Saturday, January 24, 2009

Should I Invest? #2: What Do You Believe?

Question #1 was about your timeframe. Question #2 is about your beliefs. To be a successful investor, you need to be cautiously optimistic. Optimistic because if you didn’t think there was a future, and a better one to spend your money in, you wouldn’t invest. Cautious because if there is any chance you could be wiped out, eventually you will be.

Investment = Sacrifice
You sacrifice something now, usually time or money, because you feel you will get something better in the future. You sacrifice living in this home, and let somebody else live there, so that you’ll have a paid-for home in the future for income or to live in. You sacrifice $1,000 of current spending money for the income it could produce, or the chance that it will be worth more in the future. This is often referred to as Return on Investment (ROI), and a 25% ROI means you’ll get back a quarter of your investment a year – and four years from now, you’ll have your original investment AND your money back out. But you must be optimistic that you will get back your money, and inflation won’t kill your profits, or why would you put off gratification?

The Meaning of Risk
If you have an investment that works 90% of the time, but has a 1% chance of costing you all of your money – you will go broke if you try it enough times. In a more normal world, if you win 55% of the time, and risk even 1/10th of your wealth, there is a 2% chance you’ll lose 5 times in a row – half your wealth! You must be cautious with your money! Warren Buffett’s famous two rules of investing are:
1. Never lose money.
2. Never forget Rule #1.

What Are Your Beliefs?
So what are your beliefs? Do you think the economy will get better or worse? What will the world look like in ten years? Twenty? Will the economy rebuild? Will businesses still be profitable? Will your life be better if you’ve doubled your money over the next ten years? Or will inflation cut money to less than half its value in that time? If you double your money, but the cost of living triples, you’re moving backwards. Take some time and think about these questions:
1. Will things get worse or better in the future? By how much?
2. Will there be inflation, deflation, or high inflation? (2-3% inflation is considered “normal”)
3. Will businesses still be profitable in the future?
4. Will your country’s economy and currency be strong in the future?

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