother, Suzanne, too is an intelligent investor. She is set to retire from her well-paying job in 10 years’ time. After her retirement, she wants to get a regular monthly income from her investments.
As you can see, Suzanne and Andy have drastically different expectations from their investments. Thus, what is a good investment for Suzanne would be very different from what would be a good investment for Andy. Hence, instead of asking what are good things to invest our money in the question that we should ask is how to make good investments. In this article, we will give you the secret recipe that would empower you and tell you how to make good investments.
How to make good investments – the secret behind the success of such legends as Warren Buffet and others
In a popular Ian Fleming novel, Goldfinger (the antagonist) says, “once is happenstance; twice is coincidence; the third time it’s enemy action”. In the world of investing, one or two successes can be the result of luck (happenstance, coincidence, etc.). But, if some people are successful again and again, then their consistent success can only be attributed to good investment strategies. So, let us quickly look at the secret 3-point mantra behind the success of investment legends.
1. Study (and prepare) thoroughly before actually investing anything.
The importance of this point cannot be overstated. Warren Buffet is famous for remarking that he does not invest in industries that he does not understand (he has repeatedly made this point to justify his decision to stay away from new industries like information technology). Isn’t it remarkable that one of the greatest legends of investing openly claims that he does not understand certain industries?
What is good enough for Warren Buffet must be good enough for a lot of investors! Never invest anything without first:
- understanding the basics of investing
- understanding the different investment options suitable for you
- identifying the best of these opportunities
- comparing these top opportunities to each other to distil down to the very best (the absolute best) opportunities for you.
Success in any field is usually the result of hard work rather than mere luck. This holds true for the world of investments as well. The number of investment options available to us is simply mind-boggling. For example, if you wish to invest in a bank savings account, you have thousands of banks to choose from. On top of this, each bank may have many different types of accounts (sometimes as many as 10 to 20 different types) that you can choose from.
Similarly, if you wish to invest in the stock market, you have thousands of companies to choose from. You also have thousands of mutual funds and exchange traded funds to choose from. Out of this massive sea of choice, you need to pick out the few pearls that are most likely to give you the best possible returns.
When you are faced with so much choice, it may be a good idea to seek professional help in order to identify the best investment opportunities for you. This can be especially helpful if you are looking for a more diverse portfolio. A good financial planner or wealth manager would help you keep track of your existing investments and would also offer useful advice regarding new opportunities available. Thus, good professional help may be a useful asset for your investments. Do note that while choosing professional investment support, you should always compare the services offered and fees charged by different firms or individuals.
2. Aim to invest for the longest term possible.
This might seem a surprising and contradictory statement – contradictory because you may have heard from many sources that you should keep switching your investments (flip is a common term that you would have come across). Do remember a couple of important points always. First, switching investments is costly – every time you switch investments, you incur transaction costs (and these costs usually mean more commission for someone). Along with transaction costs, you may also incur heavy penalties if you switch certain investments early (for example, charges for pre-closing a term deposit account or charges for exiting a mutual fund).
The second (and possibly far more important) point is that longer periods of investment usually offer the best returns. Hence, investing for shorter duration may mean that your investment does not generate the maximum possible amount of returns that it could have. Just take a look at the interest rate offered by your bank for various bank accounts. Typically, term deposit accounts with the longest period of maturity would offer the highest rates of interest. As the period of maturity decreases, the rate of interest offered goes down. Similarly, bonds with longer periods of maturity offer higher rates of interest.
Let us consider another example – suppose you wish to purchase shares of a company. In the short term, market conditions may not be very good or the company may underperform. In the longer term, such momentary variations would not matter. If the company is managed well, then in the longer term it is certainly likely to generate good returns. This is why the best investment experts always suggest that when people invest in the stock market, they should always plan on staying invested for at least 5 years (and possibly for even up to 10 years). This ensures that their investment has the maximum possible chance of generating good returns. This is also a mantra that many legendary investors like Warren Buffet follow regularly.
3. Be in full command of your personal finances.
A leaking bucket can never be filled, goes the old adage. If your personal finances are not in order, you will always struggle to achieve your financial goals. You may make excellent investment decisions but if your expenses are too high then they will eat into whatever profits you make. Thus, it will be difficult for you to build up your financial assets. Note how Warren Buffet, a multi-billionaire and one of the richest people in the world, is known for his frugality.
Irrespective of whether you want to build a fortune or just want a small amount of steady income, you need to get your expenses under control at the earliest possible. Any significant amount of costly debt (for example, credit card debt) that you carry must be paid off quickly. Even small amounts of monthly pay-outs can add up to a large expense over time. Secondly, always plan your expenses as far as possible. This would enable you to stick to your investment plan and will allow you to realise the maximum possible return on your investments. In case you need to liquidate some of your investments in order to meet unplanned expenses, then it will adversely affect your investment plan. It will also lead to higher transaction costs and possible penalties (early liquidation charges).
This is the secret recipe for successful investing. Many investors start with the question – what is a good investment. As we have seen, the more appropriate question to ask is how can we make good investment decisions, how can we become a successful investor. Simply apply the mantra that we have just discussed and you will definitely be able to achieve financial success.
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