If you’re the kind who seek ‘security’ in a job and are not willing to move out of your comfort zone to massively increase your income, then the best, and probably the only choice you have to build a million dollar net worth is to invest your money.
Conrad Alvin Lim - Co-Trainer At Wealth Academy - In Action
But really, just about anyone, whether you aspire to be a millionaire or not, should invest your money because it is the only way you can put your money to work for you to secure your own financial freedom.
I know the word ‘investing’ may sound intimidating, or maybe even daunting considering the current financial turmoil we’re going through at this point of time.
Perhaps you’ve had painful investment experiences in the past or you’ve just had them very recently! And these experiences may lead you to think that investments are very risky.
Yes, investment does involve some risks. There’s nothing that’s risk-free in this world. Even if you just leave your money in a fixed deposit – supposedly a safe haven – you risk losing out to inflation. In fact, it’s almost a guaranteed lose-out to inflation.
In my opinion, this is the most stupid risk of all because this is an investment (if you can even consider it an investment) with almost 100% chance of losing. This is what I call a risky play-safe strategy because to take no risk is the greatest risk of all.
Then just how risky is investing? Well, it depends. For example, driving is risky if you’ve never taken a lesson on how to work the mechanism of a car and learn the rules on the road.
But if you know the rules and had practical driving lessons, then it becomes a low risk activity.
The same goes for investing. As Warren Buffett
But sadly, more often than not, people who invest have little or no knowledge of how to invest. What’s worse is they don’t even know what they are investing in!
Recently in Singapore, a lot of people have lost their entire life savings because they invested in a structured product called Lehman Minibonds that’s linked to the now bankrupt Lehman Brothers Bank. Please read the newspaper articles below (click to enlarge).
Source: The Straits Times, Thursday 16 Oct 2008
Source: The Straits Times, Thursday 16 Oct 2008
Most of these people are retirees and I do feel sorry for them. However, there are a few big lessons we can learn from this unfortunate event.
First, never invest in anything you do not fully understand. If the investment product cannot be explained in a few simple sentences, forget it; it’s too complicated.
Second, always do your own research. Never rely solely on the advice of your relationship manager, broker or financial adviser. They are simply salespeople, not investors.
Just like if you’re going to learn how to play golf, you learn from a golf coach, not the person selling you golf equipments.
It’s amazing how some people would go into extensive research when buying a car or even a plasma tv, yet when it comes to investing involving tens or hundreds of thousands of dollars, they can make a decision within 10 minutes.
Third, take full responsibility for your own investment decisions. If anything goes wrong, don’t blame it on other people. Please read Part 1 on responsibility.
Fourth, learn how to invest. Nobody will care about your money as much as you do, so it’s best if you take care of your own investments.
If you think investment is too hard to learn, or you’re too old to learn, then please read the following newspaper article (click to enlarge). It says about how a man, at the age of 61, went from being a technophobe to being an avid blogger who can’t live without IT.
Source: My Paper
Every skill can be developed and acquired. Nothing is too hard to learn or you’re never too old to learn. It’s only a matter of whether you want to learn. The ability to invest is one of the most powerful skills you can ever learn in your life.
But just how powerful is investing? Imagine if you were to invest only $300 per month into a stock with an annual compounded return of say 15%, using a financial calculator to calculate, the figures are as follow:
5 years
$26,202
10 years
$78,905
20 years
$398,122
30 years
$1.69 Million
Impressive? But what if the annual compounded return is 25%?
5 years
$33,409
10 years
$135,369
20 years
$1.4 Million
30 years
$13.14 Million
You see, by just investing a small amount of $300 per month consistently at an annual compounded return rate of 25%, you can become a multi-millionaire in 30 years! Isn’t that amazing?
But the question now is, can you achieve an annual compounded return of 25%? Or even 15%?
The answer is “YES”.
At Wealth Academy, Adam Khoo shared with us the 4 stock investment strategies that he personally uses to achieve exceptional returns.
Strategy 1: Buying Markets & Sectors
This is the first and the most basic strategy for making money in the stock market and Adam Khoo calls it the idiot-proof way of making guaranteed returns.
You do not need to be a financial expert or have high financial intelligence to make at least 10% compounded annual return over the long term. This is the best way to start off if you are a complete beginner. The only requirements for this strategy are patience and discipline.
But how do you buy the entire market or sector?
Stock markets are measured by indexes and in the case of the US market, the S&P 500 Index and Dow Jones Industrial Index are the two most common portfolio of stocks used to represent & measure the performance of the entire market.
There are more than 10,000 stocks in the entire US stock market and they are divided into sectors such as energy stocks, shipping stocks, aviation stocks, health care stocks, financial stocks, technology stocks and so on.
The performances of these sectors are also measured by their respective indexes. So to buy a market or a sector, the best way to do it is to buy the Exchange Traded Fund (ETF) that tracks the particular index.
ETFs are index funds that are listed on a stock exchange and you can buy/sell anytime of the day like a stock.
And the great thing about ETFs is that it also pays you regular cash dividends on top of the capital gains on the ETF’s share value.
So how is this strategy idiot-proof?
It doesn’t take a genius to know that the market always moves up over the long term. While the market may be volatile in the short term, it will always go higher and higher in the long term.
Take a look at the chart below (click to enlarge).
Source: S&P 500 Chart from Yahoo! Finance
The booms and busts are just part of the natural market cycle. The reason why the market will keep going higher in the long run is because stock prices are driven by company profits. And the share prices go up when the companies’ profits go up.
There are 2 reasons why company profits will go up over time. First, inflation pushes the prices of a company’s products and services higher.
Second, as the world’s population grows and becomes richer, more and more people will buy from these companies.
Therefore, higher prices at higher volumes will result in higher profits for the companies and will in turn result in higher stock prices.
Hence, smart investors love a market crash because a crash is when investors can buy the market at a low and sell when the market rebounds – which always happens.
That is why it is now a good time to buy into the market as we are going through a crisis that’s sweeping across the world.
“Be fearful when others are greedy and greedy when others are fearful.” – Warren Buffett
To learn more about why you should love a market crash, click here.
Strategy 2: Value Investing
This is the strategy that Warren Buffett, the world’s greatest investor and richest man, uses to accumulate a personal fortune of US$62 Billion (according to Forbes) over the last 52 years with an initial investment of US$100,000.
There are a few reasons why Buffett is able to consistently beat even the best fund managers on Wall Street.
1. Unlike many fund managers and financial experts who advocate diversification across different financial instruments such as stocks, bonds, commodities, currencies, hedge funds, etc; Buffett believes in being focused.
He believes that it’s impossible to be an expert in everything and that diversification is simply a protection against one’s own ignorance.
He believes in investing within your ‘circle of competence’, which means to invest in only the businesses or companies that you understand very well and can track very closely.
“Risk can be greatly reduced by concentrating on only a few holdings.” – Warren Buffett
2. Most investors go in and out of the market based on the movements of the stock prices in the short term. However, Buffett takes a Contrarian approach.
He buys the stock of a good company when nobody wants it because that’s when the stock price is extremely low and vastly undervalued.
He’ll then wait patiently for other investors and fund managers to realise the value of the company and start to push up the company’s stock price. That is when he’ll sell his shares for a nice profit.
3. It is common to hear your financial advisers or brokers telling you that if you want high returns, then you’ll have to take high risks.
Warren Buffett does not believe in taking high risks. As a matter of fact, he’s extremely risk averse. His number one investment rule is ‘Never Lose Money’ and his number two rule is ‘Never Forget Rule No. 1’.
He believes it’s high financial intelligence that leads to high returns. He makes an investment only if there’s a wide margin of safety.
This means that he invests only in companies that are selling way below their intrinsic value. And by doing so, he’ll still be making money even if his calculations are off.
4. Warren Buffett invests only when he’s able to find a great buy. If there’s nothing attractive in the market, he’ll just keep all his money in cash.
During the dotcom boom in year 2000, Buffett kept all his money in cash as he thought that most stock prices were insanely overvalued.
But he began to buy after the market crashed in year 2001 and businesses could be bought at ridiculously low prices.
Now that you have an idea of how Warren Buffett invests, let’s take a look at the three major steps of Value Investing.
Step 1: Identify Great Businesses
When you’re buying a stock, you’re in essence buying the business behind the stock. That means you’re buying into the business to become a part owner or shareholder.
So if you were to invest in a business, it’s only common sense that you invest only in a great business.
Then what makes a great business?
A great business is one where its profits will increase over the long term; one that will stand strong in the face of intense competition; and one that will not only survive, but also always recover and prosper after a major downturn.
But a business can only be as great as its management team. Hence, it is extremely crucial that there is a great management team running the business.
Step 2: Buy Only at a Huge Discount
Great companies are usually expensive to buy because they’re usually favoured by fund managers and stock analysts.
However, the market will always go through the cycle of booms and busts and there will also always be short-term bad news that hits a company.
No matter how great a company is, it will very likely fall victim to the investors’ and fund managers’ panic selling during these periods of trying times.
Under such circumstances, it is highly likely that the company’s stock price will fall way below its intrinsic value.
These are times that a smart value investor deem as the ‘SALES’ period and will buy as much as he can as long as he knows the company’s true value.
“Great investment opportunities come around when excellent companies are surrounded by unusual circumstances that cause the stock to be misappraised.” – Warren Buffett
Step3: Wait for the Market to Realise the Stock’s True Value or Overvalue It
After any downturn, the market will eventually come to its senses and picks up once again. The smart and patient investor will then sell to reap a substantial return.
So the best time to buy is when the market is tumbling or when there’s bad news; and the best time to sell is when the market is booming or when there’s good news.
It is during these times that the smart value investor capitalises on the over-reaction of the market to make a fortune.
Strategy 3: Momentum Investing
In value investing, the core principle is to invest from a business perspective and therefore, you have to be able to study and evaluate the business behind the stock you’re buying. This method is called the Fundamental Analysis.
Whereas in momentum investing, less emphasis is placed on fundamental analysis. Momentum investors uses a technique called ‘Charting’ and is based largely on Technical Analysis.
“Technical analysis is the process of studying securities (e.g. stocks) by analysing statistics generated by market activity, such as prices and volume. Technical analysts do not attempt to measure a stock’s fundamentals or intrinsic value. They use charts and other tools to identify patterns that can accurately predict future price movements.” – Secrets of Millionaire Investors
While fundamental analysis attempts to study the business behind the stock, technical analysis attempts to study the mass investors psychology behind the stock.
Historical price movements and volume of shares traded are what allow momentum investors to predict the forward trend because history tends to repeat itself. There is always a high level of probability that investors will tend to buy and sell the stocks when it reaches a certain psychological price levels.
While value investors buy a stock only when it’s way below its intrinsic value, momentum investors will buy a stock even when it’s overvalued.
The reason is because the majority of investors become optimistic when they see that a stock’s price keep moving up. This leads them to believe that the stock will just keep going higher and higher just like how the Americans believed that the price of their properties will keep rising before the subprime crisis swept them off their feet.
This is known as ‘the greater fool’s theory’. The theory says that people invest even at a ridiculously high price because they believe there’s always a greater fool who’ll buy it at an even higher price from them later. Such stocks are known as momentum stocks.
Momentum stocks are stocks that are usually ‘hot’ and ‘popular’ with fund managers, stock analysts and the general pubic.
There is usually a lot of hype and good news surrounding the stock which drive investors to believe that it’s a good stock and therefore keep buying and buying, driving the price to go higher and higher.
However, such stocks will not remain the favourites forever. Once they fall out of favour, their price will come crashing down.
Investors, especially the fund managers, will then pour their money into another up and coming hot stock and start the ball rolling all over again.
In his book, Secrets of Millionaire Investors, Adam Khoo used a very interesting analogy to bring across the concept of momentum stocks.
He said that playing with momentum stocks is just like being friends with the hottest and most popular girl in school.
She may be a lousy friend but her popularity will make everyone else thinks that you are hot and cool as well.
However, when she loses her popularity to a sexier and more charming new girl that comes along, you will be stuck with an unpopular and lousy friend no one likes anymore.
As you can see, value investing and momentum investing are two very different strategies, but both can be just as highly profitable.
However, the probability of loss in value investing is much lower because you buy only when the stocks are largely undervalued, hence, your capital won’t be very much affected during a market downturn, although you could lose a huge portion of your profits.
On the other hand, for overvalued momentum stocks, there is a higher probability of loss because you are already paying a high price when you buy the stocks, a slight change in market sentiment or investors’ optimism can cause the stock price to plunge, thus wiping out all your profits and capital.
To reduce the risk, you can put a stop loss at 10% below your purchase price. That means, if the stock price drops to 10% below your purchase price, your stocks will automatically be sold.
This is known as cutting losses. No investor gets it right all the time, no matter how great he/she is. There will be times that you’re wrong and you’d need to cut your losses when you’re wrong.
To this, George Soros
Strategy 4: Options Trading
What is an Option? It is a contract that gives you the right to buy a specific asset at a pre-determined price within a specific period of time.
For example, in Singapore, after you’ve paid a deposit for a piece of property, you’ll be issued an Option to Purchase by the seller. With this Option, you have the RIGHT, but NOT the OBLIGATION to purchase the property at the agreed price within the agreed time period.
That means you can choose to complete the purchase or choose not to. However, if you choose not to go ahead with the transaction, your deposit will be forfeited.
Option works pretty much the same way in stock investment. But the money you pay to acquire the Stock Option is called a premium, instead of a deposit. A Stock Option usually allows you to buy a stock in lots of 100 shares.
Perhaps you may have heard of Options Trading and you may have been told that it’s a very risky investment.
As mentioned earlier, investment is risky only if you’re not trained and you have no idea of what you’re doing.
Nevertheless, there is indeed still a higher risk in trading Options because there is a probability that you could lose a lot more than your initial investment as compared to stocks where you can lose only whatever you have invested.
Therefore, you need a lot more knowledge, skill and discipline in Options Trading than investing in stocks alone.
But if you have a good understanding of how Option works, you can actually use it as a leverage tool to REDUCE RISK and generate 5-10 times greater returns than buying stocks.
In my opinion, this is a pretty sophisticated tool which is beyond my scope to explain exactly how it works. But I do believe it can be a very powerful leverage tool to generate extremely high returns within a very short period of time.
If you’d like to find out more about Options Trading, you’d be able to find very good insights on this investment in the Secrets of Millionaire Investors.
Out of the 4 stock investment strategies that I’d learnt at Wealth Academy, I personally take a much greater interest in Value Investing because its core principle fits perfectly with how I perceive stock investing to be.
This is also one of the main reasons why I signed up for Wealth Academy in the first place.
Back then (March 08) I didn’t know what value investing was. What I wanted to learn was how to study and evaluate a business because that’s what I thought I should know if I wanted to invest in stocks. And during the seminar preview, Adam really caught my attention when he talked about value investing.
The more he talked about it, the more convinced I was to sign up for the programme. And boy am I glad that I did. I learnt a great deal of what I set out to learn – which is evaluating a business – at Wealth Academy.
Although I still have a long way to go to becoming a great investor, I’m glad I’m heading down the right way. 
In the next lesson, which is the last lesson of this millionaire secrets series, I’m going to wrap it up by sharing with you how to design your own million-dollar roadmap.
Speak to you then.
Cheers~
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on Dec 12th, 2008 at 10:46 pm
Nice writing. You are on my RSS reader now so I can read more from you down the road.
Allen Taylor