The real secret of investing
Written by Simon Davies on July 17, 2018.
When it comes to saving money and investing, too many of us in Hong Kong get caught up in get-rich-quick strategies for growing our wealth that can work spectacularly but more often end in failure. Over the past 25 years in HK I have seen people looking for the next best thing or believing that trading in and out of investments is the way to make your wealth grow. They are always chasing the next stellar share or market to boom, picking the top and bottom of a market or share, investing in esoteric funds, restaurants, bars or properties in unpredictable countries.
Yet time and again we overlook the simplest, most reliable friend to the average investor, a concept that should be at the very heart of your wealth or retirement-building programme - compound interest, and its close partners - buy and hold and diversification.
Here is a reminder of how compounding works and why it should be your best friend, along with a cautionary note on the natural enemies of your savings and investment plans - inflation, poor choices and the lack of a defined strategy.
Compounding happens when you let the earnings on an investment build up instead of spending them. To give an example, let’s say you invest $ 10,000 and gain 10% over the first year. You could find many ways to spend the $1,000 you made but instead you decide to leave the $1000 where it is, attached to the original $10,000 which means you have $11,000 working for you the following year.
Assuming a constant 10% gain each year, by increasing your capital sum or ‘principal’ you have $1100 interest at the end of the second year. Choose to leave that $1100 with your new principal of $11,000 and you will have $12,100 invested at the end of the second year. You have increased your original capital by 21% in two years just by letting the interest or gains compound instead of spending them. Notice that this required no effort on your part. All you had to do was choose not to spend the gains.
If you had chosen to spend them, you would just be treading water and your wealth becomes exposed to its mortal enemy of inflation. This is because if the prices of the things you need to buy keep rising, as they tend to, the buying power of your original savings decreases.
The dramatic effect of compound interest can be shown if you imagine you have an investment such as a quality share or fund that starts off at $100,000 but grows by 10% per annum. At this rate it will double in value every seven years – yes, double! Take a look at these figures (rounded off):
End year 7
End year 14
End year 21
End year 28
End year 35
There is one vital factor you should note with regard to these figures - the growth for the last period is always greater than the total growth of all the previous periods.
It is true that compounding is slow to get going, which is why people often give up too soon, but look at how the growth accelerates as time goes by. And here is another important point to remember: if your friend started investing like this today but you waited 7 years, in 35 years’ time your friend would have twice the capital sum you have! It really does pay to get started early with saving and investment.
And what about the other friends and enemies of wealth building I mentioned? Here’s a round up of those:
Inflation is a factor outside our control but it is possible to design a saving or investment strategy that aims to beat it, preferably with the help of a professional financial adviser.
Poor choices, and lack of a defined strategy are errors which are sometimes made because ego takes control, other times it is simply a lack of professional advice or someone being unsure of how to get it and what it looks like.
Buy and hold - the majority of expats living in Asia, and Hong Kong especially, should avoid looking for the golden bullet and accept that a simple, patient strategy works best. Statistics show that buying and holding works consistently given enough time because….
Time in not timing - whether you are investing in shares, bonds, property or other assets it is a misconception that timing when to buy and sell is the way to make money. Most experts will tell you it is pretty much impossible to pick the low or high point of the trajectory of a share price. The truth is that most of us buy near the top, because that is when we feel it is safe to invest, and then we sell too late when the damage is probably already done.
Diversification - a well-balanced, diverse portfolio is key to making the steady compounding effect work. Avoid putting all your eggs in one basket by diversifying over different asset classes, geographical regions and business sectors. Just a word here on property which can be a great wealth builder but should be treated with caution, especially in Hong Kong. We have all heard the success stories of those who have made a fortune on their homes here but there are plenty of others who have not, you just don’t hear the less successful stories! There is a lot to be said for the beauty of buy-to-let investment properties too where someone else (a tenant) pays off your mortgage but more on that in another post…
Most of us do not have the time or knowledge to micro-manage a portfolio of investments, picking the exact right time to buy in or sell out. We might select a fund based on past performance but fund managers move around and if the manager who was responsible for that performance moves on those results are no longer an indicator of future success for that fund.
That is why my advice is to find a qualified investment adviser with a proven track record to help you develop a long-term strategy which controls the effects of risk and volatility and to select an adviser who seeks out and follows managers rather than particular funds or fund houses.
In short, the real secrets of investing are simple: look for steady gains with the bulk of your investments, get the compounding train started, let it run and take professional independent advice.