Why small investors should make long-term investments

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TStory Highlights:

  • Only invest what you can lose: Most fresh investors always think of the upside. What would I gain? Seasoned investors on the other hand consider the downside and typically invest what they can lose. CNBC Experts recommend between 15-30% of net income be set aside for investing.
  • Focus on quality over quantity: There would always be that colleague or family member coming up with a new investment opportunity. You want to focus on high-quality investment opportunities over advice from every Tom, Dick and Harry.
  • Do your due diligence, always: Investing is a risky game and you are solely responsible for your decisions. Because of this, you must make sure you do your homework properly. If you are investing in a stock, you must thoroughly understand the company and what they do. Beyond that, you must access revenue, profits, and growth potentials objectively before putting your buck behind it.

Albert Einstein is often credited as the one who declared compounding interest the eighth wonder of the world. Furthermore, he claimed that whoever understands compound interest earns it, while those who don’t, pay it. But what is compounding interest? Why do I even need to properly understand it as an investor?

Compound interest is the interest calculated on the principal and the interest accumulated over the previous period. It is different from simple interest, where interest is not added to the principal while calculating the interest during the next period.

Compounding interest rates for several time periods

You may be puzzled as to why you are being greeted with an impromptu compounding interest lecture when all you want to know is if your investments as a typical Nigerian employee would be actually worth it. Well, to understand how well your investments would perform especially for a small-scale investor, you must have a firm grasp of compounding interest and make it work for you.

Using compounding interest to project returns

Tayo is a Physics Education Lecturer at the University of Ibadan and every year, he has N100,000 in disposable income set aside for investing. He decides to invest a year’s quota in the Stanbic Dollar fund with a typical annual yield of around 5%. If we look at the table above, in ten years, his investment would multiplied by 1.63. That means he would have made returns of N63,000 in ten years.  Let’s assume Tayo chooses to invest in an ETF instead with returns in the neighborhood of 10-14%, he should expect returns between N139,000 to N271,000 in the same time horizon.

Clearly, investments with higher annual returns provide more reward for the time and money invested. However, the moment returns begin to seem too good to be true, then they probably are.

How small investments can grow with compounding interest

One of the biggest worries small-scale investors always have is if their investment is really worth the time and effort. I mean what’s the point of a 100% return if my initial principal is just N1000? If Tayo had invested N1000 and earned 5% every year, in ten years, he would have made a “whooping” N630. How many years will it take me to make something substantial off my small investments? Is this how wealth is truly built?

Unfortunately, the small-scale investor lacks both capital and information. While large investors can throw in a couple of million dollars and hire the best market analyst, the small investor must safeguard their penny and mostly rely on their wit.

According to a University of California Research, 90% of individual investors lose money. While this does not sound like the sales pitch you get from your broker selling you the new investment brochure that would guarantee you return trading NGX listed stocks; this is the sad reality.

To make matters more grim, there are even statistics to show that several investment firms with all of the modern quants and wide-eyed talking heads fail to beat benchmark indices like the NASDAQ.

That being said, with small investments, you basically have two methods of growing your portfolio.

  • Investing in high-risk high return assets: In 2021, a short squeeze on meme stock Gamestop led to a 1000% pump in share prices. This is an example of a high-risk, high-return investment. Say you have N100,000 to invest which would yield returns of N1,000,000. While this may be tempting, with high returns also comes high risk. This is sometimes referred to as hitting home runs. It is typically a hit-or-miss kind of scenario with little room for in-betweens. For example, high-risk investors may have managed to lay hands on Solana, a digital currency that soared over 900% in 2023 or have been unfortunate to have invested in LUNC, another digital currency that had 36.96% of its value shaved off in January 2024 alone.
  • Playing the long-term game with compounding: There are several blog stories of investment “superstars” who bought a piece of a stock while dinosaurs still roamed the earth and sold thereby making headlines. According to Mootley Fool, for example, superstar investor and founder of Berkshire Hathaway, Warren Buffett bought Coca-Cola shares in 1988 for around $1.3 billion and earns about a 54% return every year. While tales like this always excite the investment public, the real problem is how to identify the next Coca-Cola, Tesla, or Apple. In a nutshell, that’s how the long-term game works. Pick a solid stock or asset like an ETF or mutual fund and keep reinvesting as returns come in.

How to make your small investments count

Unfortunately, as a small investor, the odds are stacked against you. Investing is not a walk in the park and the moment you decide to put money behind your convictions, you stand the risk of losing all or some of your principal. That being said, here are a few tips to make your small investments count:

  • Only invest what you can lose: Most fresh investors always think of the upside. What would I gain? Seasoned investors on the other hand consider the downside and typically invest what they can lose. CNBC Experts recommend between 15-30% of net income be set aside for investing.
  • Focus on quality over quantity: There would always be that colleague or family member coming up with a new investment opportunity. You want to focus on high-quality investment opportunities over advice from every Tom, Dick, and Harry.
  • Do your due diligence, always: Investing is a risky game and you are solely responsible for your decisions. Because of this, you must make sure you do your homework properly. If you are investing in a stock, you must thoroughly understand the company and what they do. Beyond that, you must access revenue, profits, and growth potentials objectively before putting your buck behind it.

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