The Rwoth Ramogi 9 (The Nine Fundamental Principles of Investing) for Investment Clubs

Investing is guided by certain core principles which when followed, will lead to successful investing and becoming rich and financially independent. 

The club members need to agree on the principles that will guide the investment club. There should be a mutual agreement about what investing style my club is going to focus on. Any member that is in serious disagreement about the decisions made at this meeting has a chance to decline being a member.

The conveners should read through the Rwoth Ramogi 9, i.e., the nine fundamental principles of investing, namely:

1.     Dreaming, Thinking Big & Goal Setting: This involves painting the picture of financial freedom that I want to have, and writing what I must do to get there.

2.     Leveraging: The club should rely on Other People’s Money (OPM), to leverage, and achieve a much larger investment portfolio without diluting shareholding or committing additional personal capital.

3.     Saving-2-Invest: The club members, or investors, and the club, should accumulate money through savings in order to invest.

4.     Long-Term Investing-The club should have a three-year plus investment outlook.

5.     Portfolio Diversification-The club should diversify its portfolio so as to spread risk.

6.     Dollar Cost Averaging-The club should be investing regularly.

7.     Risk Tolerance- The clubs investment decisions should be alive to the risks.

8.     Knowledge-Based Investing-The club members must have a continuous learning culture

9.     Compounding- The club should reinvest and compound its earnings.

 

The principles herein are explained in details in the following chapters:

 

€       Principle 1: Financial Goal Setting!

£        What Is My Financial goal?

A financial goal is a target I want to achieve. It is the ‘what I want to do or be’. My financial goal is the place I want to go to; the life I want to live; the career I want to practice; the money I want to earn; the health I want to have; and the adventure I want to experience.  ‘It is not enough to do my best; me must KNOW what to do, and then do my best.’ said W. Edwards Deming, American statistician, professor, author, lecturer, and consultant. Today, I will define and describe my financial goals.

£        Financial Goals To Be Smart!

My financial goal must be smart.

 

A SMART financial goal is one that is Specific, Measurable, Action orientated, Realistic and Time stamped.

 

Specific – my objectives need to be specific, what exactly do me hope to achieve and why? Being rich for example is not a smart financial goal because it is not specific enough. I must know by how much: 1 million dollars? 200,000 dollars? Paul Nitze wrote, ‘One of the most dangerous forms of human error is forgetting what one is trying to achieve.’ People with clear financial goals, accomplish far more in a shorter period of time than people without.

 

Measurable – My objectives need to be measurable. I need a way of measuring my progress to see whether I am target. This will allow me to tweak my action plan if needed, to get the desired results. When writing my financial goals, I will create benchmarks or milestones that I can use to measure my progress and know whether I am on track, off-track or not moving at all: stagnating. I will set financial goals and posts, so that when I move closer to it, I know, and when I move away from it, I will also know. With this, nobody can stop me, nobody can slow me down, and nobody can wear me out.

 

Action orientated – I need an action plan. How am I going to achieve what I want? What are the necessary steps? What are my daily, weekly and monthly tasks?  Financial goals + Actions = Results. I need to make a commitment towards implementing my action plan. My actions will ultimately determine my level of success. Steve Chandler said, ‘a financial goal without an action plan is a day financial dream.’ I will ask myself, ‘What can I do today to get one step, however small, closer to achieving my financial goals?’ I will then take daily action towards my financial goals and financial dreams. Mike Murdock was right, ‘my future is hidden in what I do daily’. I must make the first step to begin my journey of a thousand miles.   Angelo D’Amico wrote, ‘I will accomplish my financial dream of tomorrow by acting today’. My success tomorrow will be the result of my actions today. My success is the sum of my past experiences. Without the foundation of my yesterday, my today would be pillared on nothingness; hopeless. ‘We are what we repeatedly do. Excellence, then, is not an act, but a habit.’ said Aristotle. I will work towards and achieve my financial goals gradually, but I must start today.  The anonymous 13^th century mystic must be quoted now, ‘I can only start the journey from where I am; and not where I am going’. In the future we will say one of the two things, ‘I wish I had’ or ‘I am glad I did,’ but we make that choice today’.  I should make the choice today. NOW! Most people unfortunately just expect success to happen, what they fail to realise is that success comes to those who make it happen. Men of action are favoured by the goddess of good luck.  ‘Financial goals allow me to control the direction of change in my favor.’ Brian Tracy said. It is proven that 95% of achieving anything in life is knowing what it is that we want.

 

Realistic – Is my action plan and objective achievable? If not, I should go back and tweak it such that it is. I should ask myself, can I possibly sell goods worth 1 million dollars in two days? Can I possibly earn 200% return on my investment in six months? If the goal is not realistic, it is a wish, and will frustrate me. I need to set realistic goals. Big, but realistic.

 

Time stamped – I will put a date on achieving my targets and ensure that I remain accountable. Napoleon Hill wrote, ‘A financial goal is a financial dream with a deadline’.  By when do I want to earn my first 100,000 dollars? By when do I want to earn my first one million dollars? I must state the year, month, and date. I must time stamp my financial goal.

€       Principle 2: Leveraging!

“Leverage is the reason some people with money become rich, and others with money do not become rich.”

-Rwoth Ramogi

There’s a saying:

I need money to make more money.

Every financial goal and result requires resources; from building a house, to investing, to starting a business, to attending school to get an education. After all, ‘there is no such thing as something for nothing’, Napoleon Hill reminds us. The Egyptians were right, ‘There grows no wheat where there is no grain.’ I to earn money, I must use money. To use fewer resources, and still achieve my financial goals, I need to work smart; I need to employ the concept of leverage.  What resources am I going to need to help me achieve my desired outcome? The trick is to use fewer resources, and achieve more results. The trick is to work smart. The trick is to leverage.

 

Leverage is the process of using less to achieve more. The root word for leverage – lever – comes from an old French word meaning “to make lighter,” which is an apt description of the power of leverage. Leverage allows people to work smarter, not harder. Even the Bible says in Proverbs, 23:4-5: ‘do not overwork to be rich.’

 

"Give me a lever long enough and a place to stand, and I can move the Earth."

– Archimedes

To lift a heavy object, I have a choice: use leverage or not. I can try to lift the object directly – risking injury and certain failure– or I can use a lever, such as a jack or a long plank of wood, to transfer some of the weight, and then lift the object that way.

Leverage is about using other people’s resources to achieve my financial goals; other people’s STEM (skills, time, effort & money) to achieve my financial goals; leverage is about using less of my own, to achieve more. A smart financial goal is one that employs leverage.

 

Leverage is borrowing money, which I use to make even more money. The money-making potential is always proportional to the total amount of money involved. Whether it is borrowed or not, it does not matter. As a common saying goes in Kenya, ‘money has no colour.’ Millions of people struggle financially because the power of debt leverage is used against them. Good debt makes me rich and bad debt makes me poor. Robert Kiyosaki said, “I retired young and rich because we were deeply in debt, deeply in debt with good debt, debt that made us rich and financially free.“ People without leverage work for those with leverage.

Leverage is the use of various financial instruments or borrowed capital, such as margin trading, putting down lesser amount of money, and using it to control larger amount of money, hence, earning the margin.  It is used in futures, forwards, options, as well as forex trading, re-purchase agreements, future contracts, and most forms of commodity trading.

Leverage is making sure both my principal, as well as the interest it earns, earn me interest. This is the “The rule of 72,” also called the “doubling concept”, a mind-boggling wealth-building concept that the world’s top investment brokers teach their rich clients.

The poor and middle class have a hard time getting rich because they try to use their own money to get rich. If I want to get rich, I need to know how to use other people’s money to get rich…not my own.

I can read about how to leveraging time, leveraging skills, or leveraging effort in Rwoth Ramogi’s  69 Ways to Make Extra Money While Keeping My Day Job!

 

€       Principle 3: Saving-2-Invest!

How do I start investing money?  By saving! The key to investing is savings. An effective savings strategy coupled with a smart investing strategy will help me to meet my financial goals. ‘if you cannot save money, the seeds of greatness are not in you.’ wrote W. Clement Stone.

 

Money should not just be saved; rather, it should be saved for investing. When it is just saved, it is kept, and it loses value due to inflation. However, when it is invested, it purchases assets, and sells those assets, at more money, called profit, or interest, or dividend. This is why money is called currency; it should be in constant state of motion, not static.  Today, out of every amount of money I earn, I will save 10% and invest it. Saving what I earn is the first step to acquiring assets.  In his masterpiece, The Richest Man in Babylon, George Clason, the soldier, businessman and writer, advises income earners thus; ‘pay yourself first.’ To save is to pay myself. Savings are used to create more money, not to pay bills. Benjamin Franklin, one of the Founding Fathers of the United States and a noted polymath, author, printer, satirist, political theorist, politician, scientist, inventor, civic activist, statesman, soldier, and diplomat was right, ‘A penny saved is a penny earned.’ This is one area where the Universal Law of Accumulation works.

 

To save, I need to apply Rwoth Ramogi three saving strategies. The three rules of saving; the three saving strategies are:

1)    Put away

2)    Put away small

3)    Put away small regularly

Saving in assets: the other method of saving is to directly purchase an asset, so that the money is saved in the asset.  I can read extensively about the saving strategies in Making My Child Financially Intelligent - Money Lessons by Age Group (from 3-13 yrs).

 

Further, in order to save-2-invest, I need a budget. Budgeting helps me to plan my finances. Budgeting lies at the foundation of every financial plan. Unlike what most people might believe, budgeting is not all about restricting what I spend money on and cutting out all the fun in my life.. Budgeting is understanding how much money I have, where it goes, and then planning how to best allocate the money. It does not matter if I am living paycheck to paycheck or earning six-figures a year, I need to know where my money is going if I want to have a handle on my finances. I will remember, ‘…money arrives like a tortoise, BUT departs like a hare!’

 

To create a budget, I will use The Rwoth Ramogi 10% Budget Plan. The Rwoth Ramogi 10% Budget Plan requires that I divide my revenue into TEN equal and separate areas, which all get 10% of the revenue allocation. The equality is premised on the fact that all parts of my daily living are equally important.

 

The Rwoth Ramogi 10% Budget plan is as below:

 

1.               Giving to help the needy, whether directly or indirectly; as tithe or charity; or through the church, mosque, temple or Red Cross, etc.;

2.               Rent & Utilities, including security & gardeners, mortgage, home insurance, lease, etc;

3.               Saving-2-Invest in various assets, which will also include retirement plan payments as (old age) insurance;

4.               Entertainment, including vacations, gifts, club membership fees, hobbies, etc;

5.               Education, both personal and for children, including seminars, talent development programs  and education insurance plan, etc;

6.               Food & Drinks, excluding those taken as entertainment, e.g, alcohol, etc;

7.               Transport & Communication, including fuel, repair and insurance; 

8.               Clothes & Personal Hygiene, including leg wear, sprays, jewellery and bathing items, etc;

9.               Household & House Maintenance,  including furniture & fixtures; kitchen appliances; and house help expenses, as well as property insurance;

10.           Emergency & Insurance Fund. This covers my emergencies, including health insurance and life insurance premiums since, since disease can and will strike at anytime; and death, however certain, is always an emergency.

 

The rule of thumb is that any excess money that remains from any of the categories will be added to category 3 and invested to make me financially independent.

 

 

I can read extensively about budgeting in Making My Child Financially Intelligent - Money Lessons by Age Group (from 3-13 yrs).

 

 

 

€       Principle 4: Long Term Investing!

 

Many people want to get rich, or invest in the investments the rich invest in, but most are not willing to invest the time. Almost anyone can easily become a millionaire if they simply follows a long-term plan. But again, most people are not willing to invest the time, they want to get rich NOW. Instead they say things like ‘investing is risky’ or ‘it takes money to make money’ or ‘I don’t have the time to learn to invest. I’m too busy working and I have bills to pay,’” Robert Kiyosaki says,

 

“Their ideas about money and investing cause their money problems.”

 

All they have to do is change a few words, a few ideas, and their financial world will change like magic. But most people are too busy working and they do not have the time. ‘Always invest in the long-term’, Warren Buffet advises. I need to invest long term. I should not be influenced by short-term fluctuations. These are inevitable in all economies as well as businesses experience the boom and bust cycle. I should not try to time the market. I need to get in and stay in. I should review my plan periodically, and whenever my needs or circumstances change. If I am not confident that my plan makes sense, I will talk to an investment advisor or someone I trust. A long-term view helps me to safely invest in 'riskier' investments, such as stocks, which the market rewards in general. This requires patience and discipline, but it increases returns. This approach reduces my choices to two: stocks and stock mutual funds. In the long run, they are the winners. The additional risk is worth it due to the power of compounding. 10% a year for 20 years is 570%, but 7% a year for 20 years is only 280%. I should not procrastinate. Research shows that since 1960’s, five year and above investment in the stock market always brings positive return on investment. Warren Buffett advises thus: ‘The rich invest in time, the poor invest in money.’ Most investors lack control or are out of control. rich dad used,

 

“There is risk driving a car. But driving the car with your hands off the steering wheel is really risky.” He then said, “When it comes to investing, most people are driving with their hands off the steering wheel.”

 

If I didn’t have a plan, a little discipline, and some determination, the other investor controls would not mean much.

 

I should begin now because an early start can make all the difference. An early start provides a long time horizon for compounding to show its true benefit for the investor. For average people, investing is not so much a helpful tool as the only way they can retire and maintain their present lifestyle. By investing long term, I am planning ahead. By planning ahead I can ensure financial stability during my retirement. ‘It never was my thinking that made the big money for me. It was always my sitting. My sitting tight!’ said Edwin Lefevre. This blunt warning is treated by many financial advisers like the Holy Bible. Once I arrange my assets into my ideal allocation, I should not tinker. Warren Buffett again advises me, ‘I never attempt to make money on the stock market. I buy on assumption they could close the market the next day and not re-open it for five years.’

 

I will rebalance once a year to keep my mix on track, but otherwise, I will listen to Livermore and sit tight. Henry Ross Perot, the American billionaire noted, ‘Most people give up just when they are about to achieve success. They quit on one yard line. They give up the at last minute of the game one foot from a winning touch down.’ I will remember that even if the market tanks it always recovers for long term investors, and when it is low I will snatch up a lot of shares at bargain prices. As long as I am dollar-cost averaging I will always be buying shares at a cheaper price.

 

The market can remain irrational longer than I can remain solvent. Bubbles occur. However, investors should never attempt to short them because, while bubbles eventually burst, they can grow larger and last longer than investor resources. This requires patience and discipline, but it increases returns. The additional risk is worth it due to the power of compounding. To invest long term, I should not procrastinate. I should begin now because an early start makes all the difference. An early start provides a long time horizon for compounding to show its true benefit for the investor.

 

Further, I should invest long term since the liquidation value (if I said, ' give me my money back'), I will often get less than my original capital contributions during the first two years. That is to say, investing in the stock market is a long-term proposition, and I may only see my contribution increase in value after the second year or so of investing.

 

 

€       Principle 5: Portfolio Diversification!

 

“Only a fool tests the water’s depth with both feet. “ (Ghanaian Proverb)

 

Portfolio diversification is the golden rule of successful investment:  This simple strategy is overlooked by 85% of investors. Diversification is a fundamental aspect of financial planning.  In a nutshell, it is the old adage to not put all my eggs in one basket.  If I have all my eggs in one basket and something happens to the basket then I am in big trouble.  But instead, let me say I keep some of my eggs in the refrigerator.  Then if something happens to the eggs in the basket I still have the ones in the refrigerator. The practice of diversification says that I should have a little in each of these to diversify myself against risk of the stock market and whatever else might happen in life. 

 

There are two main methods of diversifying ones portfolio:

 

$      THE AGE METHOD: One of the most popular formulas designed to provide a stage of life allocation - the age method - is to subtract your age from 100 to determine my share percentage, put 10% in cash and the remainder in bonds.

$      TIME HORIZON METHOD: The next method that can be used is the resource / financial goal method. Here I would need to determine my time horizon. The longer the period (time) the greater the share allocation. Money that is needed in the short term should not be invested into shares

 

I will diversify - by company, by industry, by company size and by geography. In stocks and bonds, there is safety in numbers. No matter how careful I am, I can neither predict nor control the future. So I must diversify. ‘In stocks and bonds, as in much else, there is safety in numbers.’ If I own the right number of stocks, bonds and funds and they are allocated across several categories, industries and geographies, I can substantially lower the risk of losses to our portfolio and increase returns at the same time. If I diversify properly; I can lower risk AND improve returns at the same time, making this a no-brainer. Diversification is the process of finding the investing sweet spot where I can optimize risk vs. return.

 

Woody Allen stated the general idea when he said: “The advantage of being bi-sexual is that it doubles your chances for a date on Saturday night.”

 

Diversification is about mixing: Another critical piece is the diversification mix. I want to invest in a wide variety of industries, categories and geographies to ensure that when one specific area goes south, it does not tank my whole portfolio. My portfolio should be spread across a wide variety of categories and geographies, most of which will not correlate at all with anything going on in telecom, some may even be inversely correlated (meaning they do well when telecoms do poorly). To diversity, I need a portfolio.

 

PORTFOLIO:  A combination of different investment assets mixed and matched for the purpose of achieving an investor's financial goal(s).

 

For example, if I own a telecom and suddenly the industry is getting bad press due to invasion of privacy lawsuits, the rest of our portfolio can cover the losses of that stock. Why? If we're diversified, that is probably our only telecom investments, the rest are in unrelated industries and will not be directly affected by these lawsuits.

 

Diversification reduces risk: Diversification is important. If I spread my investments across various types of assets and markets, I will reduce the risk of catastrophic financial losses. Diversifying investments in a portfolio helps to manage risk. The safest port in a sea of uncertainty is diversification. As most successful investors will tell me, diversification is king. A diversified portfolio not only reduces unwanted risk, but also contributes to a winning portfolio. And having a well-diversified portfolio does not necessarily mean just buying more than one stock; branching out into other areas of investment could be a viable alternative.

 

The strategy to get rich is entirely different than the strategy to stay rich. One gets rich through inheritance or by taking risk. One stays rich by minimizing risk, diversifying and not spending too much.

 

Items that are considered a part of my portfolio can range from real items such as art and real estate, to equities, fixed-income instruments and their cash and equivalents. There is not just one strategy that can be used to invest successfully. Ideally an investment portfolio should have both equity and debt instruments. Using this guideline I can allocate my money as best fits my personal situation. This strategy does not even rely on my ability to pick stocks. It relies on the principle of diversification. I should divide my money between these types of investments.

 

 

 

€       Principle 6: Dollar Cost Averaging!

 

Dollar cost averaging is buying at intervals: Dollar cost averaging is a technique by which an investor divides the given investment over a period of time and invests that amount on a regular basis as opposed to buying in all at once.  When I buy the same stock or mutual fund at regular intervals and with a fixed amount, I am said to be using the dollar cost averaging method.

 

If the market price of the selected stock or mutual fund declines, the investor will buy a greater number of shares.  On the other hand, when the market price of the selected stock or mutual fund increases, the investor will buy lesser number of shares.

 

Dollar cost averaging reduces risk of price fluctuations: By putting in, say, $100 each month (rather than a large amount once a year), I sometimes buy when the prices of the units of the fund are higher, and sometimes when prices are lower. In the end, the purchase prices average out. I can hence reduce some of the risk that poor timing and potentially adverse price fluctuations will have on my investment decisions. Just about any fund company or bank will let me invest like this with an automatic payment plan.

 

However, dollar cost averaging will not protect me in a steadily declining market. Further, if I discontinue with a dollar cost averaging plan, I will lose money when the market value is less than cost of the shares.

 

 

 

Month	Dollars Invested	Price per share	No. of shares purchased
January	100	12.76	7.84
February	100	13.25	7.55
March	100	15.25	6.56
April	100	18.76	5.33
May	100	20.26	4.94
June	100	18.85	5.31
July	100	15.62	6.40
August	100	17.85	5.60
September	100	16.62	6.02
October	100	13.26	7.54
November	100	14.5	6.90
December	100	16.76	5.97
Total	1,200	193.74	75.94
Average price per share = 193.74/12 = $ 16.15
Average cost per share  = 1,200/75.94 = $ 15.80

 

Dollar cost averaging encourages automatic savings: The best thing about dollar cost averaging is that it gets me into the habit of saving every single month. Dollar cost averaging permits systematic contributions to an investment portfolio periodically, hence encouraging savings Dollar-averaging (continuing to invest the same amount of money every month) really works.

 

This investing strategy will, over a period of time, result in the investor buying the selected stock or mutual fund at an average cost per share that will be less than the average price per share.

 

For example, assuming that a person invests $100 per month for 12 months in a Mutual Fund; as can be seen from the below table, the average cost per share is lower than the average price per share.

 

 

 

€       Principle 7: Risk Tolerance!

“risk is the other side of investing”

-Rwoth Ramogi

 

Risk is a necessary element of life.  There is always the chance that something will not work out for me and this chance is called risk.   There is a risk in everything I choose to do in life including my financial life.  The broad range of investment opportunities represents varied levels of risks and rewards.  History unequivocally supports this ‘no free lunch’ principle. Stocks (high risk) have paid more than government bonds (medium risk), which in turn have beaten low-risk Treasury bills.  Among many, many other things, this law suggests that to earn returns high enough to build true wealth, I have to put some of my money in risky assets like stocks-the only investment to handily beat inflation over time. As Rich Dad said, “What good is making a lot of money if you wind up losing it all?”

 

The greater the risk I take, the greater the reward I will receive.  This applies to investments but also to life decisions.  In the financial world this is illustrated when I choose to invest in a stock over a safer investment.  The extra risk I take is rewarded in terms of the stocks growth.  In our personal world this is illustrated in a decision to attend college.  Attending college is essentially a case of one assuming a risk.  I am foregoing years of income for the chance that the increased education will pay off for me in more income in the long run.  This is actually a pretty safe investment that usually works. Bill Gates was right, ‘To win big, you sometimes have to take big risks.’

Investing involves managing risk rather than managing return. The four basic risk management strategies are:

¯       Risk Avoidance: This is where I avoid any real chances of loss. It is generally a poor strategy for my entire portfolio but is useful for parts of it.

¯       Risk Anticipation: Position your portfolio to protect against anticipated risk factors i.e. by maintaining a cash reserve.

¯       Risk Transfer: Insurance and other investment vehicles can allow for the transfer of risk, often at a price, to another investor who is willing to bear the risk.

¯       Risk Reduction: Effective diversification and asset allocation strategies can reduce risk, sometimes without sacrificing expected return.

If I want to invest with very low risk and high returns, I have to pay the price. And the price involves study, lots of study. I need to study the basics of business. So to be a rich investor, “I have to be a good business owner, or know a business owner.”

 

 

£        Types of Risk

Depending on the nature of the investment, the type of 'investment' risk will vary. The risk can be caused by market changes, interest rates fluctuation, management imprudence, liquidity rates, industry practices, political issues, etc.

£        Risk Reduction Strategies

Since there is imminent risk in entrepreneurship, every entrepreneur should take risk reduction measures. I can do this by applying various strategies:

 

Experimenting: The first strategy is to experiment. This involves taking action through a series of low cost events and projects before committing a great deal of resources (time, energy, skills and money).

 

Risk Sharing: Risk sharing by partnership with individuals or corporations that have complementary skills will increase the chance of success while reducing the risk in terms of time, skills, money and energy that is required.

 

Risk Should Be Proportional To Available Disposable Income: The golden rule surrounding all investing is: I should not spend more than I can afford to lose. This is the absolute truth. As a general rule in risk taking, I should not take more risk than ability, willingness or need dictates. I should take risk with money I can afford to lose. As multi-millionaire, in an effort to increase my profit for the year; I may have no problem putting down $100,000 in a speculative real estate investment.

 

Risk Should Depend On My Investment Objectives: The two main investment objectives are income generation and capital appreciation. Capital appreciation will require high risk, high return investments like equities, while income generation require low risk, fixed securities, like bonds. Some examples of goals that can form your investment objectives are:

 

¯       Capital preservation: To maintain purchasing power and minimize the risk of loss.

¯       Capital appreciation: To achieve portfolio growth through capital gains and accept greater risk.

¯       Current Income: Look to generate income rather than capital gains. It can be referred to as the “spending phase”. There is relatively low risk.

¯       Total return: Combine the income returns and re-invest with capital gains. It has moderate risk.

Risk Should Be Based On My Age:  A 75-year-old widow living off of her retirement portfolio needs income from her investments to survive, she cannot risk losing her investment, and takes a passive investment strategy. A 35 year old young executive, on the other hand, has time on his or her side, and hence, takes an aggressive investment strategy.

 

Diversification Mitigates Risk: Whatever my personality type, putting my eggs in different baskets protects me from a failure in one industry sector, or one company.

 

Knowledge Mitigates Risk: The more extensive my knowledge of what has been done, the greater will be my power of knowing what (not) to do. ‘As a general rule, the most successful man in life is the man who has the best information.’ said Benjamin Disraeli. I should build my knowledge base to help me in achieving financial independence. Whether it takes a week, a month or a year to become thoroughly knowledgeable, it does not matter. I should start learning immediately, today. Investing is a big bet on an unknowable future. I should accept I need to learn, and then learn. This will reduce the risk of venturing into this unknowable future. Think about how much information I have! Too little increases risk. Warren Buffett said, ‘Risk comes from not knowing what you are doing.’

 

 

 

€       Principle 8: Knowledge-Based Investing!

To be a great investor, I need have a great financial IQ.

 

Financial literacy is one of the most important investor basics, especially if I want to be a safe investor, an inside investor, and a rich investor. Kiyosaki said,

 

“Anyone who is not financially literate cannot see into an investment.”

 

Improving my financial literacy ultimately reduces my risk and improves my investment returns.

 

I do not need to be an expert in order to achieve satisfactory investment returns. But I must recognize my limitations. It is vital, however, that I recognize the perimeter of my “circle of competence” and stay well inside of it.  I will focus on the future productivity of the asset I am considering. No one has the ability to evaluate every investment possibility, but I need to forecast for five years to ten years, at the least. If I lack the ability to estimate future earnings, I should move on to other prospects. If I do not feel comfortable making a rough estimate of the asset’s future earnings, I will forget it and move on.

 

I need to be an informed investor. Investing is the key to building wealth, but investing in and of itself is not enough. If I have to invest, I need to invest wisely!  I do not need to be a financial expert to invest, but I do need to learn some basic terminology and concepts so that I am better equipped to make informed decisions. This is what this guide is all about. Investment is not speculation. Investment is informed speculation.  My financial goal is to be informed enough to understand and analyze what I hear. Then I can decide what fits with my investing personality. When asked how he managed to become a rich investor, Warren Buffet said, ‘we read hundreds and hundreds of reports every year.’

 

 Investors are willing to pay for knowledge. They read books, journals and magazines ranging from investing to personal development. They attend seminars to improve themselves. They are voracious. Successful investors know that their cup of knowledge must never be full so they always keep their minds open; ever ready to learn. Robert Kiyosaki reminds investors that investment is all about being an insider. To be an insider today, I will be informed. As Kiyosaki says, “knowledge is the new money”.

 

I make the most money as an investor by being financially literate as well as knowing internal strengths and weaknesses of the investment. I find the best investment opportunities from understanding accounting, the tax code, business law, and corporate law. The more I read financial statements, annual reports, and prospectuses, the more my financial intelligence, or financial vision, increases. Over time I will begin to see things that the average investor never sees.  It is in these invisible realms where the real investors shop for the biggest investment bargains. As Warren Buffet says, “the income statement and balance sheet the magic carpet of investing.” Learning to read financial statements is a tedious process, especially when I first begin to learn. The good news is that it gets easier and faster as I practice. But not only does it get easier, but I can also review many more investment opportunities almost automatically without thinking, just like riding a bike, or driving a car.

 

The reason most people suffer financially is because they purchase liabilities and list them under assets.  If I want to be rich for generations, I must know the difference between an asset and a liability. I must know the difference between something of value and something that reduces value.  I will always remember that my expense is someone else’s income, and my liabilities are someone else’s asset. When I am out of control of my cash flow, I make the people who are in control of their cash flow rich.

 

I need to understand the financial ratios, mainly the return on equity, return on assets, and return on capital, which all analyse how the transforms capital into profit for investors. The other ratios are debt to equity ratios, or leverage ratios, which indicate what percentage of the company is funded by debt, and hence, how much more debt the company can absorb before it becomes fully leveraged.

 

Warren Buffett never invests in businesses he cannot understand or that are outside his “Circle of Competence.” All investors can, over time, obtain and intensify their “Circle of Competence” in an industry where they are professionally involved or in some sector of business they enjoy researching.

 

Buffett’s logic is compelling: “If you own a company (either fully or some of its shares) in an industry you do not understand, it is impossible to accurately interpret developments and therefore impossible to make wise decisions.”

 

There is a great investing saying thus, ‘Invest in things you know.’ Peter Lynch said it best when he said, ‘Never invest in an idea I cannot illustrate with a crayon.’

 

 

€       Principle 9: Re-Investing & Compounding!

 

Reinvesting means plaughing back what I earn as profit into purchasing more assets, hence, investing it. When I am investing, I should not be a hungry investor. If I make a profit, at least 50% should be ploughed back in investments. Compounding is the most important principle in saving and investing. It has been called the eighth wonder of the world. It is the key concept of any saving and investing plan. Albert Einstein called compound interest ‘the greatest mathematical discovery of all time’. This is true partly because, unlike the trigonometry or calculus I studied back in high school, compounding can be applied to everyday life, and in finance, it applies to amplify the growth of my working money. Whereas investing maximizes my earning potential, compounding maximizes the earning potential of my investments.

 

Compounding makes money make more money: The wonder of compounding (‘compound interest’) transforms my working money into a state-of-the-art, highly powerful income-generating tool. Compounding is the process of generating earnings on an asset's reinvested earnings. To work, it requires two things:  re-investment of earnings and time. 

 

The more time I give my investments, the more I am able to accelerate the income potential of my original investment, which takes the pressure off of me. Compounding is premised on the doctrine of the Time Value of Money. (TVM). Time Value of Money (TVM) is the idea that money available at the present time is worth more than the same amount in the future due to its potential earning capacity. This core principle of finance holds, provided money can earn interest, any amount of money is worth more the sooner it is received.  The time value of money demonstrates, all things being equal, it is better to have money now rather than later. I need to start investment now, today. I need to start investing now, today. By giving my investment more time to grow, I earn myself more money. Investments start to grow slowly and then accelerate. The invested money accumulates interest, and the accumulated interest is itself accruing more interest. Everyone knows that money deposited in a savings account will earn interest. Because of this universal fact, I would prefer to receive money today rather than the same amount in the future.  The earlier I put money to work, the longer it works for the members, and the more wealth is generated. It makes a lot of sense. Wealth is generated via production. The longer my money works in good companies, the more time it has to produce further profit; profit which I also get to share.

 

Reinvesting earnings allows me to take advantage of compounding. I must keep hands off the principal and earned interest. Compounding is realized by reinvesting the earned income or interest. Reinvesting is the investment of both principal and income from principal rather than distributing it as dividends or profits. Reinvestment of resources is a useful strategy that all entrepreneurs regularly employ. As long as I do not need the income (from dividend payouts), It is generally a good idea to reinvest. Reinvestment dovetails with the investing maxim of ‘dollar cost averaging,’ which holds that investors do well to consistently invest small amounts of money. The return I receive on an investment is interest. If I invest $20,000 and it returns a modest 10% a year then I will have earned $2,000 in interest. Compounding interest is the escalating effect of interest. As an example, if my $20,000 investment was returning 10% per year after 10 years I would expect to receive $20,000 in interest. Actually it is much more than that. Compounding interest ensures the amount I earn is more. After Year 1 I receive $2,000 which makes my investment $22,000. For Year 2, 10% of $22,000 is $2,200. This is because I reinvested that $2,000; it works together with the original investment. This means the amount of interest I receive in year 2 is greater than year 1. This interest I am earning is compounding. Every year, my investment compounds more and more. After 5 years my investment of $20,000 has gone up to $32,210. That is interest of $12,210 not $10,000 as I first thought. This little bit extra may seem like peanuts, but I did not have to lift a finger to earn that $2,210. More importantly, this $2,210 also starts to earn interest. At the end of 10 years my investment is worth $51,875. I have returned $31,875 and not $20,000.

 

Dividend Reinvestment: When I am paid a dividend, I typically can choose to receive it in cash or reinvest it and purchase additional stock. Dividend reinvestment is a systematic method of accumulating shares of a stock that pays a dividend. Many investors use dividend reinvestment as part of a long-term buy-and-hold investment program. This will happen even as I send voluntary contributions to purchase additional shares.

 

Further, putting dividend reinvestment stocks in a retirement account can shelter the dividends from current tax liability. If I choose to reinvest our dividends, in effect, we're taking the dividend payment in stock instead of cash. Reinvesting dividend income is an important part of the overall return on our investment as a club. It is similar to compounding interest, with the principal of our investment constantly growing and theoretically paying higher dividends each quarter. The process takes time, but reinvesting our dividends can increase our total return in the long run. The cool thing is that I can put all of my profit back to work, and effectively have more money generating more profit. This process can keep iterating so long as I do not withdraw my money.

 

 

 

$       Investment Advisors/Brokers

Buying securities, which are, stocks or bonds, requires that the club has a stock broker.

Our stock broker can also be an investment advisor (institutional company that advises, and also executes trades).

Our investment club should have an investment advisor, and or stock broker, to execute our trades in the securities exchange, also called, the stock market.

Before anyone buys stocks, they need to have a stockbroker. 

€        A STOCK BROKER /STOCKBROKER is a regulated professional broker who buys and sells shares and other securities through market makers or Agency Only Firms on behalf of investors. A broker may be employed by a brokerage firm.

There are two types of stockbrokers: a full-service broker and a discount broker. A full-service broker offers investment advice whereas a discount broker solely takes care of executing stock orders.

Choosing brokers depends on the following:

Commissions: Although the largest difference in between traditional and discount brokers is the cost of each transaction, differences in commission prices between two firms of the same kind can be tremendous. In some cases, the higher price means better service, faster execution (i.e., our buy and sell orders are carried out in a shorter period of time), and more perks, but this is not always the case. That is why it is important to look around and compare brokerage firms before the club opens an account. Further, it is good engage performance/fee based brokers, since, as the American Billionaire entrepreneur, Mark Cuban, said,

“it is not smart to take advise from people who will not live with the consequences of their advise.”

Minimum Opening Balance and Maintenance Fees: Each broker has a minimum opening balance requirement. Some are as low as $50, most are around $1,000, and several are higher. Some brokerage firms may have a low opening balance but will charge us a maintenance fee if our balance falls below a certain amount. Although the fee may be little, it can significantly eat up our investment returns if we are just starting out.

Services, Perks, Research, and Investment Tools: No broker offers the exact same set of tools, research, and perks to their customers. Some will allow us to instantly log in to our account via the Internet and print out an analysis of our portfolio, view the balance of our account for the past six months, check our realized and unrealized gains, and view dividend records for the past few years. Others may be slim on features such as this, but offer amazing research that we cannot get elsewhere. I will have to decide if I want to trade low price for customer service.

Credit Cards: Lately, a lot of brokerages have begun offering Visa Check Cards which work exactly like a credit card. The difference is that the money we spend is taken directly out of our brokerage account. This way, we have the combined functionality of a checking /savings /money market account with a stocks / bonds investment account. It is tremendously convenient and can help simplify the club’s finances. If we are looking for an all-in-one solution, an asset management account may be a more attractive alternative.

Number of days: It is important that orders are executed immediately, and so, this is an important point to note when getting the stockbroker.

 

£        Full Service/Traditional Broker

This broker guides investment clubs and offers advice at the occasional meetings. Some clubs have traditionally favored full-service brokers who will provide some advice and guidance and perhaps even attend meetings on occasion. If we decide to open an account with a traditional brokerage firm, we will work one-on-one with a personal stock broker. He will offer investment ideas, prepare reports about our portfolio, give us a run-down of how well our investments are doing, and generally be available with a single phone call or email to buy or sell stocks, bonds, mutual funds, or other investments for our account. In addition, traditional brokers offer a variety of different research sources to their customers. In exchange for this one-on-one service and guidance, we will be charged a significantly higher commission.

£        Discount Brokers

If I do not want to use a broker on a full-time basis I can use what is known as a discount broker. Using a full-service broker essentially defeats the purpose of forming a club, which is to benefit from the work and collective efforts of the group rather than relying on the advice of a broker. Since clubs are self-reliant and self-directed, there is no need to pay hefty commissions to full-service brokerages. A discount broker will give me some detailed information about stocks but will not give me advice about what to sell or buy. Using a discount broker seems to be the more popular choice since the purpose of the investment club is to make my own decisions about what stocks I am going to be dealing with. When I use a discount broker I will not have to pay a huge commission to a full time broker. My club will have to take a vote and decide what is in the interest of the majority.

Discount brokers may offer some research, but they will not tell me what to buy or sell. Discount brokers are geared toward the do-it-yourself investor. They will simply execute orders once we've decided to buy or sell an investment. Instead of working with the same stock broker, we will do most of our trading online, or if we decide to call in our order with the first available broker. Recently, discount firms have been offering research that is on par with those offered at the traditional full service brokerage firms. We may also want to think about using the services of an online broker.

£        Online Discount Brokers

The club should consider taking advantage of the incredibly low commissions offered for online trading by online discount brokers. Online discount brokers will have low commissions that can be a benefit to my club. My investment club should delegate one or two members to find the best discount brokers that they can find, both on the Internet and locally. There are a few things that I should keep in mind when I am looking for a discount broker, namely, the customer service that the broker offers; fees and other incentives, like research, to hire the broker.

When I am looking for a broker and basing my decision on customer service I will want to take some time looking at the broker’s website. I will want to make sure that the website is easy to use and easy to navigate. I will want to know what type of customer service the broker offers. I will soon be able to make my decision about customer service after I conduct my first trade with the broker. I will make sure I find out if there is any other incentives offered that make me want to hire the broker.

Other perks that an online broker may offer that can be of benefit to my investment club include educational books and materials to buy at a discounted price or to read online or a discount on my first trade.

€       Opening the Brokerage Account

Before we can begin investing, the club must open a brokerage account. All brokerage firms deal in basic securities, including buying and selling stocks and bonds on behalf of their clients. Some brokers execute orders for additional investment products, such as options and futures contracts.

€        FUTURES: Exchange-standardized contracts for the purchase or sale of a commodity at a future date.

€        FUTURES CONTRACT: A standardized, exchange-traded contract to make or take delivery of a particular type and grade of commodity at an agreed upon place and point in the future. Futures contracts are transferable between parties.

€        OPTION: A right to buy (call) or sell (put) a fixed amount of a given stock.

€        OPTION PREMIUM: The amount per share paid by an option buyer to the seller. An option premium that is quoted at 2 1/8 means an option buyer would pay $212.50 for an option contract controlling 100 shares.

 

 

£        Open Demo Accounts

Instead of jumping into full-fledged trading, the club could begin with opening a demo account. During this time, the members should ask a lot of questions to get familiar with the broker and the trading process. This would allow us to get a feel of the customer service support different brokers offer.

£        The Brokerage Account

The first step to building our portfolio is to open a brokerage account. A brokerage account is also called a trading account, and is an account that allows my Investment club to buy and sell investments online and by phone, and hold investments on our behalf.

It is an account similar to a traditional bank account, holding cash and securities, and a number of other types of investments, and is administered by an investment dealer. We pay the stock brokers/professionals to buy or sell the items we tell them to, and we pay them a fee called a ‘commission’, which is usually a percentage.  The price difference arises when we choose between a discount and traditional broker. Most offer the option of either having an application form sent to us, or allowing us to fill them out online, print them, and mail them in with a check. The process is easy and can be done fairly quickly at almost all financial institutions. The club will have three nominated people who are able to actively trade on the account, however all members can login and view the account at any time. When the club starts using a number of different trading strategies or have a number of brokerage accounts, we may separate our accounts in order to avoid confusion.

One account may be a registered account for our retirement savings; another account may be a buy-and-hold account for our long-term stocks; another may be a Margin Account; and another may be a trading account used for conducting day-trading activities.  Once we have opened an account, we have the ability to start investing our money. All brokerages give us the option of setting up automatic monthly withdrawals, which will transfer an amount we specify each month from our savings or checking account to our brokerage account. This can be an easy way to start building up our equity; if we do not see it, we will not spend it. Furthermore, this option is very good for the individual salaried investor. Since we will not notice the money that is missing each month, saving will be relatively painless. 

€        MARGIN ACCOUNT: Brokerage account allowing customers to buy securities with money borrowed from the broker. A signed MARGIN AGREEMENT is a prerequisite to establishing a margin account.

€        ALTERNATIVE INVESTMENT MARKET is market for the stocks (shares) of small growing companies which cannot afford the expense of a full listing on the Stock Exchange. The fully listed companies trade in the MAIN MARKET

€        SECTOR: A group of stocks often related to a particular industry that has certain shared characteristics.

€       Analyzing the Market and the Market Conditions

There are different styles and types of investors that exist in the stock market. Investors use the stock market to build their investment portfolio so that they can see a long term profit that takes place over a long period of time. Someone who is just using the stock market to make money quickly for a short period of time is called a ‘trader’. Members of an investment group are in the investment market for the long haul. They are called ‘investors’.  The different types of investors use different methods to analyze the market and the market conditions.

The three common methods of analyzing the market are: 

$      TECHNICAL ANALYSIS. This method of analysis is used by a ‘momentum’ investor. Technical analysis looks at the price fluctuations that occur in the stock market. The investor bases the decision to buy or sell on what he feels the price will do next.  

$      FUNDAMENTAL ANALYSIS #1. Fundamental analysis is used by the ‘growth’ investor. This type of analysis decides if a certain company is a good investment based on the earnings of the company, growth sales, and margins of profit. 

$      FUNDAMENTAL ANALYSIS #2. A ‘value’ investor uses this type of analysis. This method of analysis is similar to the analysis that a growth investor uses but is slightly different. A value investor takes a close look at those companies in the stock market that have a low value, whose stocks are currently cheap but that have the potential to make a good comeback.

Most stock investment clubs use the fundamental method of analysis to make most of their investing decisions. They find companies that are listed on the stock market that show good growth, profit, and earnings but that are still cheap to buy and haven’t yet reached their potential.

Members of the investment club buy this stock and hold on to it for several years so long as the fundamentals, as listed previously, continue to hold strong. This type of investment strategy is called ‘buy and hold’.

€       Online Trading

When we buy and sell stocks online, we are using an online broker that largely takes the place of a human broker. Some online brokerages offer advice from live brokers and broker-assisted trades as part of their service, but otherwise, they are discount firms.  If we need a broker to help us with our trades, we will need to choose a firm that offers that service. Since the invention of Internet people have been able to do practically everything virtually. But if debt free advice is required, we must seek quality advice.

Due to the Internet, online trading has become one of the most popular ways to trade since stock trading turned out to be as available to independent investors as possible. Online trading gives both beginners who have just had a single day trading course and advanced traders an opportunity to trade stocks, options, forex and futures all over the world without physical presence of a broker and with much lower commissions, because everything is done online.  In order to trade online, we will have to open our online account and choose online trading software. When we choose a certain website for our future account, we should search for information about a company we are going to fix upon and make sure that it has a trustworthy reputation. The same refers to choosing online trading software, platform and online trading portal.

€        ONLINE PORTAL is a website system which gives both traders and brokers an access to a great variety of financial news and information which enable traders to take their decisions. These various financial services are provided by a great number of different companies.

Online trading is a perfect opportunity to trade and earn money but before we start trading, we should find out more about online trading pros and cons, online trading concepts and of course about online trading tips. Knowledge is a main key for the club’s successful online trading. We should ensure that the club’s finances are structured accordingly before we hit the trading floors online.