My short investing journey has had its fair share of ups and downs ever since I started investing when I was only 20.
It began with dabbling in stocks as I tried to put my knowledge from reading loads of investing books into practice. I am approaching my 30s and 70-80% of my portfolio is currently in stocks. The rest are allocated in a mix of Singapore Savings Bonds, cash and gold.
As I look back on my investing journey, it’s been a roller coaster ride. I experimented, failed, got burnt and picked myself up from failure. Perhaps the journey could have been smoother sailing if I had learnt a few key investing concepts while I was still a novice investor. If you are starting out your investing journey, there are four investing concepts that you should be aware of in order to have a more smooth run.
- Compound interest is the foundation of all investing concepts
- Price is what you pay; value is what you get
- High return doesn’t always mean it’s a good investment. You need to weigh against the risk that comes with it
- Learning to find the right balance between diversification and concentration
Let’s deep dive into each concept:
1. Compound Interest: The foundation of all investing concepts
Compound interest is perhaps the most important investing concept every beginner investor should learn. It was only when I truly understood the power of compound interest that I started to see my investments grow.
Here’s how I would explain compound interest to a five-year old kid. Compound interest is like a snowball effect. You take a small snowball (i.e. your first investing sum) and keep rolling it (aka investing). The longer you keep it rolling (aka invested), the bigger your snowball is going to become as it rolls down the hill. So, if you want to grow your wealth, make sure you stay invested in the long run, and start that first snowball as soon as you can.
2. Price vs Value: Price is what you pay; value is what you get
For many of us who have just started investing, there isn’t too much difference between price and value. But the thing is, price isn’t the same as value. Warren Buffett famously said, “Price is what you pay. Value is what you get.” When I first read this from his book, I couldn’t comprehend it. In my mind, I was thinking, “Aren’t they the same?” Well, it turns out that they are very different.
When I first began investing, I invested 20% of my savings from my NS pay in cheap penny stocks. These stocks were so cheap that any movement in the stock meant that my return on investment will double, triple or even quadruple. I thought that I knew it all. After all, I had read so many investing books. Unfortunately, such a day didn’t come. Eventually, the stock was delisted. That’s because intrinsically there wasn’t any value in the stock.
Losing 25% of capital was so demoralising, but it was a much-needed wake up call for myself. I learnt that price is what the market quotes me on a daily basis. Value is what the stock is intrinsically worth. As an investor, you need to discern the value of the stock and wait for the market to quote you the right price.
3) Risk vs Return: Higher potential return comes with higher risk
The higher the return, the better it is for an investment, right? For example, making 10% net gain on your investment is a pretty good return for most of us. That’s what I thought too until I learned about the risk-return trade-off.
Well, what if I told you that, in order to achieve the 10% return, the risk that you are taking on could have led you to lose 30% of your capital? On a good day, you will be making 10% return. However, on a bad day, you could lose up to 30% of your investment. Overall, the reward-to-risk ratio for your investment is 1:3. Would you still agree that the return is good?
In investing, there is always the risk-return trade-off conundrum. The more risk you take on, the higher your potential return in an investment. The rule of thumb is to make sure the risk you take on is what you are comfortable with. You need to make sure the reward-to-risk ratio is more than 1 at a risk factor that you can accept.
Personally, I have a large risk appetite. I allocate 70-80% of my portfolio in stocks. The rest are allocated in a mix of Singapore Savings Bonds, cash and gold. I would attribute my risk appetite to my long investment horizon (20-30 years). As I grow older and take on more financial commitment, I foresee my allocation in stocks diminishing and shifting towards more fixed income/dividend yielding assets.
4) Diversification vs Concentration: Finding The Right Balance
As you start to build your own investment portfolio, you will soon learn that you need to make a choice between diversification and concentration. Do you concentrate all your eggs into a few baskets, or do you diversify your risk and keep your eggs in many baskets?
Keeping your investments concentrated in a few assets can help you maximise return on your portfolio. But what happens if one of the investments turns out to be a dud? It can have a huge negative impact on your investment portfolio. That’s why diversification is key help.
One diversification strategy I use is to invest in indices. For example, I am bullish on the tech sector. Thus, I invest in ETFs/funds that focus on a basket of tech stocks like Facebook, Alphabet and Amazon.
The advantage of diversification is that it reduces the volatility of your portfolio and the potential risk. Even if a few assets are doing poorly, it will be compensated by the good performance of the remaining assets. However, diversification is not without its risk too. Overly diversifying can reduce and water down the gains on your investment portfolio.
If I were to start my investing journey again, these are the four investing concepts I would definitely want to pick up first as a novice investor. So, if you are looking to start yours, you could avoid making novice mistakes by learning from my example.
More importantly, I will encourage you to start small and start early. Don’t worry so much about making mistakes. Mistakes will be made along the way, but that’s how we learn. And if you have a long investment horizon like me, that’s plenty of time to get the fundamentals right and see your money grow.
Read these next:
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