How to invest wisely and avoid the debt trap

Mention the words stock markets and investing and many people tune out because they are intimidated by the very talk on finance. However, this is not the right response.

You cannot create wealth on your salary income alone.

This is because investing is the activity of putting your money into securities or assets using an investment framework, backed up with adequate risk management, supported by insight and research into the prospects of the company or the different assets you want to invest in.

Investing requires an investment philosophy — a set of guiding principles that provide you with direction and discipline, irrespective of whether the markets are racing high (bull phase) or are falling towards rock bottom (bear phase).

Newcomers to investing often make the mistake of behaving in a rash manner, throwing their money blindly into things they don’t understand.

This isn’t investing, its speculation which is more like gambling where you are relying on chance and luck.

Investing on the other hand cannot be left to chance.

It requires patience, especially for your investment thesis to mature, something speculators have little time or interest in.

Three reasons to invest. Long-term accumulation of wealth: Investing has proven to be the best way for the long-term accumulation of wealth.

Sure, there are risks associated with it.

But, if one takes only risks that are suitable to one’s stage in life and investment horizon, then investing provides a great way to take advantage of the compounding of capital over a long period of time.

Reasons to invest

Take advantage of compounding of capital: Compounding is the ability to earn a return in the current year on not only your principal amount, but also on the returns earned in the previous year.

Compounding is the process through which your money multiplies, and you can earn returns that can go towards meeting your various financial goals in life such as educating your children, or paying for their marriage, or buying a new house, or paying for your parents’ health care costs and so on.

Offset the damage from inflation: Additionally, it is only through investing that you can offset the damage that inflation wreaks on your personal finances.

Inflation reduces your purchasing power every year.

You need to keep up with the rising cost of living.

The experience of other countries has shown that relying on your salary alone is not going to be enough.

Let’s use the following stylised example.

Let’s say you earn a salary of Sh10,000 and you deposit it into your bank account which earns you a measly four per cent return.

You know from paying for your household and other expenses that your cost of living is rising by far more than this.

Investing requires the discipline of going through a mental checklist to ensure that as best as possible one can avoid making mistakes, or is best equipped to deal with them if an adverse situation arises.

Mental checklist for investing

Just like pilots use a checklist before they start a flight, investors must also have a checklist before they invest money. Create your own, or use the following list.

Start early to take advantage of the compounding of capital.

You can even start with a small amount of money — investing is not just for the wealthy

Invest for the long-term. Don’t churn (frequently get in and out of investments) as you will needlessly create a tax issue for yourself and also pay high transaction costs and fees
Don’t borrow money to invest. If the investment falls in value, you still have to pay money back to your lender

Understand that you cannot earn high returns without taking on high risk.

Not all investments are suitable for everyone, so recognise the obvious and the hidden risks you are entering into

Be realistic — investments can go up and down in value.

Returns revert to the long-term mean, i.e., returns will trend towards their long-term averages.

Don’t expect markets to go up 30 per cent every year, when the long-term average is more like 10 to 12 per cent.

Investing is not the same as speculating. It requires skill, discipline and patience.

When you buy or sell, your counterpart might be a professional who does this for a living. Understand if you or they have the edge.