What is investment?

Stock Investment, Real Estate Investment, Bond Investment, Fund Investment… Investment, Investment, Investment

We’ve heard the word a lot, maybe even too much, but what exactly is investment?

In short, investment is ‘3) preserving 2) current purchasing power 1) for the future.’

Understanding this simple sentence correctly is crucial for discussing what kind of investments to make and how to make them. If you don’t understand this sentence properly, you might be speculating rather than investing.

1) For the Future

From the phrase ‘for the future,’ there are two things to consider. First, how far into the future are we talking about? It’s important to understand whether you’re thinking about 3 months, 6 months, or a decade ahead. You shouldn’t choose assets that require a 10-year investment period if you’re only looking ahead 3 or 6 months, and vice versa.

For example, consider the ‘Magellan Fund’ managed by Peter Lynch. It recorded an accumulated return of 2,703% from 1977 to 1990, making it a legendary fund on Wall Street. However, ironically, half of the investors in the fund recorded negative returns. This was because they treated it like a bank deposit, moving in and out within 3 to 6 months, despite the need for a long-term approach.

Sure, the Magellan Fund did achieve a 70% return in one year, 1980, so if someone had invested ‘well’ and exited ‘well’ that year, they could have seen massive returns. But as the results show, such ‘miracles’ rarely happen.

The second thing to consider is how much you’re willing to sacrifice for the future. The assets you invest in cannot be used until the ‘future’ point in time. Therefore, you should invest within the range that doesn’t affect your current lifestyle. Otherwise, if you invest excessively, you might end up needing to withdraw your investment before the intended time, leading to unfavorable situations.

2) Current Purchasing Power

The concept of ‘current purchasing power’ stems from the nature of money.

Have you heard of the time value of money? Money loses value over time. The prices of goods increase over time. For instance, a Big Mac cost about $1.5 in the 1980s. In the 1990s, it rose to $2, then over $3 in the 2000s, and over $4 in the 2010s. You need more money to buy the same item as time goes by.

So, if you hold onto your money without investing, you’ll experience the ‘miracle’ of being able to buy less and less over time. This is due to the inflationary environment we live in.

3) Preservation

Lastly, ‘preservation.’ This is a key word that can distinguish between speculation and investment.

The purpose of investment is not to make unlimited amounts of money. It’s to earn enough to maintain your current purchasing power. (In professional terms, this is known as ‘inflation hedge.’) Earning more is great, but investment returns are a function of risk.

There’s a well-known formula for calculating expected returns called the Capital Asset Pricing Model (CAPM). The formula looks like this:

Expected Return = (Risk-Free Rate) + (Volatility) x (Market Risk Premium)

In simple terms, if you want to earn big money, you must take on a lot of risk. There’s no free lunch in the world. If you come across an unknown product that claims to be safe but offers high returns, it’s safe to dismiss it as a scam. (If someone introduces such a product to you, first check if they have sold all their assets to invest in it themselves. Why are they selling such a good product to others instead of investing in it themselves? ‘Skin in the game’—if they don’t have it, you don’t need to listen to their advice.)

So, ‘preservation’ means consistently accumulating returns that at least hedge against inflation. Recent inflation rates are around 2-5%. Should you be satisfied with such a low return? Is the only way to preserve your capital to deposit it in a bank?

No. Investment assets need to grow at the rate of inflation to maintain future purchasing power, which means this is the minimum baseline you cannot compromise on. Of course, pursuing higher returns is natural, but you should avoid risky investments that could threaten this baseline return.

Winning the lottery could yield astronomical returns, but we know the high probability of losing everything makes it more of a gamble than an investment. Instead of gambling away your future purchasing power, it’s better to use your money now if that’s the only alternative.

Are all high-return investments risky? Here, an understanding of risk is crucial. Risk isn’t the same for everyone and isn’t static. In investment terms, risk usually refers to ‘volatility’—assets with highly fluctuating prices are considered risky. But what if an asset only appreciates in value? Volatility measures magnitude, not direction, so even a steadily appreciating asset is considered risky.

Therefore, risk can be reduced through careful consideration and study. Consider real estate auctions; they seem extremely risky to beginners. However, someone who has diligently studied real estate, law, and economics may not find all auctions risky. Knowledge and experience can mitigate risk.

Do you know Warren Buffett’s two key investment principles?

First, never lose money!
Second, never forget the first principle!

‘Preservation’ in investment cannot be overstressed.

Investment?

In summary, investment means steadily increasing your current funds to maintain your purchasing power at a specific future point in time, bearing risks you understand, and ensuring it doesn’t affect your current lifestyle. Aim for returns that hedge against inflation at a minimum, with the potential for higher returns based on how much you study and deliberate about your investments.

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