My recent read, "The Elements of Investing" by Burton Malkiel and Charles Ellis, is one of the few books which didn't give me a hard time on comprehension. Haha... It's a compilation of classic lessons on investing written in easy and digestible bites.
How long does it take to double your money at 8%.
72 / 8% = 9 years
An investment will allow you to double your investment in 4 years, what is the effective rate of return?
72/4 years = 18%
How cool is that? :)
Rebalancing simply involves periodically checking the allocation of the different types of investments in your portfolio and bringing them back to your desired percentages if they get out of line.
4. Invest only in stocks which business you fully understand.
The classic example cited by the book is Buffet.
5. There's no such thing as stock market pattern.
I like how the authors started the book by revisiting why saving is good for us. In the authors' words - "The real purpose of saving is to empower you to keep your priorities - not to make you sacrifice."
Thus, saving isn't about deprivation. "Your goal is to enable you to feel better about your life and the way you are living it by making your own best-for-you choices. Think of saving as a way to get you more of what you really want, need and enjoy," as the authors put it.
Thus, saving isn't about deprivation. "Your goal is to enable you to feel better about your life and the way you are living it by making your own best-for-you choices. Think of saving as a way to get you more of what you really want, need and enjoy," as the authors put it.
Sharing with you my top 5 key takeaways from Elements of Investing:
1. The Amazing Rule of 72
Did you know that there's a simple formula to compute how many years it takes to double your money? And the formula is:
X x Y = 72
where X is the # of years it takes it takes to double your money
and Y is the percentage rate of return
How do you use it?
To double your money in 10 years, what rate of return do you need?
72 / 10 years = 7.2%
72 / 10 years = 7.2%
How long does it take to double your money at 8%.
72 / 8% = 9 years
An investment will allow you to double your investment in 4 years, what is the effective rate of return?
72/4 years = 18%
How cool is that? :)
2. The power of compounding
The book cited a classic and real life example. Here you go -
Benjamin Franklin died in 1790, he left a gift of USD5,000 to each of his 2 favorite cities, Boston and Philadelphia. He stipulated that the money was to be invested and could be paid out at 2 specific dates, the first 100 years and the second 200 years after the date of the gift.
After 100 years, each city was allowed to withdraw USD500,000 for public works projects. After 200 years, in 1991, they received the balance - which had compounded to approximately USD20M for each city.
Benjamin Franklin died in 1790, he left a gift of USD5,000 to each of his 2 favorite cities, Boston and Philadelphia. He stipulated that the money was to be invested and could be paid out at 2 specific dates, the first 100 years and the second 200 years after the date of the gift.
After 100 years, each city was allowed to withdraw USD500,000 for public works projects. After 200 years, in 1991, they received the balance - which had compounded to approximately USD20M for each city.
Here's how Franklin liked to describe the benefits of compounding - “Money makes money. And the money that money makes, makes money."
Please note though that compounding applies not just to investing but to debt as well. And yes, the rule of 72 also applies to debt.
For example, if your loan interest is at 18 percent per annum, the debt doubles in 4 years and and then redoubles again in the next 4 years. That’s 4 times as much debt in just 8 years - and it’s still compounding.
3. Diversification.
Please note though that compounding applies not just to investing but to debt as well. And yes, the rule of 72 also applies to debt.
For example, if your loan interest is at 18 percent per annum, the debt doubles in 4 years and and then redoubles again in the next 4 years. That’s 4 times as much debt in just 8 years - and it’s still compounding.
3. Diversification.
Diversify across securities, across asset classes. across markets - and across time.
By holding a wide variety of company stocks, the investor tends to reduce risk because most economic events do not affect all companies the same way.
Diversifying over time (preferably on auto-pilot e.g. monthly or quarterly) is a very important advice. Though it may not totally eliminate risk, it will reduce your risk. How? If you make all your investments at a single time, you run the risk of buying your entire portfolio at temporarily inflated prices.
By holding a wide variety of company stocks, the investor tends to reduce risk because most economic events do not affect all companies the same way.
Diversifying over time (preferably on auto-pilot e.g. monthly or quarterly) is a very important advice. Though it may not totally eliminate risk, it will reduce your risk. How? If you make all your investments at a single time, you run the risk of buying your entire portfolio at temporarily inflated prices.
For example, an investor who invested at the peak of the US stock market in 1929 would not have broken even for more than 20 years. And an investor who invested at the peak of the US stock market at the start of the year 2000, would have a negative return over the entire decade.
Buying over time gives us the benefit of dollar-cost averaging since can't really predict accurately when stocks will go up and down.
3. Rebalance.
Rebalancing simply involves periodically checking the allocation of the different types of investments in your portfolio and bringing them back to your desired percentages if they get out of line.
Rebalancing reduces the volatility and riskiness of your investment portfolio and can often enhance your returns.
4. Invest only in stocks which business you fully understand.
The classic example cited by the book is Buffet.
In the 90s, Buffet avoided all tech stocks. He told his investors that he refused to invest in any company whose business he did not fully understand - and he didn’t claim to understand the complicated, fast-changing technology business - or where he could not figure out how the business model would sustain a growing stream of earnings. Some said he was a passe.
Buffet had the last laugh when Internet-related stocks crashed in 2000.
5. There's no such thing as stock market pattern.
If you do spot one, expect the others to discover it too. Soon people will be altering their behavior to take advantage of the pattern. Just like you, they will also be buying (or selling) and thus, the apparent stock market pattern will not last.
Elements of Investing is a quick read (less than 200 pages) and very easy to understand - no head scratching, promise! Haha... :)