ft. Some Simple Investment Concepts
I recently got especially annoyed at someone who had been giving fairly bad advice. Maybe it was because I had high expectations of him and even recommended him a prospect for US-equities investing.
One of the reasons for my annoyance was because he stated that investing was undoubtedly a zero-sum game when it isn't.
Seriously. It isn’t.
You are not stealing or taking money from someone to increase your own wealth or worse, compound it. The possibility that you are making someone poorer as you get richer does not make investing a zero-sum game. This is not gambling. Forex and Options are not part of this purview, of course (because they actually ARE zero sum games).
True investing creates economy value which creates economic growth, which is what wealth creation is all about.
Gather round, my children, as I tell you a short story on how investing works.
Once upon a time...
A rich king (Investor) demanded a yearly tribute from his farmers (25 bushels of wheat). This was about half what they could produce at the time, which was 50.
Now, farming was very eff-ing hard back then because there were no tools, so every farmer had to work 12 hours a day, 365 days a year (otherwise known as Modern Day Slavery).
In addition to not having time to make a family, let alone spend time with them, the farmers were dying in droves from disease, exhaustion, hunger etc. Desperate, they cried out to the king to let them implement a solution.
You see, one of the farmers, who was a bit more creative. Farmer A had an idea that he'd been considering for a very long time.
The idea meant using a solid two-handed tool where the end had a wide surface area that could pierce a larger surface area of ground far more effectively than human hands. However, he lacked the time and money to put the tool together.
In any case, this farmer was granted an audience with the King in order to present the solution to all the problems.
The King was very cynical. After all, granting this audience already required time, and time is money. Furthermore, if the king were to leave things as they were, he would probably still get his 25 bushels of wheat, albeit very reluctantly.
This was Farmer A's presentation.
He explained that the total cost for the shovels would be 100 silver pieces. This is known as his investment capital.
Farmer A said that it would take 3 years to construct the shovels and teach the other farmers how to use them. The worst case scenarios involved the farmers having a high learning curve and therefore having no free time to produce any bushels. This possible loss of 3 years' worth of bushels (75 bushels) and misc events is what investors call market volatility.
However, Farmer A projected that the king would now be able to receive 50 bushels of wheat yearly upon completion of the shovels. This is also known as his expected Return on Investment (R.O.I.).
Intrigued by the prospect of getting more each year from the 4th year, the king did the math in his head.
Even if production was completely zero for the first three years, he would have made back the same number of bushels by the 6th year. The knowledge that he would continue reaping far higher returns afterwards was enticing.
Of course, he also accounted for the 100 silver pieces paid upfront. This is called accounting for your expense ratio.
Since 1 bushel cost 1 silver coin, he would need 2 more years to earn back his capital. The end of the 8th year is what you would call the break-even point.
Having to wait 8 years for no real return on his investment didn’t make a lot of sense to the king. As a result, he only agreed to help the farmer if he received 10 years of tribute, or 250 bushels of wheat in 5 years, followed by 50 bushels of wheat a year from the 5th year onwards.
The Financial Advisor – erm, Farmer A, quickly took the 100 silver pieces and got to work.
It was a rocky road for both Farmer A and the King. At one point, a horrendous winter wiped out the crops. The King got upset at Farmer A, but Farmer A reminded him that he never promised immediate or specific-guaranteed results. After all, investment is non-guaranteed.
Sometimes, the King wanted to get his bushels of wheat earlier than 5 years so that he could throw feasts and stuff. He would also get upset at himself for agreeing to this deal, until Farmer A reminded him of the promise of much higher reward ahead.
This is called delaying your gratification for higher returns.
At another point, the shovels were defective, and the King had to consider whether he should repair them or not, or risk only being able to use a lower amount of working shovels. This is called your investment is subject to risk and capital loss.
But finally, 5 years later, every farmer was now able to produce 100 bushels of wheat a year instead of 25 for the same amount of work.
This meant that the farmers could now pay the King in full while,
1. Working 6 hours a day instead of 12 or
2. Feeding their families and having 25 bushels of wheat left over.
This is known as your created wealth. The wealth did not come out of nowhere, but it came out of innovation.
With the ability to produce at a much more efficient way, the farmers were able to use their excessive time and money to do all the things that they were never able to do before like take vacations overseas, start a family, get an education, etc etc.
The King was happy with his increased crop and began scouting ways to get even more. The demand for productivity and a better life not only kept farmers alive and healthy, but opened up jobs for both farmers and the makers of the shovels, which in turn created productivity, which opened up more jobs.
This cycle of growing abundance is known as a growing economy.
And the Financial Advisor – I mean, Farmer, began to look for the next great investment to make everyone’s life better.
What’s the learning lesson?
1) Investing is NOT a zero-sum game.
Ultimately, all investments go towards making life subjectively better for the human population.
Through wealth creation, the quality of life for a person today is much higher than it was 100 years ago. Today, even a poor student can travel thousands of miles abroad, sleep in an air-conditioned dorm with easy access to food kept safe by an innovation known as the fridge.
Wealth is created all the time, largely through investing in products that assist in the freeing of time or the opening of access to novel human experiences.
2) Wealth is NOT simply the possession of money, electronic or otherwise.
A prince in the 5th century had far more physical wealth than you or I, but we are both much richer than he could ever be. One must understand that money is only enjoyable when spent. True wealth – aside from health, happiness and all that jazz – is really about the improvement and quality of a lifestyle.
3) When will you start?
If the King had not chosen to invest, he would have been stuck with a miserable amount of production for the rest of his life – not to mention a bunch of dissatisfied farmers.
This creed continues to this day. The one who does not invest gets stuck with a miserable amount of money and stays largely dissatisfied with his/her single paltry income. That is likely to be you, working your ass off to retire at 65 or later so that you can do so with dignity (money).
It doesn’t have to be this way.
Today, you can be the King who took on that risk to invest. Create wealth for yourself and open up access to a new, large stream of income in your life, for your life as well as lasting a lifetime.
It was not easy for the King to delay his gratification but by sticking with it, it paid off for him in huge numbers – and it can for you as well.
At a paltry 7% compounded interest, you get more money from your investment in THREE DAYS than you would from a savings account across as ENTIRE YEAR.
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Featured Image Credit: Max Pixel