Why would a person want to spend extra time learning about investments when he does computer programming for a living?!

I suppose that before reading this article, you would already have some answers to that question.

Investments is a very large term that emcompass things such as buying properties, investing in unit trusts and mutual funds, trading in shares, and even founding a business. All that they have in common, is just one thing: The desire that over time, whatever time and financial capital you have invested would significantly appreciate.

To be able to appreciate investments, we would have to look at the concept of active and residual income. In one of the more popular personal finance book, 'The Cashflow Quadrant' by Robert Kiyosaki, he talks about 4 different groups of people with their philosophy on generating income.

Active VS Passive Income

Basically active income is when you are paid linearly and instantly for the work you have done. An example would be, you work for 1 hour at a job that pays $10 per hour, then you would have earned $10. Or if your work pays you $2000 a month, then that is your active income. Simply said, active income is what you get when you are doing something. The other side of it, would be active income is what you don't get when you are not at work.

Passive income, is used to describe income that is paid when you may not be working on it at that point in time. Certain examples of these would be writing a book, coming out with a patent, creating a business, putting money into investments, etc.. For most of these, you would have to put a large amount of initial effort which pays very little (compared to active income proportionally), but as time passes, the income would continue paying even after you have finished the job.

When Robert Kiyosaki says that people who are on the left hand side of the Cashflow Quadrant(namely the employees and the self-employed) can't become wealthy, what he is trying to say is that you can't be depending on your work income all your life. Which makes sense really.. I don't think most people would want to be depending on work income when they are 80 years old.

Strategies 

So the question would be, how do you build an asset that gives you enough income after X amount of years?

Of course, you could just take a proportion of your income every month and stash it under the pillow. 30 years later, you start to draw down on that income. Well, that might work, but theres really no passive income there and if you are living in places like Zimbabwe (with a hyper inflation of more than 900%) or a more moderate country like China (with inflations of 6-8%), those stash of notes under your pillow might not last you very long.

The next better way would be to put it in your bank account. Savings account in Singapore typically pay up to 1% per annum. While inflation usually tend to be lower than 1%, the growth rate isn't going to give you a spectacular amount of passive income. Assuming you would be able to live on $1000 per month, that would mean you need $1.2million in the savings acocunt to give you that.

Power of Compounding

One of the reasons why you should invest young is the power of compounding. When you put capital into an investment, the capital would generate a return year after year. But thats not all! The returns that you get after the first year, also generate a return for the next year onwards, and so forth.

Looking at it another way, lets compare 2 people and their lifetime savings habit. Peter does a lot of part time work and likes to read up on investments. Starting at 15 years old, he started to save $1000 a year in an investment that gives him 12% per year. After 10 years, he decides to enjoy life. Not putting a single cent into his investment account, he spends all his money travelling, partying and slacking. He did keep his investment account and swears not to ever touch it.

Bob is a good friend of Peter. Having been caught up with fashion trends and consumerism, he spends all the money he earns on toys, gadgets and parties. When he reached 40, he woke up. Both his parents are retiring and they barely have any money in their retirement account. He panics and then starts to save $10,000 every year for the next 25 years of his life.

Guess who has more when they are both 65 years old? Peter, after putting away $1000 a year for 10 years, has $1.6million by the age of 65, whereas Bob who scrimped and saved $10,000 per year for 25 years only has just under a $1million. While both of them aren't exactly going to struggle through retirement, but its obvious how the 50 years of compounding has helped Peter with his money.

Of course, 12% may sound wildly optimistic, but imagine if you invested continuously since you were 15 years old till you are 65 years old.

Earlier on, we looked at the different types of investments you can do. Now's the most important question, why stocks?

Stocks is a fairly interesting instrument actually. Its simple enough to understand, its easily accessible to most, if not all people. You don't need $300,000 to buy a position in stocks. (unlike a private hedge fund) Coupled with low transaction costs and the fact that the companies listed are companies you see in you daily life, it just makes sense to invest in Singapore stocks!

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