Basic principle on stock and real estate investment
While helping one of my students learning Business, preparing for IGCSE exam, she asked me about stock and real estate investment. This is my answer:
Price of stock and real estate properties fluctuate constantly; we must learn to take advantages of this fluctuation. In principle, we ought to buy them at lowest price, hold until selling point at high price. In short, buy low, hold and sell high.
Figure 1: Buying Point, Selling point, and Holding period
However, this is not sufficient. If we buy at lowest price, and hold too long period, the appreciation does not recompense the loss due to inflation of the initial investment or just barely cut off this inflation, our return on investment is almost zero or negative. It is not good.
In case we borrow money from banks, the generated income (capital gain and dividend or rental income) must high enough to payback the cost of capital (associated interest and opportunity cost of financial capital) plus the operating expenses.
We should only buy and hold them in two situations:
Second: Or we buy them at low price and hold them to earn dividends (for stock), or rental income (for properties). In this case, the stock must be highly valuable, sustainable, evidence-based giving high yield dividend. For properties, they must be able to generate high income that sufficient to recompense capital cost (loan interest, opportunity cost), operating cost, and a surplus net income.
The aforementioned principle seems easy, but very hard to follow for many reasons. First of all, we must identify the right stocks or properties to buy. For instance, new stocks are always riskier than established stocks. The next question is how to identify correctly the buying point, selling point and should we buy to hold and how long should we hold? Due diligence analysis is key for decision making, including emotional control.