Investing is important because there are external forces that erode wealth, such as inflation, devaluation, and insecurity and internal forces such as lack of knowledge or errors of judgment.
A prudent investor counteracts these forces and takes advantage of opportunities to multiply his money.
In summary, there are two main reasons to invest:
- To protect and preserve money.
- To multiply money
What is an investment and why is it important?
An investment is an asset acquired or created with the objective of generating income or appreciation.
Appreciation refers to the increase in value over time. When a person acquires an asset as an investment, his intention is not to consume the asset, but to use it in the future to create wealth. An investment is always related to the disbursement of resources (money, time, effort, etc.) in the hope of obtaining an amount greater than that initially disbursed in the future.
Why it is necessary to invest money:
1. Protection
The importance of investment becomes evident when analyzing the threats and opportunities on the assets.
First, we will list the main risks and threats to wealth. In general, when talking about threats and opportunities, we refer to external factors. In the case of money, some of the worst risks are represented by factors internal to the wealth owner.
Below, we describe forces or phenomena that erode wealth, which can be counteracted or mitigated through investment:
Devaluation
Devaluation is the loss of value of one currency relative to another. If you have the bulk of your wealth in euros or dollars or pounds you probably do not consider and do not protect yourself against this risk, or do not even consider it.
When investing, it is ideal to diversify the currencies in which the assets are denominated, so that if one currency loses value with respect to others, the decrease is limited to only a percentage of the investment portfolio and is eventually compensated by the revaluation of the other currencies.
Judgment errors in the placement of assets
Judgment errors in deciding the placement of assets in an investment portfolio are quite common and frequent. There is no investor who has not made them. Preparation and experience are important, although not sufficient to reduce their occurrence and severity.
There must be a proportion between knowledge, preparation, experience, and the amount invested. A very true phrase of R. Kiyosaki is:
“It is not the investment that is risky, but the investor”.
Taxes, fees, and contributions
These are compulsory contributions required by governmental entities of different levels from individuals (natural persons) or legal entities. Tax optimization is an essential aspect when investing. If it is not taken into account, an important part of the valuation, the income, and even the principal can be reduced unnecessarily.
Inflation
Inflation is the loss of purchasing power of your money. If in one year you need 3.95 EUR to buy a BigMac hamburger and the next year you need more than 4 EUR it means that there is inflation.
If you keep money under your mattress, so that not a single bill is lost and the mites don’t eat it, you will incur the full impact of inflation. This is especially true of the currencies most susceptible to inflation.
Maintaining the purchasing power of money is one of the most important reasons to invest. Uninvested savings lose their value. It is preferable to invest in it even if it is to maintain purchasing power.
Loss of income
It consists of not receiving any income or appreciation by decision or omission. The act of investing allows the investor to obtain the profit potential of his patrimony. It is always important to balance profitability and risk.
If you have managed to save 100,000, you can easily invest it at 5% per annum, earning 5,000 EUR per year. It would be a pity not to take advantage of this possibility; you may not lose EUR 5,000 in the strict sense, but you will lose EUR 5,000, which is understood as a loss of profit.
If you invest the 100,000 and spend neither the savings nor the yields, one year later you will have 105,000 EUR. If you invest them again at 5%, your return will rise to EUR 5,250 because of compound interest.
Investing gives you access to the power of compound interest.
Physical security of money
By holding assets in cash or physical property such as works of art, jewelry, cash, real estate, and gold, among others, the wealth is subject to the risks of damage, destruction, or loss of the asset. This does not occur with dematerialized investments, such as stocks, bonds, or ETFs.
The costs of insuring and protecting the assets must be deducted from the return on the asset.
Theft, fraud, and other crimes
It is important to distinguish between investments, speculation, and fraud. In history, there have been large pyramid schemes, such as Ponzi, Madoff, Murcia Guzman, and many others.
According to Dodd and Graham,
“An investment operation is one, which, through analysis, promises safety for the principal and a satisfactory return. Trades that do not meet these criteria are speculative.”
It is advisable to understand the difference between investment and speculation. If you choose to speculate (closer to gambling than investing), you should be aware of what you are doing and determine the amount accordingly.
On the other hand, if you choose to invest, you should be prepared to perform a rational analysis that maximizes the chance of profit and limits the risk.
2 Multiply it
Most people seek to multiply their money when investing. The following are the two most common ways in which an investment can multiply the invested capital:
Cash flow
It is the income that an asset produces for its beneficiary. This is the case of the income produced by a real estate property, the dividends that a stock generates for shareholders, or the yields of a bank deposit.
Valuation
The increase in value of an asset. This is the case of the increase in the value of a property or the increase in the market value of a stock.
It should be noted that there are many investment instruments that allow the investor to earn through cash flow and appreciation.
How good is investing
Investing is important; however, investments can be very successful or tremendously mediocre or unsuccessful. Stating that we should all invest does not mean that we invest in anything without knowing.
The purpose of this article is to raise the reader’s awareness to start the learning process that will allow him to protect and multiply his wealth. We recommend the mega guide “How to invest well” to start this process.
Advantages of Investing
The main advantages of investing lie in the possibility (read “necessity”) of protecting money against external and internal forces that tend to erode wealth and in making use of investment vehicles, tools, and techniques that allow the investor to multiply his money.
Why is important to invest at an early age?
Time plays a key role in investing. The following example shows the relevance of time in investing:
Four friends start saving the same amount of money (250 a month) until they reach the age of 63. They all manage to invest their money at an effective annual rate of 8%.
The only difference is that each started saving at a different age.
Julia at 20, Tom at 30, Judith at 40, and Carlos at 50. Look at the huge difference in the amount each of them manages to save at 63!
As you can see, the four friends who invest the same amount each month at the same rate at different ages at which they start investing have dramatically different results.
While at age 63 Carlos has 72 thousand, Julia has managed to accumulate over 1 million. All the variables in this example are totally realistic: the interest, the monthly amount and even the names.
For Carlos or Judith, it may simply be too late to catch up with Tom or Julia; they would have to make a grandiose effort just to get close.
There is a phrase that sums up the situation: “The best time to plant a tree was 20 years ago. The second best time is today.” Start investing today!
In our article “When to Start Investing” we delve into this important question.
Why invest in a business?
There are some cases in which investing in a business of your own can be a good idea, regardless of the fact that in many cases it is a riskier option. The following are some advantages:
- A good business can produce a much higher return than a lower-risk investment.
- A business can produce appreciation as well as cash flow.
- A business can produce an explosion in value by going public (IPO).
- Substantial gains can be realized when a business is sold properly.
- It is generally convenient to invest in a business when you have a deep knowledge of the market, operations, and key contacts among others because for years you have accumulated experience in a certain niche or industry.
Conclusion on “Why Invest”.
Investing is important because there are external forces that erode wealth, such as inflation, devaluation, and insecurity, and internal forces such as lack of knowledge or errors in judgment. A prudent investor counteracts these forces and takes advantage of opportunities to multiply his money.
In short, there are two main reasons to invest:
- To protect and preserve money.
- To multiply money
- An investment is an asset acquired or created for the purpose of generating income or appreciation. Appreciation refers to the increase in value over time. When a person acquires an asset as an investment, his intention is not to consume the asset, but to use it in the future to create wealth. An investment is always related to the disbursement of resources (money, time, effort, etc.) in the hope of obtaining an amount greater than that initially disbursed in the future.