Every year during December, Indian’s start thinking about investment. Because they have to submit investment proofs at their company for income tax benefits.
Some will buy tax savings fixed deposits. Others will buy tax saving mutual funds. All in the name of investing. It is like a circus.
But most people some to miss one very important point. That they are not investing. Nobody seems to have a clue about what investment actually means.
In this post, I talk about 3 definitions of investment from some of the greatest investors of the world.
Definition of Investment as per Ben Graham
Ben Graham, the Father of Value Investing, defines an investment as follows.
“An investment operation is one which, upon thorough analysis promises safety of principal and an adequate return. Operations not meeting this requirement are speculative.”
He goes on to explain each component of the definition:
- Thorough Analysis means “the study of facts in the light of established standards of safety and value”
- Safety of Principal means “protection against loss under all normal or reasonably likely conditions or variations”
- Adequate returns refers to “any rate or amount of return, however low, which the investor is willing to accept, provided he acts with reasonable intelligence”
Definition of Investment as per Warren Buffett
“Investing is often described as the process of laying out money now in the expectation of receiving more money in the future.
At Berkshire we take a more demanding approach, defining investing as the transfer to others of purchasing power now with the reasoned expectation of receiving more purchasing power – after taxes have been paid on nominal gains – in the future.
More succinctly, investing is forgoing consumption now in order to have the ability to consume more at a later date.”
Definition of Investment as per Peter Lynch
Peter Lynch, another of the greatest all-time investors, defines investment as “simply a gamble in which you’ve managed to tilt the odds in your favor.”
Myths about Investment
Many people suffer from the misconception that that trying to make serious money requires that one take serious risks or that the rate of return which the investor should aim for is more or less proportionate to the degree of risk he is ready to run.
In fact, the converse is true.
Not making losses is a basic requirement for achieving high rate of returns.
Moreover the rate of return should depend on the effort expended by the investor in terms of analysis, due diligence
Warren Buffet has the following to say.
“To invest successfully over a lifetime does not require a stratospheric IQ, unusual business insights, or inside information. What’s needed is a sound intellectual framework for making decisions and the ability to keep emotions from corroding that framework.”
As per Peter Lynch,“In terms of IQ, probably the best investors fall somewhere above the bottom ten percent but also below the top three percent.”
As per Peter Lynch , “Investing is an art, not a science, and people who have been trained to rigidly quantify everything have a big disadvantage”.
To summarize, an investment should involve:
- adequate homework and research.
- capital protection, that is at a very minimum we should get back what we put in.
- inflation protection, that is we should get back not only the investment but also returns that take into account yearly price rise (in real terms, our wealth has not actually increased).
- real returns, that is returns in excess of inflation.
- minimal or reasonably quantifiable risk, and no unnecessary risks.
For example, given that inflation in India has been around 8% for many decades now.
- getting back Rs 100 on an investment on Rs 100 after 1 year means that we have become poorer in terms of purchasing power
- getting back Rs 108, means that while nominally we make an 8% return, we have not become any richer
- getting back Rs 112, means that while nominally we make a 12% return, we have made 4% real returns and become slightly richer