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  • Rohit Musale, CFA

How to Invest Like a Pro

What do you look for, whenever you are making any kind of an investment?


Do you follow a step by step process?


What if I give you three super simple things to look for, in any potential investment that you are planning to make?


Would that make your life easier?


Just to give you some context here, the only reason why you must be investing is: for cashflow, not for capital gains.


Cash flow gives you financial freedom, not capital gains.


Always keep that in mind.


Here are three simple things I look for, before I make any kind of an investment:


1) ROI (Return on Investment)


Whenever I ask people, 'why are you investing your money?', they are not sure exactly why they are investing.


Most of the people say, they want to make money.


I think that's a very narrow way of looking at investing.


In my view, investing is something that should take you from point A to point B.


Point A is your current financial situation.


And point B is your financial freedom.


So any kind of investment, that doesn't take you to financial freedom, I wouldn't call it an investment at all.


Financial freedom is when your total monthly passive income either equals or exceeds your total monthly expense.


So this means, any kind of investment that can give you passive income is a true investment.


That is where the concept of ROI comes in.


ROI basically means, how much money am I putting into this investment, and in exchange for that, how much money am I receiving back, on an annual basis.


For example, if I buy a stock for $100, and the stock pays me a dividend of $1 annually, then my ROI is 1%.


On the other hand, let's say I buy a real estate unit, which is worth $100,000.


And I put a down payment of $20,000.


And then I put the real estate unit on rent.


And annually, I am making a cash flow of around $2,000, after deducting all of the expenses from the rental income.


In this case, my ROI is 10%.


Because, I have a mortgage of $80,000 on this property, the actual money that I have to put in the investment deal is $20,000.


So I am earning $2,000 on that $20,000.


That's why the ROI is 10%.


If I go to a bank and tell them to open up a fixed deposit account, and they offer me a rate of 3%, then that's the ROI -> 3%.


The higher the ROI, the more lucrative is the investment.


2) Reward to Risk


Just because your investment offers a very high return on investment, doesn't mean that it is a risk free investment.


If there was an investment, which was almost risk free, and it offered a very high ROI, then everybody would have already jumped on to the deal, right?


Every investment comes with an element of risk.


It is our job as investors to do our due diligence to find out, what are the odds that this investment will do well in the future.


I want to know whether my downside is protected or not.


I want to know, what is the potential reward.


If you make 10 investments, and you have a reward to risk of 2.5, then you can still make money, even if you get 7 out of 10 investments wrong.


Let me explain.


For example, you risk $10 each on 10 different investments, and the reward to risk is 2.5.


So, for every $10 that you are risking, your potential reward is $25, on each of those 10 investments.


Now assume that 7 out of those 10 investments go south.


The total amount of money that you have lost is $70, because that was the risk you took.


But on the remaining three investments, you make $25 each, so that's 25 times 3, which is $75.


Overall, you make 75 minus 70, which is $5.


Even if you were wrong 7 times out of 10, you still made money.


That's the power of the concept of reward to risk.


3) The degree of control over the investment


This immediately removes all of the standard and conventional investments available out there: things like stocks, bonds, mutual funds, fixed deposits.


They don't provide me any control over that investment.


So, when I am putting my money in this kind of an investment, I am like an outside investor.


For example, if I buy a stock, I have no influence over the price or the value of that stock.


I am completely dependent on the mercy of the markets to deliver me the returns that I want.


That's what I mean by control.


The more control I have on my investment, the lesser is the risk of that investment.


And the lesser is the risk of the investment, the higher is going to be the reward to risk ratio.


I pay very close attention to the degree of control that I have on my investments.


When it comes to the degree of control, it makes a lot of sense to invest in your own part time or full time business.


There you can control the cashflow, the investments, taxes, etc.


Please understand that: investing does not mean investing in other people's businesses.


Investing can also mean investing in your own business.


In summary, what I would say is, I look at three basic things, when I am making any kind of an investment.


I look at how much bang I am getting for the buck.


I look at the reward to risk ratio.


And I look at the degree of control on the investment.


I try to ascertain whether I am an inside investor in this deal, or am I an outside investor in this deal.


A quick example I can give you is:


If you own a real estate property, you can develop that property and increase the value of that property.


That is what I mean by degree of control over your investment.


You can't do that with stocks.


If the management of the business behind the stock ends up taking very bad decisions regarding the day to day operations of the company, then it will have a material impact on your investment in that business.


That's what I mean by not having control.


Overall, I would say that, investing is something that can take you to financial freedom, if you do it correctly.


Regards,


Rohit Musale, CFA


30 December 2022

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