How to make an investment decision?
Updated: Jan 17, 2022
As a financial planner, I ask my clients, why are you investing in the stock market?
They will say returns. The stock market gives the best returns.
How much of the returns you will get?
This question will labor on for an hour or two and finally, they will agree that their intuition says that if something is going up and something is going down if we jump the boat at the right point, I will get great returns. I will say that is good. Your intuition is right, after all, everyone can see the ups and downs, in hindsight. Do you know which will go up and which one will go down in the next 6 months or in a year? Do you have any data to believe that it would work? After a few hours of discussion, we will conclude that the data is not conclusive. Then I will say what you are trying to do is called timing. No one ever timed the markets and became rich. In other words, no one became rich in hindsight. I will allow the reality to sync in.
Then after some time they will counter me and ask there are so many traders, fund managers, successful investors. Yes, there are traders and fund managers. Do you think they are playing with their money? After some thought they will say no. Then I ask them do you know how much money they have, to manage their risk? At the end of the day no matter what happens, it is not their money and they will sleep well in the night.
But when you trade, you are trading from your savings account. If you don't know what you will get in return in the future without any certainty then you are gambling away your future wealth. Let me be clear, I am not against trading. My only suggestion is just to play with 10% of your gross salary and see what you will come up with. Then we will discuss the performance of your money.
What about successful investors?
Yes, there are. Successful investors know the return they are going to get in the near future. They know the intrinsic value of the asset they are investing in. So they can estimate the future value. And that is how they become successful.
Then my client would say, you know what, I understand technology, their business, some of the leading indicators, so I am equipped to be an investor. So I tell them if you know the intrinsic value of the asset you are investing, then don’t look at all the fluctuations. Just give me a plan of what your return will be for next year and the following four years. After a couple of hours, I will get an answer that is too much work. Yes, it is. It is your money. You have to do your homework. If you don’t, you are back in square one - where we started - hoping to ride the wave. This is the polite way of saying, you are still gambling. There is no certainty to your returns.
So we can conclude that there are two big strategies in finance: trading and investment.
In trading - returns are completely uncertain and you risk losing the capital. The goal for professional traders and fund managers is just one thing. Just don’t lose too much money. For that, they will start with big money and try to at least keep the original capital.
In investment - returns are predictable to a certain degree because you know the intrinsic value of the asset that you are owning. So you would never lose the capital. Your returns are intrinsic value plus market returns.
If you are trading on stocks, please go ahead, limit your amount of money, and trade for the next four years. You would have either made money or lost money. If you lost money, come back I will tell you how to recover from the loss. If you made money, then come back I will tell you how to save your skin.
The key takeaway is: if you know the future value of your asset with certainty then it is called investment. If not you are trading. In trading, the risk to capital is more than you can bear. Don’t let the coin flip to decide your future wealth.
If you want to know more about building your wealth, schedule a 1-on-1 session with me using this link: https://calendly.com/balajik-hgi/fincare-zoom-15min