Wednesday, May 2, 2012

What is the right amount to invest?

Investment is a process to make a profit from the capital for a period of time. In other words, it is a process to grow savings at a reasonable rate to beat the inflation and enough for retirement. However, every investment involves risk. Risk appetite of the investor is one important factor. So, how much money should one invest?

Different people have different risk appetites when it comes to investment. Some people is willing to put their money in fixed deposits, where capital is guaranteed. Even if the interest is only about 1%, they can have peace of mind that they money are save. Some people have larger risk appetites, where returns are much higher. But bear in mind that investments with higher risks can also make one lose their money at an alarming rate.

In order to make the suitable investment, we have to ask ourselves this question, "Are we ready to make a failed investment?" No one likes failed investments, neither do I. That is why doing "homework" is important. Even when I have made a wrong decision on investing in a particular company, I accept the consequence of losing the money and learn from it. Recently, I bought an IPO of Genting's perpetual securities. First mistake, I assume that perpetual securities is the same as bonds or preference shares. In fact, they are ranked lower than bonds and preference shares. Second mistake, I did not find out more about it before investment. I sold them right after it's open for trading. Luckily, I lost $26 only. This $26 lesson will wake me up and be more diligent. 

After this "failed" investment, a phrase appeared in my mind like a flash. "Only invest the amount of money that you are willing to lose." By following this phrase, I invest with a peace of mind. If the investment is lost, take it as a lesson learnt. If the investment is right, then our savings will grow at double digit rates. Not only have we beat inflation, we can also retire comfortably.

Here's an example.

Sam is married and have two children. His family managed to save $20,000 after 5 years. What should he do with the savings? 
1.   Put all the money into fixed deposit that gives a rate of about 1.5% per annum, and capital is 100% safe.
2.   Put all the money into stocks that can grow at a rate of 8% per annum, but there is a risk to lose a lot of money.
3.   Put 50% in fixed deposit and 50% into stocks.
4.   Set aside $15,000 in fixed deposit as emergency cash and $5,000 in stocks.

Which of the above choices is the wisest?

It is important to set aside some money for emergency, even if these money value depreciates due to inflation. Once the amount is set, invest the rest of the savings. If the $5,000 is lost due to failed investment, there is still $15,000 to fall on for any emergency. But if the $5,000 is growing at a double digit rate after investing in the right company, savings can growth at reasonable rates to beat inflation too.

Many friends and relatives asked how much money should they invest. My reply is always the same. Set aside the right amount of emergency cash reserves and invest the rest at their comfort level. Of course before investment, we will do research with our diligence and minimize the risk to the lowest possible. Only in this way will we have many successful investments.

Personal finance is for one to decide on his own. It is not for the financial consultants to decide what to do with the money. A responsible financial consultant will only give advice and will never push the customers to invest in a certain product. Take control of your own finances.

Cheers and happy investing.

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