In 1949, a guy called Ben Graham wrote one of the greatest books on investing titled “The Intelligent Investor.” The book was written following the American depression when millions of people lost their livelihoods following the stock market crash of 1929. Prior to this great crash, there was a lot of exuberance and speculation in the markets. Ben Graham was perhaps the first person to bring a disciplined analytical approach to investing.
Ben Graham defined an investment operation as one which, on thorough analysis, promises safety of principal and a satisfactory return. Operations not meeting these requirements are speculative. Based on this definition we can delve a bit more into what constitutes an investment.
First; investing should be preceded by thorough analysis. You should develop a deep understanding of any investment venture before you risk your hard-earned money. A good investment is easy to understand. If someone is talking a lot of gibberish run for dear life. The business should be clear for anyone to understand. If the person can’t clearly explain the underlying economics; then you might be the product. The venture should have a clear track record of making money and a foreseeable future. So be very wary of startups and if possible avoid them as an investor! Startups are good agents of change and help to spur innovation and creativity within society. However, they don’t generally make very good investments. The management of the business or investment vehicle should be people of integrity who know what they are doing. Don’t do business with people you don’t trust. A good investment is also one which matches your level of knowledge, skills, experience, and interests. Avoid doing things that you are not good at, and dislike. Avoid going with the bandwagon. Stay within your circle of competence. If you do decide to stray outside your comfort zone make sure you acquire the necessary specific knowledge and experience. Do your own research and don’t rely on family and friends for investment advice. Seek out an accredited financial advisor for guidance.
Second; your principal should be safe. At the bare minimum, an investment should return the principal. So be careful with any venture where there is a high risk of losing your capital. Avoid investments that require huge capital and have high operating costs. Try and find investments with high profit margins which don’t require too much ongoing capital investment to generate more revenue. Stick to regulated investments. If a scheme is not regulated, then you invest at your own risk. Also try not to pay too much to acquire a certain asset. For example, if the value of a piece of land is ugx 10m; try and acquire it at a price of ugx 8m. This difference between the price of something and its intrinsic value is what Ben Graham referred to as a margin of safety. The higher the margin of safety the lower your risk of permanently losing your capital.
Third; the investment should provide a satisfactory return for the level of risk. A simple treasury bond is earning 18.5% per year. So you really need to give me a good reason to invest my hard-earned cash in other risky ventures without any track record. A simple unit trust pays me 12% per year. These returns are what you would call benchmark returns moreover with safety of principal. So if anyone is trying to convince you to invest in some scheme then the reward should be better and safer than what you would earn in a simple unit trust or treasury bill/bond. There are many business ideas that sound good on paper but cannot even come close to earning good returns. The challenge is most of our businesses are informal and not documented. So it is difficult to independently determine if a certain business venture is good or not. We are forced to rely on the business owner’s testimony. Such testimonies are often heavily edited to paint a rosy picture and neglect all the troubles of running such a business.
Lastly, any scheme which doesn’t meet these criteria is pure speculation. Speculation carries the risk of permanent loss of capital. Speculation works for some people but the majority lose money doing it. So it is not a very good strategy for wealth building. The slow steady path of consistent investing in simple things is much better and safer!