3 Forgotten Principles of Investing

There are 3 principles of investment which many people ignore or take for granted yet they form an important part in selecting investment strategies.

1. Leverage. To what extent are you able to increase your returns by using other people's money i.e. borrowed funds?

For example; Compare two banks, B and C, which are able to lend you money at the same interest rate. Bank B requires you to put down 20% while bank C requires you to foot 3% of the initial cash outlay. If you had $3,000, this means bank B can lend you $12,000 while bank C can lend you $97,000. The amount of money that you can earn from investing $100,000 far outweighs what you can earn using $15,000.

Using other people's money usually comes with many strings attached but it affords a giant leap to someone of little means when trying to cross the chasm of poverty and being broke,

2. Probability. Every venture has a chance of success and failure. Probability puts a number that is easily understood to the chance of success or failure. For example; If 100% represents guranteed success and 0% represents guaranteed failure, then any percentage point between 0% and 100% will give you an idea of your chance of success.

As a rule of thumb, embark on a venture when the probability of success is at least 70%.

In the corporate world, mathematicians who use statistics and scientific models to determine probabilities for business are called actuaries. I do not expect you to consult an actuary for simple financial decisions but I would like you to appreciate the importance of determining the probability of success for any venture and especially in comparison with other similar ventures.

It may be interesting to note that in very simple terms, there are only 3 main outcomes to any investment venture. 1) You will make money2) You will lose money3) You will neither make nor lose money

If these 3 outcomes are equally likely, then each outcome has a probability of 33⅓%. This probability is crucial because it implies that even if you are just average at investing, and if you invest many times for a long period of time, at least you will make money 33⅓% of the time. It is sad to note that many retail mutual funds managers have failed to achieve even 33⅓% success rate.

What is the success rate of your mutual fund manager or investment advisor?

3. Risk. In the context of this article, risk is the factor, thing or event that could make you lose a significant portion of your initial investment.

In my other article titled,

Do You Know The Secret of the Safest Investment Strategy? , I introduced the importance of managing risk. You may read the article by clicking here

When considering risk I want you to deterimine as much as possible the things that could go seriously wrong and cost you to lose more than 10% of your investment? Then put measures to avoid or lessen the impact of such events. Some simple strategies may include insurance, partnerships, mentoring, consultancy, piece-meal roll out etc

In another article I will present 5 basic principles of investing which even your barber should be aware of. Experience tells me that often what we expect to be common may not be as common as we think. It may therefore pay off to have a word with your barber and then read the next article on the basic principles of investing.