Investing is much like growing a fruit tree. All the principles needed for successful investing are also present when growing a fruit tree. Starting with a sapling fruit tree is very similar to investing a small amount of money and energy initially into an endeavor that will deliver returns that grow every year for many years into the future.
Delayed gratification
Delaying gratification means forgoing all or some of the instant reward redeemable right now so that an even greater reward at a future time. When planting a fruit tree sapling, we must wait a few years for it to mature and bear fruit. However, when it does mature and starts bearing fruit, it will do so at a slow rate initially, and increase exponentially for many years until it fully matures.
This can be compared to investing a small sum of money right now which won’t be redeemed for many years. In the early years of our investment, the principal won’t have generated very much interest. However, as the years pass, the magic of compound interest delivers exponentially larger amounts of money as the years pass. At this stage, some of the interest being generated can then be withdrawn without disrupting the revenue being generated unduly.
Risk
Doing some research into the selection of our fruit tree is very important. While the monetary amount we are investing is not too important, the time we are investing and our result at the end of that investment in time is very important. Imagine for example we invest six years growing a cherry sapling to fruit bearing maturity. We taste the fruit in the sixth year expecting to have some deliciously sweet cherries to enjoy but are shocked to taste a tart and almost inedible cherry instead. We didn’t conduct adequate research into the cheery variety. Now we are twelve years behind our goal of having an annual cherry harvest; the six years already invested and another six needed to grow the correct cherry type. Even more, if we are sure we select the correct variety, some varieties will deliver a better yield that others.
This is the same in our investment selection process. Protecting against the risk of permanent loss of our principal is of utmost importance. There are many factors to consider at this stage, and countless investment vehicles to chose from; for example government issued bonds, money market ETFs, to investing in individual company stocks. The option chosen will depend much on our timeline for redeeming the investment and our risk appetite.
Nurturing
When we are confident that we have the correct cherry variety, we must now plant and maintain it so that it to position us for the best probability of success. This mean putting it into the correct soil, providing nutrients, protecting it from pests, and making sure it has adequate water.
Like our cherry sapling, once we’re as certain as we can be that we’re not going to suffer permanent loss of capital with our investment, our next job is to position ourselves for the highest possible rate of return. Factors such as tax and commissions and fees paid to brokerages and intermediaries can make a huge difference in the mature years of an investment to the return. Therefore, selecting tax efficient investments that have a low commission and transaction cost are highly desirable. We also need to pay attention to the likely returns that the investment will provide. This is balancing our need for the safety of the principal with our certainty over the rate of return the investment will provide. Is it worth risking the safety of the principal for another half percentage point? Certainly not! But there are common sense measures we can take to make sure that we’re beating inflation, legally maximizing our tax burden, commission expenses, and fees while invested in an instrument that will confidently deliver over the long term, even if volatile in the short term (think the S&P 500).
I look forward to diving deeper into all of the aspects written in this article in greater detail, but for now, start planning how you’re going to grow that fruit tree!