“ A fool and his money are soon parted. -Thomas Tusser“
Imagine this situation: You invest a sum of ₦500,000 in the stock market. One month passes by, and the value of the investment declines to ₦480,000. Do you pull the rest of of your money out? Okay you choose not to. The next month it falls to ₦450,000. What about now? Is it time to pull the plug? No. Again the value of your investment shrinks to ₦400,000! Decisions, decisions! The week after its at ₦350,000……you get the drift. The sole question remains, at what point do you decide you can’t take the pain anymore and cut your losses? How much could you bear to lose knowing there’s a chance to make more than the ₦500,000 you invested?
Savvy investors seek an average growth rate of return on their principal investment over a long period of time. Inexperienced investors, on the other hand, are quick to rush into an investment opportunity, in anticipation of making a ‘killing in the market.’ A lack of experience leads investors into believing they can make crazy returns on their investment in a short amounts of time. This post offers newbie investors a better way to think about investing; all that needed is a little calculation and an understanding of the asset class one wishes to invest in. This calculation can help identify a reasonable rate of growth for investing money. Here’s how it works:
Step 1: The first thing the investor does is to ask, “If I invest my money, how much of it could I stand to lose? . This is done to estimate how much of the principal investment the investor can bear to lose.
Step 2: Once step 1 has identified the percentage the investor can stand to lose, divide the percentage by 50%, (50% is half), then add the annual average money market return (9%-10%) The outcome of the calculation is your reasonable rate of growth.
Example: A blog reader gifts blogger ₦500,000
Let’s say, just because you like my blog, you decide to give me ₦500,000. I decide to invest the gift in the stock market going into the fourth quarter of 2018, instead of buying the Samsung note 9. Step 1: I’m clear in my mind that I cannot stand to lose more than 10% of this gift in search of higher returns. Step 2: I divide my expected return by half and that gives me 5%, before adding the money market rate of 9% which is the annual average return of the Nigerian Money market). This brings my expected rate of return on my investment to 14% (5% + 9%). This means I can bear to lose ₦70,000 (14% of ₦500,0000 is ₦70,000) from the principal investment in search of better returns in the future. My reasonable rate of growth I can expect to capture is 14% over a 3 to 5 year period (medium- to-long term view). I may experience declines in excess of this amount or I may have superior returns within the period.
This way of thinking is useful for setting realistic financial goals on a quarterly basis. In addition to this, it is of the uttermost importance to have thorough understanding of the asset class (stocks, bonds, money market instruments etc) one decides to invest in. A good rule of thumb to practice before investing in an asset class is to make sure you can explain how the asset class works, how this asset class supports your risk appetite as well as your time horizon before deciding to invest in an asset class.
Many experienced investors say that the one rule to live by is never lose your principal – that is the initial sum for investment. Now we have established above what you can bear to lose, but this is to help you manage your expectations and understand that it is a real possibility. As you gain experience as an investor, your strategies or moves should be guided by the fundamental principle that – whatever happens your principal should be protected and even an average increase in the month for your principal is successful, why – because you’re not investing to lose money. There are many more strategies out there, and I encourage you to learn as many as possible to develop an investing mindset. More importantly is to understand the thinking behind the strategy and how it serves you with better returns in the future. So what’s next?
As at the close of today’s market (12th September 2018) the Nigerian Stock Exchange (NSE) (NGSEINDX: IND) is down -15.56% year to date. (down -3.46% from the previous day’s close). The Market was dragged lower due to massive sell-offs in the banking stocks. From all indications, the market should continue to go down. This presents opportunities for investors to take positions in fundamentally sound stocks that are sure to return to strong positions come 2019. Kindly note that using the calculation discussed earlier, one may experience declines in excess of this amount or may have superior returns within the period.
It is a good time to consider the available stock market opportunities within with a medium to long term view of how things are going to play out. Pull out your calculators, open up your excel work books. Talk to financially savvy people. Take action. What do you really stand to lose?
Digging deeper
The expected rate of growth calculation is from the book “The first-time investor : How to Start Safe, Invest Smart, and Sleep Well “by Larry Chambers and Dale Rogers. I recommend it as a lovely primer for beginner investors. The authors did a wonderful job in explaining asset classes and the fundamentals of investing in a relatable manner for newbies.
Also check out these explainer videos (split into 4 short clips) on asset classes courtesy, Prudential South Africa, here, here, here, and here. (This is not a paid advert). I made my recommendation based on how easy the material is to understand.
A special shout out to African Entrepreneur’s Feyi Olunuga for helping out with this post. I would like to thank for her insightful questions and contributions concerning the challenges new investors face on the African continent. Check out the African Entrepreneur blog here
Key takeaways:
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- The one rule is never lose the principal
- Think how much you can stand to lose from this investment (no pain , no gain)
- Understand the asset class: Always consider the history (the historical average returns of the asset) you are trying to invest in. Make sure you can explain how the asset class works, how this asset class supports your risk appetite and your time horizon before deciding to invest in an asset class
- Be clear about your goals. All successful investors have goals
- Using the expected rate of growth calculation, one may experience declines in excess of his or her expected rate of return amount or may have superior returns within the period. Have a medium to long term perspective to reap its benefits
- The bearish stock market presents investing opportunities. It is wise to take a medium-to-long term perspective, so as to take advantage of cheaper and fundamentally sound stocks.