Are your ‘Investments’ making you poor?

Now that we have successfully created our kitty of ‘investible surplus’ by following the first five steps, what do we do with it? Of course, we put it to work through investments. But what constitutes ‘Investments’? And by extension, an ‘investor’?

Defining ‘Investments’

Investment is broadly defined as ‘Purchasing an asset which will generate revenue/income, a return and/or appreciate in price over a period of time’. While this definition isn’t incorrect, we need to get more specific since our clear and singular objective is creation of wealth.

I therefore refer to Benjamin Graham and David Dodd’s seminal work “The Intelligent Investor”, where they say “An investment operation is one which, upon thorough analysis, promises safety of principal and a satisfactory return. Operations not meeting these requirements are speculative”.

Key Attributes

As per their definition, an investment should have three key attributes.

1. Thorough Analysis: In details lie both, the divine and the devil. All investment options must be looked at with enough skepticism and analyzed in great detail to see beyond the superficial.

2. Promise of Safety of Principal: An erosion of the principal in investments is completely unacceptable and runs contrary to the idea of wealth generation. Any investment operation that does not guarantee safety of the principal is purely speculative.

3. Satisfactory Return: the term must not be confused for “Low returns”. Satisfactory in this case means “Handsome” but not “Astronomical” or “Abnormal”. The inherent idea is to not get trapped by promises of huge and quick returns, a ploy often used by people trying to pawn off poor quality financial products. To make it more tangible, anything above 24% compounded annually should be considered “Astronomical” returns. To put it in perspective, Warren Buffet (arguably the smartest investor in the world) has averaged a return of 21-22% compounded over the last three decades.

Smart investments with 15-18% annual compounded returns can create sufficient wealth in the long term for the investor to be financially comfortable. 12-15% annual compounded returns (if also leveraged) can also create handsome wealth on long term averages. These are the returns that investors should ideally target through their investments.

What makes the cut?

Another thing we should get very specific about is “what kind of financial purchases qualify as investment?”. I take exception to people clubbing all forms of financial purchases – Gold, Real Estate, Insurance, Mutual Funds, Artefacts etc. – and labelling them as investments. In most cases these are sales operations masquerading as investments. They leave the buyer under a happy illusion of having made an investment while in reality they end up making the seller richer at the buyer’s expense.

Protect your hard-earned money by comparing the ‘purchase’ being offered against the definition of investments. Do they deliver on the three key attributes of investments as outlined above? It is imperative to do your due diligence and understand if you are truly investing. The alternative will most certainly be counterproductive to your objective of creating wealth and may well end up eroding your principal as well.