Investing vs Trading vs Speculation

Hi there,

In this article, i would like to talk about the difference between three terms – investing, Trading and Speculation.

INVESTING

Investing is the proactive use of money to make more money or, to say it another way, you make your money work for you.

When you invest, you are buying an asset like shares, real estate or gold. The basic idea is to sell it at a future date when the value of these assets appreciates.

An asset can include anything from a small business to fine art, rare wines to gold coins, stocks, mutual funds, bonds, real estate, antiques, song rights, patents, trademarks, or other intellectual property.

Good investments are the soundest way of growing wealthy but can take time, perhaps even years, to work out because we live in an uncertain world.

Depending on the asset class in which you invest, the potential for profits and risk will also differ.

Investors adopt a “Buy and Hold” approach.

TRADING

Trading is a more short term activity than investing. It’s buying something at low prices and selling it for a gain. Trading can be done in many fields. So the crucial factor that distinguishes a trade from an investment is the length of time you hold on to the assets.

A trader is always concerned about short-term fluctuations in prices, because he’ll even out them in the long run. Traders adopt a “Buy & sell” approach.

Short term price fluctuations are caused by the variations in the demand and supply of a particular asset. So, traders generally rely on Technical Analysis, a form of marketing analysis that attempts to predict short-term price fluctuations using graphs, charts and oscillators.

SPECULATION

A speculator is nothing but a man who makes his living out of hope.

I don’t think I should explain it in more detail.

Benjamin Graham the author of classic books Security Analysis and The Intelligent Investor is regarded as the father of financial analysis. Graham’s key insight is the premise that “investment is most successful when it is most businesslike. An investment operation is one which, upon thorough analysis, promises safety of principal and a satisfactory return. Operations not meeting these requirements are speculative”-(Benjamin Graham, security analysis,1951)

Now, at this point of time, It is unnecessary to start a complex discussion about investing, trading and saving.  What is important is to understand that investing; trading and speculation are three different things. Since we are discussing about shares and stocks for trading or investment, our next chapter discusses about shares and stock markets in detail..

Till my next article …….

………..have a nice day !!

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Lessons in computing returns – VII Break even return

Hi there,

In economics and finance, there’s a concept called break even point. Break even point is that point at which you make no profit or no loss. This concept is also applicable while targeting returns on investments. We will call it the ‘break even rate of return’. That is, the minimum rate of return that your investment should generate in order to maintain a no profit-no loss situation.

How to find out the break even target?

The only two factors that eats into your returns are –

  • Inflation  and
  • Taxes.

Inflation, as explained in previous articles, reduces your purchasing power and taxes reduce your disposable income. In other words, your investment should generate a minimum return that will cover the inflation and income tax. So, the key is in finding out the rate of both these factors and generating a return that’s equal to it so that you are position is safe – No profit – No loss.

To do this –

The first step is to find the inflation rate in your country. Inflation rates are published in almost all financial newspapers and web sites.

The second step is to find the income tax rate of the particular investment. In India, only incomes like long term capital gains are taxed at special rates. The rest falls into the general slab system. So find out the slab rate or the special rate you’d be taxed.

Apply the following formula –

  • I / 100 – R

Where –

  • I = The rate of inflation ( you can also take the average rate of inflation)
  • R= the effective personal income tax rate on investments

For example – If the current rate of inflation is 7% per annum and your effective tax rate is 30% , your required return from investments to break even would be –

  • 7 / 100-30
  • = 7/70
  • = 0.10  0r 10%

This means that your investments should earn a minimum of 10% return just to break even and maintain the purchasing power of your money. If you earn less than 10% you are losing money.

That’s about break even point. See you soon.

bye for now !!

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Lessons in computing returns – VI Rule 114 and Rule 144

Rule 72 was amazing. Isn’t it? Just as I finished writing that article, my wife (Being a micro-biologist, she doesn’t have much questions to ask about finance but she reads through my articles before I publish) came up and asked a question. “You wrote about calculating the time it would take an investment to double. I would like to know how long it would take for my money to triple. Do you have an easy method for calculating that?”

Of course, yes. Not only that, you can also find out the time it would take to quadruple your investment – Enter rule 114 and Rule 144.

RULE 114-HOW LONG TO TRIPLE YOUR INVESTMENT

To find out how long it will take to triple your investment at x% interest rate, take 114/x.

So, it will take 114/12 (or 9.5 years) to triple your money at 12% interest rate.

Want to triple your money in 6 years? You will have to generate an annual return of 114/6 (or 19 %!)

RULE 144 – HOW LONG TO QUADRUPLE YOUR INVESTMENT

To find out how long it will take to quadruple your investment at x% interest rate, take 144/x.

So, it will take 144/12 (or 12 years) to quadruple your money at 12% interest rate.

Again, If you want your investment to quadruple in 6 years, you will have to generate an annual return of 144/6 (or 24 %!).

I would like to repeat what I said in my previous article. The above rules are not 100% accurate. However, it gives you a reasonable estimate of time required to triple or quadruple your investment at a particular rate of return.

I hope this article was interesting! It will greatly help you with your financial decisions.

For example, if calculations show that 20% is necessary to accomplish your goal and the risk-free interest rate is 8%, you have some choices to make. First, if you insist on the risk-free rate then you must extend the time period you are willing to wait for that money. On the other hand, if you cannot extend the time, you’ll have to accept a little more risk.

Till my next post ….

………..Have a nice day!

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Lessons in computing returns – V The Rule of 72

Hi ,

So we were playing some  games with percentages in the last few posts.

In this article, let me introduce a short cut – an approximately 500 year old formulae to help you in your calculations- Rule 72.

For those who love math and accountancy, the rule 72 may not be new. Luca Pacioli (1445–1514) , in his book ‘summa de arithematica’ discusses the rule when he talks about the estimation of the doubling time of an investment. However, it’s not Pacioli who invented this rule.

RULE 72

The rule is very simple – Divide 72 by the Interest Rate. What do you get?

You get the number of years it would take for your investment to Double. Practical, very simple. The Rule of 72 is not absolutely precise, but it gives you a practical estimate that you can work out in your head.

Example 1.

You go into a bank that offers 9.50% annual interest on your FD. How many years will it take for your capital to double?

It’s Simple- Divide 72 by 9.50. Roughly 7 and half years.

Example 2.

At what rate should you invest to double your money in 5 years?

Divide 72 / 5 . The answer is 14.40%. so if you can manage to get 14.40% return on your investment, your money doubles in 5 years.

Example 3.

The rate of interest you pay for your credit cards is 24%. Your credit card liability is Rs 25,000. What happens if you keep paying your minimum due for 3 years?

In 3 years (72/24), you end up paying Rs 25,000 as interest alone. You’ll still have the Rs 25,000 liability remaining.

Example 4

You read from papers that the country’s GDP grows at 7% a year. How long would it take the economy to double it’s growth?

The answer is (72/7) 10 and 3 months approximately.

Example 5.

The inflation rates are at 9%. What the effect of it on your money?

Your money will lose half its value in 8 years ( 72/9)

Example 6

At 8% interest your money would double in (72/8) 9 years. If you decide to remain invested for 27 years, a small deposit of Rs 50,000 would become Rs 400,000!

Not only in years, can you apply this rule in any time frame.

So that’s Rule 72. Nice little mathematical formula that helps you to take financial decisions. The rule is not perfect and it does not account for taxes.

Till my next post …..

……..Have a nice day!

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