The magic of compound interest
Compound interest is one of the most interesting things in the financial world. If you truly understand how it works, it can make you a lot of money. Check out this impressive quote:
Compound interest is the greatest mathematical discovery of all time.”
Albert Einstein
Compound interest can be explained as the adding of accumulated interest back to the principal. Interest is earned on interest. Compounding depends on three factors: percentage, basis and time.
Example: You have a bank account with $10000 in it and get 4% interest per year. After the first year you have $10400, but ten years later you already have $14802.44. Sounds great, doesn’t it?
Even 0.5% make a difference
Let’s take the example from above and modify the percentage to 4.5%. After ten years you have $15529.69. That means that you get 10.77% more than with a percentage of 4%. Amazing. Always seek for that extra 0.1% to 0.5% when searching for a good investment. Over time it changes a lot and you will see the difference.
The more you have, the more you will get
It’s true, rich people get richer. We earn $400 in our first example, but with a basis of $20000 we would have earned $800. The higher the basis, the higher the profits. Don’t forget to make regular payments into your savings account, so your basis gets bigger. Ideally you save money for a reason, for example your retirement. Then you need the endurance letting the money where it is for let’s say 20 years. But trust me, the motivation is great to pay in every month, because you will see amazing results and retire completely without financial problems.
Time is on your side
How long you let your money earn money is up to you, but the longer the better.
Remember, you earn money by doing nothing. And the money you earned by letting it earn more money will earn you even more money. You just put money in your account and watch it grow over time. If you don’t need the money, let it multiply. Be disciplined and patient enough and don’t touch this money.
The three factors have to work together
The whole concept of compound interest sounds great, but it is dependent on the three factors. They have to work together well, or you will get poor results. Basically, it is up to you how long you can do without the money you put in your account. It is also your choice how much you put in,dependent on how much money you have, of course. To get the max, the basis and time should be relative high, because the third factor “percentage” is aligned with risk. You get a small percentage with little to no risk but every percentage point more goes hand in hand with more risk. It is essential to find the right balance.
Sometimes it is magic
To conclude this article, here is a amazing example on compound interest at work:
“If the Native American tribe that accepted goods worth 60 guilders for the sale of Manhattan in 1626 had invested the money in a Dutch bank at 6.5% interest, compounded annually, then in 2005 their investment would be worth over €700 billion (around USD $1,000 billion), more than the assessed value of the real estate in all five boroughs of New York City. With a 6.0% interest however, the value of their investment today would have been €100 billion (7 times less!).”
Sources: Wikipedia
Three investing misconceptions that are not true
Stock investing is hard work and inexperienced and untrained beginners have a lot of difficulties when investing for the first time. For some it looks easy during bull markets and incredibly tough during bear markets. But the main target is to make money even if the market is in a bad condition.
Of course there are always people who give expensive but useless advice about investing. I am sure, you heard of “Buy low and sell high”, which is indeed quite useless, because how would one know what is the expected low and the expected high of a stock. Some people just give wrong advice and you can get into serious financial trouble following their ideas.
Here are three stock investing misconceptions that you should definitely avoid:
Wrong: Low price stocks are better than high price stocks
A widespread misconception is that a low price stock should be preferred to a high price stock, for example a $100 stock vs. a $10 stock. This is wrong. The value of a company is expressed by its market capitalisation (stock price * number of stocks), whereby the real value of a company differs from this value. It must be calculated by analyzing the company. So, the assumption that low price stocks are better is wrong because every company has a different number of stocks on the market. The price of the stock is the effect, not the cause.
Wrong: Stocks that have fallen will rise again
We see the traders attitude here, because when a stock falls e.g. 25% on a single day, some will speculate that there will be an up rise of e.g. 5% the next day. This effect has been observed many times, but we discuss long-term investing here, so it is clearly a misconception. Stocks usually fall for a reason, even if it is not clear for everyone. But fallen stocks will rise only when the factors which led to the fall are corrected. For example, if a stock fell, because the company announced that it will suffer from a recession for the next years and earnings are down, then it won’t rise before those factors change to normal again.
Wrong: The stock market is a place where you can get rich quickly
By investing intelligent you can for sure get rich on the stock market, but this is not supposed to happen quickly. Many people behave like gamblers on the market by making quick, impulsive and blindfold decisions. They lose money and again behave like being at the casino by increasing the amount of money in the game in the intention to wipe out their loses. Logic is dominated by emotion and the game is soon over.
However this misconception can be changed into a perfectly true advise: “The stock market is a place where you can get rich as quickly as possible”. This does not mean “Get rich slowly”, it means that you can get rich as quickly as possible. With the assumption of a historical return of 10% a year and a few years of your time, you get pretty good results. Never forget that the most important thing in investing is not to lose your money.
All in all, there are always intelligent people with experience, who know what they are talking about. Do not follow the loudest voice in the crowd, search for the smart ones.
But most of all, always check thoroughly every advice which is given to you, because in the end it is your hard-earned money which is at risk.
The secrets of Warren Buffett´s success
Warren Buffett the legend of the capital markets has some very intelligent investment principles. His principles aren´t very complex and you probably don´t have to be a mathematical or a social science genius to understand them. But in order to apply them you need a very conservative, clear and analytical character. Also you should read very much about value investing especially every opus Benjamin Graham and David Dodd ever wrote, so don´t think it´s a quick there´s quick way to become a superinvestor. However when you did that these 5 rules will put the final touch on your investment style.
1. Buy the boring not the pompous ones.
Invest your money in companies and business models you understand and which are needed by the world. Warren Buffett for example buys confectionery manufacturers, drink producers, producers of clay-bricks or if he really wants to have something exciting, assurances.
The Reason: Because these companies are always needed they will always grow just like the population of world does so actually you can´t do wrong really much.
2. Beware a cool head and have patience.
If you think Warren Buffett would sell one of his stocks just because it falls in price you are definitely wrong. Because actually he does exactly the opposite he buys new ones.
The Reason: Warren Buffett always buys his stocks to a very cheap price if you want to know how he does that read the chapter margin of safety. So when these cheap companies get even more cheap he is the happiest man in the world because he can buy more share of fools to an even better price.
Mr. Buffett says you should buy castles with a big castle moat. Translated that means Warren Buffett buys companies with a very good business model which can´t be copied so easily. His companies should be something like a monopole just like Coka Cola, Gilette or Microsoft.
The Reason: The main problem of the capitalism is the profit margin when the margin is too high it attracts others who also want to participate in it and the margin falls. In order to circumvent that Warren buys companies which can´t be copied so easily.
4. Concentration instead of diversification.
Many people say you should diversify and spread the risk on at least ten different stocks. Warren Buffett says diversification is something for people who don´t know what they do.
The Reason: If you know that a stock is really cheap and you make a snap why should you also buy other stocks?
Take your time by finding good stocks and wait until they get even more cheap. Sometimes Warren Buffett even waits 2 or 3 years before he buys a stock.
The Reason: Finding a good company isn´t that difficult much more difficult is to find a good company to a good price. So Warren Buffett looks for an interesting company and waits, waits and waits until he can buy the company for the price he want´s to pay.
It doesn’t mean you’re right, when your stocks go up
Today’s article is about the reason to invest in a particular stock and the important fact, that just because a stock went up, it doesn’t mean you are right. One could argue, that when something works, the reason is unimportant, but that’s just not true. For example, if you jump into a lake and don’t know how deep the water is, there are two options: you break your neck or you enjoy your bath. Got it?
There are a lot of bad reasons to buy a stock, almost to much to mention. Let’s discuss a few.
Buying/Selling a stock because it went up/down: This is a common mistake. As written in Do not listen to Mr. Market, the stock market suffers from huge fluctuations regularly. If you want to buy a stock, don’t buy it when it’s totally overpriced. Instead search for great companies with a low price and it will be a successful investment. Also don’t panic and sell because the stock went down. Instead check the fundamentals again and make sure you didn’t overlook something.
Buying/Selling for the wrong reason: Today everything is linked to everything, so we call it globalization.This fact often makes it difficult to understand certain developments. It’s not enough to check out the product of a company and know the local business circumstances any more. You have to know exactly what the company does, understand the business model and figure out which variables are critical for success. The lack of understanding world economics like, for example, the euro/dollar constellation, might bring you into serious trouble and may cause unexpected surprises. Read Investment Research: What does the company do? for more information.
Bad investment advise: Especially dangerous for inexperienced investors who keep asking “What’s your favorite stock at the moment? What should I buy?” Again, check out our article Do not trust analysts and fund managers, which tells you why you should make your own investment decisions. Even if you have a good friend who invests successfully, you should probably not invest in the same stocks, because he buys them for specific reasons, which he monitors regularly. You will probably misjudge the case and make mistakes, because you don’t understand the company like he does. You know probably more about other industries.
Remember, we do serious long-term investing here, so if you have a trader attitude, this conclusions may not apply for you.
On the other hand, you’re not necessarily wrong, when your stocks go down. If you invest reasonably, but the stock market is not ready yet, you can also suffer months/years of falling prices, but in the end the attitude of value investing will be superior.
The man who earned 3.7 billion Dollar with the subprime crisis
Just like the Chinese philosophy jing jang tells us that every medal has two sides also the subprime crisis didn´t just produce losers. But as you can imagine when so many people nearly loose 1 Trillion USD the winner on the other side must make a real big fortune and that´s exactly what John Paulson a 52 year old hedge fond manager from Manhattan did. He earned 3,7 Billion USD which could be the highest annual profit of the history of mankind.
But who is John Paulson and how could he earn such a big amount of money in such a short period of time?
John Paulson´s story began in New New York where he was born and studied later he even went to Harvard. How to deal with money he propably learned when he worked for the fabulous financial genius Leon Levy, he also worked for Bear Stearns and the financial investor Gruss Partners. Then in 1994 John Paulson founded his own company and issued some Hedge funds. After loosing very much money by betting that the corporate bonds would fall in 2005 he started to search for new financial bubbles and finally discovered the beautiful world of the “Subprime Mortgages”. But the question was how to make money with this bubble? So John Paulson developed a complex but in the root idea still very easy speculation strategy. His plan was to collect as many “Credit default swaps” as he could get, “credit default swaps” are something like issues which hedge you of financial losses of credits. So in good times this “Swaps” cost less but in bad times when the credit risk soars there “swaps” rise in value enormously. Well since 2005 John Paulson didn´t do something else than collecting “Credit default swaps” and in the beginning he even made red ink with that strategy. But when Amriquest one of the biggest providers of suprime-credits a fine of 325 Million USD in order to avoid a process for deceptive practices John recognised how phony the market was and issued a fund just to bet against the housing market. It was 2006 and his fund against the housing market didn´t worked well not before the and of 2006 when more and more people got nervous hsi fund closed with a plus of 20 %. Now John Paulson got really amped up about profiting from this bubble and issued a second fund witch also bet against the housing market. And the rest is history the housing bubble burst and John´s on December 31th 2007 John´s first fund closed with 590 % and his second one with 350 %.
However the question how much money he really made can be answered exactly cause Mr. Paulson is very discrete.There are no official affirmations for the definitive altitude but experts assume that the earnings amounts to 3,7 Billion USD. The Magazine Monthly Trader even wrote that this could be the highest annual profit of the history of mankind and placed him on the first place of a list of the TOP 100 fund managers.
John Paulson now lives with his wife and his two daughters in a 2600 aces big city house on the Upper-East-Side, New York. Apropos he bought this house in a forced sale…
Invest money you don’t need
Investing in the stock market is a long-term thing, so you shouldn’t put money in, which you will need in the next 2-3 years.
This is a very basic investing rule, you always have to remember: Only invest money you don’t need. Before investing you have to check out your financial situation first to know how much you can afford to lose. Yes, I said lose, because that’s the point. To keep it simple, only invest what you could afford to lose without that loss having any effect on your daily life in the foreseeable future.
Short-term investing is risky
So how much would that be? It depends of course on your personal situation, but I will give you an examples. For instance, your child will go to college in 2 years, so it’s obvious that you have to save money. Don’t put it in stocks, not even in blue chips. Even blue chips can and some will almost for sure suffer periods of bad performance on the stock market. It’s to risky. You can’t afford to lose this money, because you will need it. Additionally, you can’t predict the stock market as a whole, so you will not be save from the next crash. That’s why you shouldn’t trade, for example, with the money you need for the rent. When you lose, you’ll have to sell at the end of the month again, because without the money you can’t pay your obligations. So, don’t be so foolish.
You should always be invested
To invest money you don’t need, doesn’t mean you should stay out of stocks at all. You can and should invest at any time, unless you are under heavy debt or suffer total misfortune. There are all kinds of complicated formulas for figuring out how much you should put in stocks, but keep it simple and invest what you don’t need. The question always is how much you can afford. First save money, then invest in the stock market. You can start with $100 a month. For example, save one tenth of your income no matter what happens and invest it wisely. When you have not much money, start small and grow big. Keep in mind, that your money will compound and the sooner you start to build a fortune, the sooner you will have what you desire.
Recommended:
Nearly everyone has had a financial emergency at some point in their life. Unfortunately some people have no family near to turn to. Payday loans can help you get back on your feet by giving you a small loan.
Discover the Behavioural Economics
The stock market expert and speculator André Kostolany once said that it´s better to study psychology than economics if you want to make money on the wall street. To explain what Mr. Kosolany meant with this assertion I want to show you a little example.
Imagine we trow a coin nine times, the first time we do that we receive the array of numbers (N) and heads (H) of N-N-H-N-H-H-N-H-N . The second try returns the sequence N-N-N-N-N-N-N-N-N.
So the question is which array is more probable? And if we look at the sequences most people would say that the first one is more plausible, the answer however is that they are stochastic equal. But what has this to do with investing? Well this little example tells us much about how people think. We are trying to see pattern where no patterns are, there are many people who have the same way of thinking by picking their stocks they try to see patterns. This is called representativeness heuristic and is one of the basics of behavioral finance.
The psychologist Daniel Kahneman got the Nobel price in 2002 for proving that irrational 
behavior in investment decisions can be attributed to special parts of our brain. In his experiments he lay probates in a MRI and asked them different questions about money. For example he asked if you would prefer to have 100 Dollar now or 110 in 4 month? The results of the tests were impressing, always the probands decided for getting the money immediately especially the hind brain was activated. When the probands decided for getting more money later the cerebrum made this decision. In the end Mr. Kahneman could prove that a large part of of investment decisions was controlled by mechanisms which originate from a time of eating and being eaten. Fight, attack and escaping are behavioral patterns which influence us till today. So our brain is thinkable improper for investment decisions, we build on the same mechanisms which also reptiles use for their daily life. But if you realize that you can really benefit from the manners of the others.
Search for opportunities in crises
This article is definitively not about trading or here to animate you to buy risky stocks. But I want you to become aware of the great opportunities you can come across in the actual crisis. Just take a look at Bear Stearns. After it dropped to $5 something, it recovered in a few days to $10 something. That’s 100% in 5 days for buying the stock, not considered buying options or something. I admit, that’s a very risky example, but I wanted to show how fast it can go. Usually it takes some time for a turnaround. Additionally, I think you have to be a trader to recognize such a chance like Bear Stearns and actually buy in. But we are real long-term investors here and do only buy if the story, earnings etc. are going to change in the next years.
It’s a crash! Hurray!
Stocks just got cheaper on one single day, let’s celebrate! No seriously, OK, you lost some money, and I am sure you lost some because I assume that you are fully or partly invested, but that’s not the end of the world. We are long term investors and sell when the market is hot and buy when everybody sees apocalyptica coming. Over a long-term period of 10 years you surely will see market declines a few times, so do not be shocked. Crises and recessions also kill weak companies which cleans up the market and could be considered as good for investors. However, do also never ever try to predict crashes, that’s just not possible, nobody can predict the market. But you have to be prepared.
Good companies at a cheap price
Good companies at a cheap price, that’s what we are looking for. But when it’s the best time to buy such companies? Surely not when the stock market is totally hot and the p/e ratio is 30 or more. In this case you have to wait for a market decline, so you can get a good price. Super-investors like Warren Buffet just wait for such opportunities to come (there is a reason why he had this billions in cash). Also, investors from the Middle-east and Asia bought shares of big companies in the US and Europe. The pros do it and so can you.
You should always have excellent companies on your watch-list that you want to buy, but the price is to high. If the story didn’t change, crises can make this stocks cheap because of panic on the stock markets and you can profit from it. You buy cheap and sell high in a few years after the market recovers and the stock price is again much higher than the real value of the company.
But remember: Always be careful and do not try to catch a falling knife! You have to know what you do, so do proper research first.
Recommended:
If you’re trying to find more information about people search and unclaimed money, then check out USA-People-Search.com. They will help you perform public records search on potential employees to ensure you are employing good people.
Invest in a house before you invest in a stock
Before buying stocks, you should ask yourself a very important question first: Do I own a house or apartment?
Investing in an own house is never a bad idea and you do not have to be a pro to buy a good one. It is the one good investment that almost everybody manages to make and should make. Millions of real estate amateurs have invested brilliantly in their houses and so can you.
A house is an investment just like a stock, but there are some heavy differences. An obvious one is, that a house usually does not go bankrupt or brings you big loses like stocks. OK, a house can burn down, but what are insurances for? In real estate there are no daily fluctuations like in the stock market, so you will usually not wake up one day and face a decline of 20%. And even if it happens, you still have that nice roof over your head, right?
Another advantage (I assume) is that you always lived in a house or apartment, so you know what you want, what it should be like and certainly know when something is wrong. But most of all, it is a big decision and you have to plan the investment first. Amateur investors tend to buy a stock after considering it just for a few minutes. Big mistake. You surely will not buy a house unless you know everything about it, especially if your money is limited. You also can not sell your house as fast as you can sell stocks.
Of course, you need money first to buy a house. Again, buy a house first, after that buy stocks. Do not live on rent. After 10 years living on rent you have nothing. Nada. Instead save your money, move to a cheap apartment and try to buy a house as soon as you can. The banks let you acquire it for 20% and give you the wonderful power of leverage. Just assume the value of your house increases by 5% a year. This means, you are making a 25% return on your down payment, just think about it for a while. And do also not forget the taxes, I am not an expert, but you can surely save taxes too.
Finally, you can make a nice profit by buying and selling houses over your life. You usually start with a small house or apartment and pay it off. This will take some time and when it is payed off, you sell it and by the profit you can afford a new, bigger house. If you have the money, you do not sell the first house and make profit by renting it. This generates passive income to pay of your second real estate. Than eventually you buy your third real estate, a big house for your family and the children, for example. After 20 years, the children move out and the house is to big for you, so you sell it once again and buy yourself a house on the beach and enjoy your retirement. Isn’t that a wonderful scenario? It is!
Buy the boring not the pompous ones
Bricks, drinks and razor blades are things people often don´t associate to big business, because these things sound so boring. Isn´t it much more intelligent to invest in things like microchips, fiberglass cables or super innovative mobile companies? This sounds plausible for most people because they connect big business with people in suits, complex activities and big companies with pompous images. When they hear more simple things they connect losers, insolvencies and empty cash tills with it.
But what would you say when I tell you that the most successful investors always prefer simple things. For example, Warren Buffett, he holds shares of Coca Cola, American Express or Wall Mart. Another example is Carlos Slim Helu, the second richest man of the world, has a bit more complex portfolio but still easy to understand, like Telmex a telecommunication provider or Philip Morris today Altria Group. So let´s reckon that it´s more effective to buy companies with simple activities, but how can this be explained? Here are a few reasons why the boring ones beat the exciting.
First of all very complex high tech companies just eat your money. Just imagine how much money you need to build up a company with laboratories, infrastructure and how much more millions you need for the costs of the research and progress department this companies usually have. So you have to put in a huge amount of money before you´ll ever earn one cent.
The second thing is that you even don´t exactly know if your investment will pay out one day. How can you know that you bought the second Microsoft or just a random Dot-com Bubble company?
The last thing is rather it´s more a personal opinion. Who do you trust more, the solid, money-saving, hard working little man, or the guy in the suit who comes in his new Ferrari? If you drift to the first one, you should really think about the management and the image of the companies you prefer.
However boring companies are understandable you can comprehend what there are doing, I think this is the most attractive reason to buy a company. Another reason which speaks for simple companies is that the people always need their products, so these companies may exist over 100 years. Image a company which grows over a period of 100 years, imagine the annually dividends or the market capitalisation after 100 year and you know why the best investors always buy the boring.