Are You Being Penny-Wise But Pound-Foolish When Investing?

Imagine you are walking down Orchard Road with a briefcase full of cash. While you are passing a mall, you notice a shiny 50-cent coin lying in the middle of the road.

Now, in order for you to get to the 50-cent coin, you would need both your hands free. You’d need to rush out onto the road, put one hand up to stop on-coming car traffic, and use the other hand to pick up the 50-cent coin. Thus, in order to do that, you would need to drop your briefcase (that, as a reminder, is full of cash) and complete the dash before anyone can steal your briefcase.

The question now is, would you do it for that 50-cent coin? Most people would logically forget about the 50-cent coin. After all, you could lose your briefcase and even your life for an extra 50 cents – that is hardly worth the risk.

Yet, I see many speculators in the stock market doing exactly this every day. They invest with leverage in the hopes of earning a small profit by buying shares in the morning and selling them in the afternoon. But if they lose, because of the leverage involved, they could end up heavily in debt. They are risking their briefcase (what they have), to earn an extra 50 cents (the small profit).

Tempting but (small-f) foolish

It is definitely tempting to be able to make money while using Other People’s Money. But, borrowing to invest can be a dangerous practice.

Thing is, I believe investing in the stock market can be a great way to grow our wealth if used correctly. But what is the correct way? Here’s my thinking.

First, a person has to invest only with excess cash that he has. In this way, even if the investment sours, he would not have to sell the farm.

Second, the person has to invest meaningfully. This means that he should view his portfolio with respect to his entire net worth rather than the absolute amount. Investing $1,000 in the market can be very meaningful for someone whose net worth is $10,000. But investing $10,000 might be insignificant to someone who has a fortune of $10 million. View your investments in proportion to your wealth and not worry about the absolute amount.

Foolish Summary

Understand the risks you are taking on and the profits you can expect from an investment. Invest meaningfully, but be wary of borrowing to invest. Remember the story of the briefcase and the 50-cent coin?

For more investing analyses and important updates about the stock market, check out the Motley Fool's weekly investing newsletter Take Stock Singapore. This free newsletter can teach you how to grow your wealth in the years ahead, so do take a look here.

Also, like us on Facebook to follow our latest news and articles. The Motley Fool's purpose is to help the world invest, better.

The information provided is for general information purposes only and is not intended to be personalised investment or financial advice. Motley Fool Singapore writer Stanley Lim doesn't own shares in any company mentioned.