An investment involves committing assets (typically money) to a venture that is expected to generate profits (return of the invested assets plus a premium, which is the profit or “return” on the investment, abbreviated as ROI) after some time. The investment can be anything but typical investments include opening your own small business, investing in someone else’s small business, buying stock in a publicly traded company, or buying real estate. The definition of short-term and long-term might vary for different investment types — for example the cut-off could be 1 year for stocks or 5 years for private equity.
Note that while buying stock in a publicly traded company is technically an investment and most people refer to it that way, selling a stock within a year of buying it is considered to be a short-term investment and it’s essentially arbitrage. Also, if you don’t do any research on the investment in order to arrive at the expectation that it will generate profits, investment without due diligence is essentially gambling. Finally, when we say your own small business we mean that you hire people to do the work and you’re not working in the business yourself — because that would be essentially starting a new business. In this section, we focus on long-term investments in other people’s projects with due diligence.
Investments that are very popular among investors include:
- Stock market. Buy and sell shares and options.
- Real estate. You buy a property and lease it out, or you buy a property and improve it and then sell it.
- Private equity. You buy a stake in a business. You may or may not be involved in any decisions as a member of the board of directors or as a voting shareholder.
- Private lending. You lend your money to someone. They make regular payments of principal and interest. Eventually you get the money back plus profit in the form of interest.
Advantages of investment:
- You can turn excess cash into even more excess cash
- You can invest borrowed money (called a leveraged investment), which means when it’s successful you keep the big profits and only have to pay back the borrowed amount plus interest; this also increases risk because if the investment fails you still owe that money
Disadvantages of investment:
- Investment is risky because it involves other people. You need to look out for risks both in the investment itself, the people who are executing it, the market, the economy, the government (new regulations might affect the investment), and more.
- Investing in a new business is risky because most of them fail in the first 5 years. Don’t invest all your excess cash in just one asset class or just one asset in a class.
- Investing in an existing business takes more money because they’re already making some money, so if they need more money to grow it’s going to be a significant amount.
- Investing borrowed money can cause a significant strain on your finances if the investment fails, and has caused plenty of bankruptcies. Don’t leverage more than you can handle.
- Stock prices of publicly traded companies can vary due to market sentiment or the economy more than they vary due to the merits of the business itself, so there’s a downturn you might need to wait a while to avoid selling at a loss. Don’t invest money that you’ll need in the near future.
- Borrowers can default on their loans. Don’t lend money you can’t afford to lose, or require some collateral from the borrower.
How to grow your wealth with investments:
- Know how much money you have available to invest. This must be excess cash that isn’t already allocated to essential expenses or any emergency fund. If you invest money from a retirement fund, only invest an amount you’re comfortable losing.
- Allocate your investment fund into risk tiers and asset types. The idea is that if you have a large portion (let’s say 60% to 80%) in low-risk investments and medium-risk investments and only a small portion (let’s say 20% to 40%) in diversified high-risk investments, if a high risk investment fails (and some of them will) it won’t wipe out your investment fund. But when a high-risk investment scores big, it will return a significant amount to your fund and then you can re-allocate and you’ll have even more money to invest in all the risk tiers and asset types.
- Invest in the lower-risk assets first. Create a habit of adding more money to these periodically. Following the earlier advice about risk tiers, if you want to be able to invest $1,000 in a high-risk stock, and let’s say you decided that would be 20% of your portfolio, then you need to first invest $4,000 in low-risk or medium-risk assets and then the next $1,000 you add to your investment fund could go to that high-risk stock. Another way to do it which is possible depending on the minimum investment required for an asset, is that each time you invest an amount (for example $1,000) you put a majority percentage of it (let’s say 80%) in low-risk or medium-risk assets and the remainder (let’s say 20%) in a higher-risk asset.
- Invest in for the long-term before the short-term. Build your retirement investment account first. Not the entire amount, but the amount you decide to contribute to that every month. Make that a system. The retirement investment timeframe might be 20 or 40 years. It might look like it’s growing very slowly at first but each year that you re-invest your gains or leave the money invested in growth assets, the returns compound. After 20 or 40 years it will be a lot more. If you still have excess cash to invest each month, put it into a similarly structured but separate fund until there’s enough in there to invest in bigger deals such as real estate lending or private equity in a new or growing business. Make that a system.
Compass
Return to wealth plans.