The basics of becoming an investor

My lawn is a mess.  You might wonder what that has to do with investing, the answer is nothing, but this weekend I went online to find out how to improve my lawn and found "the Lawn Care Nut" on U-Tube. As I watched his podcasts I realized how something he knew so much about could be very confusing to a beginner.  So I am revisiting the basics today.

The Three Keys: I am going to focus on the three most basic things needed to begin investing. They are Material, Time, & Patience.

Material: Every craftsperson has material they work with or a medium.  The material for investing is cash. Without cash you cannot invest. I define investing as: using your cash to earn more cash.  You can think of each dollar as a little worker that works for you 24/7.

Without material (or workers) you cannot build anything. So the first thing you need to do to become an investor is put some cash aside.  This is easiest through a retirement plan, especially if you can have it taken out of your paycheck automatically. If you never see it, you don't miss it.

If you don't have access to a retirement plan, then start small but be consistent. Over time you will be surprised at what it can grow into. Which brings me to the second key.

Time: With investing time is crucial because it allows for compounding. Compounding means you earn returns on your returns. i.e. One dollar doubles to two and then two dollars double to four and then four to eight and so on. This concept is very powerful but it takes time.

An analogy I like that demonstrates the power of compounding comes in the form of a story. 

A wise man in china is negotiating a deal to buy some land and says he would like to be paid in rice. The seller agrees and asks how much rice. The wise man says to take a checkerboard and put one grain of rice in the first square. Double that in the second and double the second's rice in the third. continue until all the squares are accounted for (that is 64 squares). This sounds reasonable and so they agree.

But when it comes time to pay, it turns out there is not enough rice in the world for the deal to get done. With the help of Excel we can easily calculate that the total grains of rice on the checkerboard would need to equal 18,446,744,073,709,600,000 (I don't even know the word for that number). The 744 would be Trillion and it goes two levels above that so I think the 446 is quadrillions but I don't know what the 18 is???

We can gain some perspective on just how much rice this is with some help from Google and a little math. Google says there are between 6000 and 18000 grains of rice in a cup, I pick 10,000 to make the math easy. This  means the cost is 1,844.674,407,370,960 cups of rice.

That is still not a number I can easily digest so I asked Google how many people lived in the world. In 2017 there were 7.6 Billion people living on the earth. Dividing the cups by the number of people on the earth in 2017 gives us 242,720 cups per person.  A cup of rice (uncooked) weights 7 oz and there are 16oz in a pound so this is equivalent to 106,190 pounds of rice.  For comparison most cars weigh between 3,000 and 5,000 pounds. If we split this to 4000 pounds then this is equivalent in weight to 26 and a half cars. For each and every person living on the earth in 2017. We have just solved world hunger!

So just how long does one have to wait for this magic doubling to happen? There is a simple math trick for that.

The rule of 72: A simple rule to figure out how long it will take your money to double is the rule of 72. You simply Divide 72 by the return you earn and that gives you the number of years to double your money. i.e. a 10% return will double your money in 7.2 years (72/10 = 7.2); a 5% return will double your money in 14.4 years (72/5 = 14.2).

Patience: Anything that requires time means we must be patient. This is the hardest part for many people. The results do not happen in a straight line, there are ups and downs. Many people react to these changes with fear or greed and severely damage there returns.  We live in a society that wants things now. The only way to turn your money into more money "now" is gambling and more often than not you will turn your money into less because that is how the math works.

When investing many people get anxious or bored or overly excited depending on what is happening with their investments and in the world in general.  Remember these simple rules when investing:

1. Emotions are not your friends, if you are about to make a change and are feeling emotional go find a dark room, lay down and wait for the feeling to pass.
2. Don't chase other peoples returns, they almost never happen twice. Bitcoin is a great example (see my previous post).
3. Invest in things that you believe are well priced, have a long future of producing ahead of them and that you are willing to stick with, even if the price drops in half.  
4. Don't watch your portfolio too closely.

This will make it easier to be patient.  It is a little like cooking, a watched pot never boils.

Pulling it all together: In order to start investing you need three things. First you need some money saved that you can invest. Second you need time. The longer you have the better but I would recommend that if you cannot commit the money for at least 5 years you save it rather than invest it. and finally you need patience. Allow your investments time to work, do not be swayed by the madness of the crowd. Look at the cash flows being generated rather than the price and never sell because of fear or buy because of greed.

Next month I will talk about the most important element in evaluating any investment opportunity.