Being able to identify winning stocks is a valuable skill in investing. There is no lack of investment newsletters out there purporting to share potentially profitable trade ideas, albeit on a paid subscription basis.
However, there is another factor in the investment equation that is seldom mentioned, or conveniently left out.
That is: a LARGE CAPITAL BASE is also required for creating meaningful cash impact in your portfolio, not just the rate of return.
In other words:
In fact, knowing how to amass capital should be the Number One lesson for every retail investor.
Let me explain why.
If you are a salaried worker like me, your investment capital will have to come from your savings, which is taking income minus expenses. (Lucky you if your capital is a lump sum from inheritance!)
Most jobs offer an annual increment, so your wage goes up every year. With a bigger paycheck, many people tend to upgrade their lifestyle, for example, from taking Grab to owning a car, from staying in a HDB flat to staying in a condominium, from short overseas trips to extended vacations.
This is known as lifestyle creep.
If you are disciplined enough to stick to a simple lifestyle, and use the excess money to invest, you can build up a sizeable portfolio over time and enjoy a comfortable retirement, even when you are just an average investor.
Let me illustrate this by introducing you to two fictitious characters: Steady Sam and Genius George. Steady Sam and Genius George are of the same age, and have just begun working in the same profession with the same starting salary. Both of them are inspired to achieve financial freedom, and have amassed $10,000 each to start off their investment journey.
After one year on the job, Steady Sam manages to save $5,000 through frugal habits. Genius George is less diligent with his money, but manages to save $4,000 nonetheless. Additionally, both of them are given a salary increment of $500. (They have an annual bonus too, but it is used to pay income tax, so the net amount is negligible.)
So far so good for both Steady Sam and Genius George. However, this is where their financial paths start to diverge.
Steady Sam is contented to stick to his current lifestyle, and invests the $5,500 ($5,000 savings plus $500 increment) into his portfolio. Steady Sam is only an average investor. His portfolio earns a return of 9.58% per annum, equivalent to the annualized gain of the S&P 500 Index over the past 30 years (from 1993 to 2022, source: Motley Fool [here]).
Genius George, on the other hand, invests his $4,000 savings, but spends his $500 increment on a new iPhone. (This model has periscope camera!) That said, Genius George is a brilliant investor with the Midas touch. He is the Asian version of Warren Buffett. His portfolio earns a superior return of 13.57% per annum, equivalent to the annualized gain of Berkshire Hathaway over the past 30 years (from 1993 to 2022, source: Berkshire Hathaway 2022 Shareholder Letter [here]).
The same situation repeats every year - Steady Sam saves $5,000 while Genius George saves $4,000. Both of them get a $500 salary increment. While Steady Sam invests his savings and increment, Genius George invests his savings but splurges his increment. Steady Sam's portfolio earns the standard market return of 9.58%, while Genius George's portfolio earns the superior return of 13.57%.
Where do they stand after 10 years? Here is a look.
After 10 years, Steady Sam has invested a total capital of $77,500. His portfolio is worth $130,205, representing an overall gain of 68 percent. Meanwhile, Genius George has invested a total capital of $46,000. His portfolio is worth $107,447, representing an overall gain of 134 percent.
Genius George is so proud of himself. He has grown his investment by more than two-fold! But notice at the end of 10 years, Steady Sam has a BIGGER portfolio value than Genius George. In terms of wealth, Steady Sam is ahead, though Genius George has probably led a more exhilarating life.
Let us extrapolate further. Assume the same situation recurs every year for 30 years till their early retirement. While Steady Sam and Genius George are capable employees, they remain unappreciated and do not get promoted or any significant pay bump. They only get the same increment year after year. The portfolio returns remain the same.
Will both of them be able to retire as millionaires? Let us find out.
At the end of 30 years, Genius George's portfolio has grown to $1,762,389 after investing a total capital of $126,000. Steady Sam's final portfolio value is slightly lower at $1,607,835 after investing a total capital of $372,500. Both Steady Sam and Genius George have comfortably reached millionaire status through the magic of compounding. However, Genius George has managed to overtake Steady Sam in wealth by the 27th year of their investment journey.
Now, I hear you ask, "Hold on a minute. At a mere 4% excess return and one-third of the capital, Genius George can enjoy an extravagant life and still end up richer? What is the catch?"
The catch becomes evident when you think in terms of PROBABILITIES.
Consider this: what is the likelihood that you can earn a superior return of 13.57% consistently every year like Warren Buffett for 30 consecutive years? On the flip side, what is the likelihood that you can save an extra $1,000 ($5,000 - $4,000) plus an incremental $500, and invest this amount consistently every year for 30 consecutive years?
It is hard to pin an exact number to the odds, but our gut instinct tells us that the second scenario is probably more achievable than the first. After all, saving money is within our control, investment return isn't.
Capital matters in investing. Keeping lifestyle creep in check and investing the excess cash can make a big impact to your portfolio, instead of striving for an elusive superior rate of return via brillant stock picking. In the game of life, emulating Steady Sam is a far easier feat than emulating Genius George.
No subscription required too.
PS: If you are keen to get behind the math, you can download the Excel file [here]. Notice I did not take inflation into account, but since it would impact both Steady Sam and Genius George to the same extent, it does not matter in the comparison.
However, there is another factor in the investment equation that is seldom mentioned, or conveniently left out.
That is: a LARGE CAPITAL BASE is also required for creating meaningful cash impact in your portfolio, not just the rate of return.
In other words:
Capital $$$ x Rate of return % = Portfolio cash impact $
In fact, knowing how to amass capital should be the Number One lesson for every retail investor.
Let me explain why.
If you are a salaried worker like me, your investment capital will have to come from your savings, which is taking income minus expenses. (Lucky you if your capital is a lump sum from inheritance!)
Most jobs offer an annual increment, so your wage goes up every year. With a bigger paycheck, many people tend to upgrade their lifestyle, for example, from taking Grab to owning a car, from staying in a HDB flat to staying in a condominium, from short overseas trips to extended vacations.
This is known as lifestyle creep.
If you are disciplined enough to stick to a simple lifestyle, and use the excess money to invest, you can build up a sizeable portfolio over time and enjoy a comfortable retirement, even when you are just an average investor.
Let me illustrate this by introducing you to two fictitious characters: Steady Sam and Genius George. Steady Sam and Genius George are of the same age, and have just begun working in the same profession with the same starting salary. Both of them are inspired to achieve financial freedom, and have amassed $10,000 each to start off their investment journey.
After one year on the job, Steady Sam manages to save $5,000 through frugal habits. Genius George is less diligent with his money, but manages to save $4,000 nonetheless. Additionally, both of them are given a salary increment of $500. (They have an annual bonus too, but it is used to pay income tax, so the net amount is negligible.)
So far so good for both Steady Sam and Genius George. However, this is where their financial paths start to diverge.
Steady Sam is contented to stick to his current lifestyle, and invests the $5,500 ($5,000 savings plus $500 increment) into his portfolio. Steady Sam is only an average investor. His portfolio earns a return of 9.58% per annum, equivalent to the annualized gain of the S&P 500 Index over the past 30 years (from 1993 to 2022, source: Motley Fool [here]).
Genius George, on the other hand, invests his $4,000 savings, but spends his $500 increment on a new iPhone. (This model has periscope camera!) That said, Genius George is a brilliant investor with the Midas touch. He is the Asian version of Warren Buffett. His portfolio earns a superior return of 13.57% per annum, equivalent to the annualized gain of Berkshire Hathaway over the past 30 years (from 1993 to 2022, source: Berkshire Hathaway 2022 Shareholder Letter [here]).
The same situation repeats every year - Steady Sam saves $5,000 while Genius George saves $4,000. Both of them get a $500 salary increment. While Steady Sam invests his savings and increment, Genius George invests his savings but splurges his increment. Steady Sam's portfolio earns the standard market return of 9.58%, while Genius George's portfolio earns the superior return of 13.57%.
Where do they stand after 10 years? Here is a look.
After 10 years, Steady Sam has invested a total capital of $77,500. His portfolio is worth $130,205, representing an overall gain of 68 percent. Meanwhile, Genius George has invested a total capital of $46,000. His portfolio is worth $107,447, representing an overall gain of 134 percent.
Genius George is so proud of himself. He has grown his investment by more than two-fold! But notice at the end of 10 years, Steady Sam has a BIGGER portfolio value than Genius George. In terms of wealth, Steady Sam is ahead, though Genius George has probably led a more exhilarating life.
Let us extrapolate further. Assume the same situation recurs every year for 30 years till their early retirement. While Steady Sam and Genius George are capable employees, they remain unappreciated and do not get promoted or any significant pay bump. They only get the same increment year after year. The portfolio returns remain the same.
Will both of them be able to retire as millionaires? Let us find out.
At the end of 30 years, Genius George's portfolio has grown to $1,762,389 after investing a total capital of $126,000. Steady Sam's final portfolio value is slightly lower at $1,607,835 after investing a total capital of $372,500. Both Steady Sam and Genius George have comfortably reached millionaire status through the magic of compounding. However, Genius George has managed to overtake Steady Sam in wealth by the 27th year of their investment journey.
Now, I hear you ask, "Hold on a minute. At a mere 4% excess return and one-third of the capital, Genius George can enjoy an extravagant life and still end up richer? What is the catch?"
The catch becomes evident when you think in terms of PROBABILITIES.
Consider this: what is the likelihood that you can earn a superior return of 13.57% consistently every year like Warren Buffett for 30 consecutive years? On the flip side, what is the likelihood that you can save an extra $1,000 ($5,000 - $4,000) plus an incremental $500, and invest this amount consistently every year for 30 consecutive years?
It is hard to pin an exact number to the odds, but our gut instinct tells us that the second scenario is probably more achievable than the first. After all, saving money is within our control, investment return isn't.
Capital matters in investing. Keeping lifestyle creep in check and investing the excess cash can make a big impact to your portfolio, instead of striving for an elusive superior rate of return via brillant stock picking. In the game of life, emulating Steady Sam is a far easier feat than emulating Genius George.
No subscription required too.
PS: If you are keen to get behind the math, you can download the Excel file [here]. Notice I did not take inflation into account, but since it would impact both Steady Sam and Genius George to the same extent, it does not matter in the comparison.
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