Build on the three pillars of investment
Tuesday, 21 February 2012 | 00:00
Costs, growth and protection are the three pillars of investing, yet few pay them much attention.They don't teach investing at school. Kids are drilled in the ancient history of long lost countries and scientific facts they will never use, yet aren't even taught the basics of how to deal with their finances.
Unsurprisingly, when the time comes for adults to invest for the first time, they do so without the ‘basics' under their belt. Yet, these basics are critical.
Tip to novice investors
A classic problem for many starting out is they do not understand the costs of investing. They might buy a futures contract for say, gold, hoping to profit from a rise without realising they have three costs to contend with. Only one cost — the brokers' commission — is immediately apparent. Many novice investors do not know that between the buying and selling price is another cost and they don't know that as time passes, the price of the contract falls with every day it ages.
The costs of investing are crucial as over time, they mount up to be a large drain on profits, eating into the growth of the capital that is the engine of future wealth.
Few investors have a good sense of what profits are possible in a normal investment environment. If they knew, they would be put off by the small percentages that are realistic. They want to double their money fast. What they also don't realise is that small numbers grow to huge numbers given enough time. As such, they would be overjoyed at apparently low yearly returns and be horrified at the prospect of losing a per cent or two on yearly costs.
Effect of time on wealth
The thing to do is plan your investments and study the effect of time and growth on your wealth. It doesn't take many hours to grasp how small percentages make a colossal difference to your future wealth.
Grasping the effects of costs and of growth rates on your investment progress is a key foundation to a successful future. Outside of picking the correct investments, these factors alone mould the outcome as substantially as world events, yet their importance carries no headlines.
The final pillar, protection, is poorly understood even by many sophisticated investors. There is no point having superb investments if you are not protected from disaster. Time and time again, people suffer terribly when banks fail or brokers collapse or fraudsters strike. You must keep your money in a secure environment. That might mean making sure your cash is kept in the best banks, under the highest regulatory inspection or insurance. It might mean checking the quality of a fund manager to a level others would think a bit odd. This need for security should permeate all investments from multiple points of view. Spreading your investments over different kinds of strategies is another kind of security. In the end, it is normally the investors' choices that provide the most risk. Never concentrate capital in one investment or investment sector or investment instrument. The risks of catastrophic failure are then dramatically lowered.
Keep costs to a minimum
The investor should always keep his costs to a minimum and search out the cheapest methods of investing. Knowing and planning to grow his wealth over time by working out how best to compound profits will drive returns, while spreading investments and capital over investment providers and investment categories will even out the effects of luck and crisis. Then, the passage of time will not only deliver a solid performance but give the investor the opportunity to develop and hone their investment skill built on a sound foundation of prudence.
Source: Gulf News
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