What is investing?

“An investment in knowledge always pays the best interest.” ― Benjamin Franklin

INVESTING

Lillaney

4/17/20232 min read

The first question that comes when somebody talks about investing is “What is investing?

I think Benjamin Graham defined this best in his book “The Intelligent Investor” as follows:

“An investment is any operation which upon thorough analysis promises safety of capital and an adequate return.”

Although the above definition seems simple to understand in theory it took me a long time to realise how insightful it is. If you do not consider the 3 parts of analysis, safety of capital and adequate return expectations you are most likely to lose money. Let me try to explain with some examples the 3 points.

  1. Most people invest without doing any analysis just because their friends / relatives / advisors told them to invest in something. For example in India, gold and real estate are the most common investments but if you see the long term record of gold it has largely given returns not much more than inflation. Even in real estate the returns over a long time have been not much more than inflation in most cases unless you have invested in a place which grows rapidly after you invest which has a very low probability.

  2. There is a saying “Return OF capital is more IMPORTANT than Return ON capital.” This is best explained by an example. There are many banks which give different rates of interest if you park your capital with them for different time periods. For example one bank will pay 6% per year and another might pay 7% per year. Most people would invest their hard earned money in the bank paying higher interest. Very few people would try to understand why the second bank is paying a higher interest and whether it will be able to pay the interest or not. A lot of people have lost even their capital in search of higher yield. 

  3. Return expectations are the third component. When investing in banks people are happy with low returns per year. But when they invest in the stock market or mutual funds they want to double/triple their money in a few months/quarters. The return expectations are not realistic. A quick way to check how quickly you can double your money is the Rule of 72. What this rule says is if you want to find out how much time it will take to double your money divide 72 by that interest rate. For example if I am getting 6% per year the time to double my money will be 72/6 = 12 years. If I am earning 8% per year it will take 72/8 = 9 years to double my money. Now imagine why people are disappointed when they are happy with 6-8% per year returns in banks which will take 9-12 years to double but in the stock market the expectation is to double the money in a few months/quarters!

Once it is clear what investment is, the next question that comes to mind is “Why Invest?” which we will cover in a subsequent article.

Stay tuned! Let us know your feedback in the comments below.

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