It is always ideal to start your investing journey early. But before you take the first step, it is important to understand basic investing concepts that will aid you in your investing journey. And here are three investing concepts that you should know before you dive into the market.
1. The Power Of Compounding
Compound interest is the key to how some of the greatest investors in the world build their wealth. The most prominent examples are Berkshire Hathaway owners Charlie Munger and Warren Buffett. Even the genius, Albert Einstein, referred to compound interest as the eighth wonder in the world.
As you start your investing journey, it is to understand the importance and role of compound interest in your investment returns. One of the greatest and surest way to fail is to think that you can become rich overnight.
Instead, learn to embrace the concept of compounding and develop a clear and consistent investment plan that accumulates wealth steadily.
2. Fundamental Analysis Vs Technical Analysis
There are two major school of thoughts that investors (or traders) subscribe to: Fundamental Analysis and Technical Analysis.
Fundamental analysis is the in-depth study of a company’s income statement, balance sheet and cash flow statement to measure the intrinsic worth of a company. With an understanding of how the company operates and generates cash, investors then projects future earnings of the company before discounting it to its net present value (NPV).
If the current share price of the company is lower than the projected NPV, it means that the company is a good investment opportunity. More often than not, investors also analyze the overall economic conditions to determine whether the company is overvalued or undervalued in the current economic climate.
Technical analysis, on the other hand, evaluates stocks based on the statistics that is generated on the charts.
There are three assumptions that technical analysis is based on:
- Price reflects all the information that the market knows (Efficient Market Hypothesis)
- Price moves in trends
- History tends to repeat itself. Since the price reflects all the information that the market knows, there is no need to figure out the intrinsic value of the company.
3. Value Vs Growth
Under fundamental analysis, the two most common approaches are value investing and growth investing.
One of the most prominent figure in value investing is Benjamin Graham (author of The Intelligent Investor), often referred to as the Father Of Value Investing. The main idea behind value investing is to find diamonds in the rough. Diamonds in the rough refer to companies that have a high intrinsic value but yet trades below their intrinsic value on the stock exchange.
To give an analogy of value investing, it is like buying a Louis Vuitton bag that is worth $3,000 for a price of $1,500. The difficulty in value investing is, however, in determining the intrinsic value of the company.
Growth investors want to invest their money in companies that are able to grow at a faster rate compared to their peers. Unlike value investing, growth investing does not look for bargain buys. Contrary to value investors, growth investors are willing to pay more, as long as the past and future growth of the company (i.e. revenue, earnings or cash flow) is justified.
We combine these concepts in our investing strategy that brings us 10 – 15% annually. (Yes, we know it doesn’t sound attractive, but it’s realistic returns for the average investor) Learn more at our upcoming Factor-Based Investing Introductory course.
An enrolled actuary. Started his investing journey as a value investor before being intrigued by the world of technical analysis. Wants to help people understand that finance is not just a rich man’s game.