Rule#31 Rule of Investment (ROI)

The Rule

            The rule of investment is always the same. Income saved equals income invested equals income gained. Then, some or all of the income gained need to be saved again and the process is repeated. Simple? Believe me, not many people are doing this and not many people can do this!

What is this rule?

            The rule of investment is the rule responsible for making people rich. People have become millionaires by implementing this rule. This rule does not make people millionaires in an instant, but it is a sure way to become a millionaire. What it means is that do not spend all of your income. Reserve some of your income to buy assets that will appreciate in value or which will give you monthly/annual dividend. If you persistently do this over a long period of time, then one day you will realize that you have accumulated assets with large value, possibly worth more than a million. You can then either sell your assets to liquidate the money or continue to earn passive income from monthly/annual dividend generated by your assets.

How to implement this rule?

            As a general rule, you must set aside at least 10% of your income every month and put it in a special account where you must not touch the money. You can even save more than 10% if you want to become rich faster via investment and are comfortable to live with the balance of your salary. Then, you need to scout around for suitable assets to buy. Examples of assets that will appreciate in value and/or provide dividends are properties, stocks, unit trust and bonds. When you have found a suitable asset, then use your saving to control the asset. For example, if you want to buy a property, you don’t need to pay 100% of the property value. You only need to pay 10% down payment and take a bank loan to serve the rest of the payment. By doing this, you leverage on other people’s money via the bank to control the asset. This will mean that you don’t have to save for a long time in order to acquire an asset and so you can continue to apply this rule to save and invest in other assets. The limitation of this process is the amount of loan banks is willing to lend you in order to buy more assets. This will probably be limited by your salary because salary statement is the indicator of your ability to pay a loan and this will be used by the bank to calculate the maximum amount of loan you can get. This is probably a good thing because the more assets that you own, the more risks that you have to bear. If you are a good investor and managed to get positive cashflow (income generated from your asset is more than payment to the bank) from your assets, there is theoretically no limit to the number of assets that you can buy. Please beware that practically it is good to limit the number of assets that you have to a certain number that you are comfortable with to limit the risks associated with each assets.

            Most people are afraid to invest because they are afraid of losing money. When it comes to investing, there will be risks involved but people should not shy away from risks, they just have to manage those risks. If you look into the record of any company in the world, there will always be an expenditure on capex/capital expenditure. There is no business in this world where you don’t have to spend on capex. Even if due to the nature of the business that you don’t have to spend on capex year-by-year, you at least have to spend it on the initial set up of the business. For example, for restaurant owners, they have to spend a substantial sum of money just to renovate the restaurant when they want to open the restaurant. Money will be spent to buy tables, chairs, fans, sink, decorations, cash registers and to build the counter, restroom etc. Some companies spend capex to the tune of billions every year to generate and maintain their profit.

            Companies spend on capex because without those spending, there will be no possibility to make profit. The same goes to you. Without investing, there is no possibility to make profit. There will be no possibility of a loss either. So, if you want to be rich, there is no other way than to invest. In order to manage those risks, you need skill and knowledge, either of which can be learned or hired. For example, if you want to invest in properties, you need to know the market price. Is the market price considered low or high? You need to know the rental yield. Is the rental yield in this area considered low or high? You need to know the capital appreciation. What is the capital appreciation of a semi-D house in this area? You need to consider the interest rate. Is the interest rate offered by this bank reasonable? Properties are just an example. There are other ways to invest for example in the stock market, the unit trust, or even profit sharing in other people’s business.

            There are some key principles that you can apply in order to make your investment. In order to identify the principles, let us benchmark Warren Buffett who is considered the best investor in the world. One of Warren Buffett principles is to invest only in the business that he understands. There are many investment vehicles in this world. Some of the examples are shares in the stock market, properties, land, gold, bond, unit trust etc. In each of the examples above, we could break it down into further different categories. There are different types of shares: construction, consumer, finance etc. There are many more companies listed in each type of shares. There are also different types of properties: landed, high-rise, residential, commercial, semi-D etc and each of these properties is located in different locations. My point is that there are almost infinitely different types of investment vehicle. Only invest in the investment vehicle that you understand. If you plan to invest in something, study thoroughly the investment vehicle before you make your decision. After you are comfortable with the risk and the potential return, only then should you make your investment. An interesting point to note is that Warren Buffet does not invest in Microsoft and any technology shares because according to him while he respected Bill Gates and think highly of him, he does not understand Microsoft business and the technology industry. His wisdom was evident following the bust of the technology stocks.

            Before you invest in something, you need to balance the risk against the potential return. Ever heard of the pyramid scheme? Yes, the return is high for the early birds; it could be as high as 100% return in a few months. But at the same time, the risk is also high. You could lose 100% of your money if you are latecomers when the scheme collapses. Because of the high risk, pyramid scheme is a bad investment. It is even illegal in some countries such as Malaysia. If you can find an investment vehicle that provides you with potential return of between 10-15% annually, that is considered good. It is even better if you can find an investment vehicle with 15-25% return. The higher the potential return the better but you need to consider also the risk. You need to make a decision on the level of risk you are willing to take on a particular investment. It is no good to get a very high return if you risk losing all of your money.

            So when you are represented with an investment opportunity, you need to study the risk and the potential return thoroughly. Don’t just blindly put your money in something you don’t know. If you are not sure about an investment opportunity, consult the experts on that field to get their opinion. After all, most of the consultations provided by our friends are free of charge. After you have gathered all the necessary data regarding the investment and you are comfortable with the risks associated with the investment and you think that the potential return far outweigh the risk, only then can you decide to put in your money in the investment scheme.

            The next aspect of your investment consideration is consistency. If you found an investment vehicle that provides consistent return every year, then that is a good investment vehicle, even if the return rate is not so high. For example Berkshire Hathaway, Warren Buffett investment company provided annual return rate or 22% consistently for 36 years since 1964. What it means is that if in 1964 someone invested USD 10,000 in Berkshire Hathaway, then the investment in 2010 is worth a staggering USD 80 million.

The benefit of this rule

            As I mentioned earlier, people have become millionaires by implementing this rule. It might take a long time to become millionaires by using this rule, perhaps 10, 20 or even 30 years. If after the long years of patience in implementing this rule you will become a millionaire, I believe it is worth it, don’t you agree?

More about this rule

           

            I am naturally an investor at heart. I have implemented this rule since I was a kid, saving every cents that I could from the day of going from house to house collecting ‘Duit Raya’ (Eid Ul Fitri Celebration money). This continued during my high school time, saving extra money that I had into my ASB (Amanah Saham Bumiputra), a unit trust account. When I continued my studies in the United Kingdom, I could save even more money due to the high currency exchange rate of the British Pound. By the time I graduated in 2000, guess how much money I have saved in my lifetime of 24 years? RM 17,000. Enough money for a down payment of a car, or for getting married or for buying luxuries (My definition of luxuries are something that are nice to have but are not necessary).

            However, I did not buy a car and at that time I still did not have a girlfriend yet so I did not use the money to get married. As you can guess, I also refrained from using that money to buy luxuries. I used that money for a down payment of an apartment which cost RM 110k (Now the apartment is worth RM 150k).

            Even now I am still implementing this rule, saving extra money from my salary and still planning to use my saving for my next investment. Implementing this rule doesn’t mean being a cheapskate. I do enjoy good things money can buy occasionally. It just means that you control your expenditure by cutting on luxuries. A car is a luxury for me at that time because I was still single and could easily take public transportation to commute to work.

            I put this as the first Rule of Becoming Rich because it is so easy to implement. Everyone can always live with 90% of his/her income. When your saving is big enough, then you need to scout for a good investment. If you don’t know how to invest your money properly, seek help and opinion from your parents, friends or professionals.