When we know for certain that two activities are crucial for lifelong success, how do we prioritise them by urgency and importance? Six days before GE 14, I was invited back onto the Ringgit and Sense show on BFM Radio 89.9 to answer this foundational financial planning question: Should we save first or invest first?
The ultimate goal of investing is to grow our money faster than inflation and taxes can chisel away our precious buying power. Therefore, investing intelligently in the present is vital for our future, specifically, for our economic well-being in that future.
Having said all that, in general we shouldn’t invest what we don’t have; neither should we spend what we don’t have. (Please understand that my deep conviction in these matters is founded upon a personal treasure trove of monumentally stupid mistakes. I hope you, at least, can benefit from my numerous financial missteps.)
There is immense personal risk associated with borrowing money without restraint for investing in volatile assets and for personal consumption. The better way to raise money in the first place is to spend less than we earn, and to save the difference. Doing so builds up cash surpluses.
Therefore, I recommend you nurture the habit and discipline of saving BEFORE you dip your toes into the volatile waters of investing. I said precisely that on the radio. (You may listen to the interview at: www.bfm.my/rns-rajen-devadason-rd-wealthcreation-investment-vs-savings-w...)
In due course, a portion or slice of your savings stockpile should form your investment seed capital. One of my most painful, hard-won, valuable personal lessons is that we should always retain lots of (safe) savings. If you heed this principle, you will do better than most people around you because the more volatile investment markets grow, the more important the tranquil safe haven of liquid savings becomes. A key lesson from decades ago underscores this truth. To get my facts straight, I dug up an old book from a dusty corner of my personal finance library.
American investment legend Peter Lynch wrote his 1989 bestseller One Up on Wall Street in the aftermath of the catastrophic stock market losses of October 1987. Even though Lynch’s book is now almost 30 years old, you would do well to buy it for your own library and to read and re-read it. (It’s still available on Amazon.)
Lynch was away from his Fidelity Investments office in Boston, Massachusetts, during the worst ever market meltdown, which occurred almost 31 years ago. The Dow Jones Industrial Average experienced its steepest one-day percentage nosedive on Oct 19, 1987: a jaw-dropping 22.61 per cent plunge.
At the time, Lynch was taking — but not enjoying — a rare holiday with his (now deceased) wife Carolyn in Ireland. Lynch cut short their vacation because of the cataclysmic market declines.
The stock market recovered, as it always does. Two years later Lynch, in his book, was able to calmly iterate the best educational points he extracted from that dark time: “To all the dozens of lessons we’re supposed to have learnt from October, I can add three: (1) don’t let nuisances ruin a good portfolio; (2) don’t let nuisances ruin a good vacation; and (3) never travel abroad when you’re light on cash.”
IMPORTANCE OF SAVING
Lynch wasn’t writing about the holiday money in his wallet or Carolyn’s purse. His Fidelity Magellan Fund was at the time the largest equity fund in the world! Lynch was referring to having extra unutilised cash left un-invested within his fund for two reasons:
1. To meet the redemption requirements of panicking investors; and
2. To buy more great stocks as the collapsing market created tremendous buying opportunities.
Understand this: saving and investing are equally important economic activities. But we should save first to build up an emotionally calming liquid reserve and also to accumulate seed capital for eventual investing.
We should utilise the time it takes to build up our liquid savings nest egg by reading about and studying investment basics so we’re ready when the time comes for us to invest gradually, wisely and profitably.
Bottomline: Start by saving first. Later, as you also invest, your savings-investment balance should match your personal circumstances and your internal capacity for handling both commonplace investment volatility and perhaps once-a-decade steep market dislocations.
HAVE SOME RESERVES
Maintaining enough, but not excessive, solvency can reduce your financial stresses. Here’s a common sense way to arrange your affairs:
Peter Lynch knew and respected another investment legend, the late Sir John Templeton, who passed away in 2008. Templeton once gave this advice on when to allocate some excess liquidity into investments and when to sell some of those investments to raise liquidity levels:
“To buy when others are despondently selling and to sell when others are avidly buying requires the greatest fortitude and pays the greatest ultimate rewards.” It would benefit your mind and your wallet to study the investment principles of both Peter Lynch and Sir John Templeton; books are a great place to start. In the meantime, if you retain one lesson from today’s column, I hope it’s this:
Focus on generating consistent cash flow surpluses each month and thus save some money. Later, when you’re ready to begin investing, don’t blow your whole wad at once. Always, always, always keep some cash in reserve. Always!
© 2018 Rajen Devadason
Rajen Devadason, CFP, is a licensed financial planner, professional speaker and author. Read his free articles at www.FreeCoolArticles.com; he may be connected with on LinkedIn at https://www.linkedin.com/in/rajendevadason, rajen@RajenDevadason.com and Twitter@RajenDevadason