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Friday, 27 July 2012

WHAT IS INVESTING?


What is investing?

At its most basic, investing is about putting your money to work. If you have a R100 note and you leave it on your dining room table, nothing much will happen to it. If you put it in the bank, it will earn a bit of interest, but not nearly enough to make up for the depredations of inflation, which reduces the value of your money over time.

However, if you take that R100 and use it to buy shares in a promising company, in years to come it will (hopefully, if you picked the right company) be worth more and more, and it will also deliver a valuable stream of income in the form of dividends, which you can use to buy even more shares. If you invest wisely, the growth you’ll see from your R100 will be enough to stave off the effects of inflation and to increase the real (inflation-adjusted) value of your initial investment and that, in a nutshell, is how you build wealth.

Why do it?

Investing is an important thing to do. If you’re anything like the average person, you’re a productively employed person in your prime earning years; you have plenty of money coming in every month, and your needs are comfortably met. Eventually, however, you will no longer be able to work, or at least, you will no longer be able to earn the kind of money you’re earning now. At that point, you’ll still have needs, but you won’t have income from employment.

This is where investing comes in – if you’ve invested wisely and well over a period of many years, when you retire you’ll be able to live on the income that your money is earning, because money, unlike people, never needs to retire (the alternative is to rely on the state, which is a terrible bet, or on your ungrateful children, which is not much better).

The secret magic of investment

The exciting thing about investing is that you can invest just a part of your current income today, but over time, your investments can deliver enough returns to replace that income. This fact seems almost magical, but really there’s no mystery to it: the magic happens through the power of compounding.

As noted above, when you invest in an asset, that asset gives you an income. The income may be in the form of dividends (in the case of shares) or interest (in the case of bonds) or rental (in the case of investment property), but if it’s a real asset, there will be an income. If you then do the smart thing and reinvest that income, you will be accessing the power of compounding – the money that your investment earns will go on to earn you even more money in a wonderful virtuous circle.

It is compounding that makes the issue of time so important for investing – a few extra years of compounding can make a huge difference to your returns. That’s why it’s so important to start investing early, and to invest consistently over the years.

Admittedly, at times like these, it can be hard to stick to your investment plans. However, just keep in mind that, when things look bad, smart investors look for opportunities, for high quality companies or bonds or properties that are being priced too low by volatile and negative markets. Buying these under-priced gems can boost your returns significantly, and staying invested despite the volatility can help you avoid locking in losses.

For investing to work, it must be smart, consistent, and strategic. 

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