Why understanding financials is your key to wealth

Assume you work for a bank as a loan officer. Every day, potential borrowers approach you for a loan. You want to reduce losses from bad loans while increasing profits for your bank. Which applications are allowed, and which are rejected? To distinguish between potentially excellent and bad applicants, you will require paperwork such as IC, payslips, tax files, EPF records, bank statements, CCRIS, and CTOS. These assist you determine creditworthiness.

It's important to note that the loan evaluation process is not just about numbers on paper. As a loan officer, you must also consider the applicant's character and capacity to repay. This involves assessing their employment stability, credit history, and overall financial behavior. Sometimes, a face-to-face interview can provide valuable insights that aren't apparent from documents alone. Your intuition and experience play a crucial role in making these judgments.

If the applicant is requesting for a mortgage, you will also require a property value report as collateral before the money can be given. This report helps you to calculate the maximum loan amount so that the bank can better recuperate the principle in the event of a default.

After doing a thorough background check on the applicant and the property, you turn to your institution's policies, processes, systems, and structures that govern loan approval. You evaluate all of the information and make a decision to accept or reject.

It's worth noting that the lending landscape is constantly evolving. With the advent of fintech and big data analytics, many banks are now incorporating alternative data sources and machine learning algorithms into their credit assessment processes. These advanced tools can help identify patterns and risk factors that might not be apparent through traditional methods. As a loan officer, staying updated with these technological advancements can significantly enhance your decision-making capabilities.

So, what if a bank does not have a credit policy? Without background information and valuation evaluations, it would be nearly impossible to identify a creditworthy individual. With a higher risk of undependable customers, the bank would incur bigger losses due to increased repayment defaults. Long story short, a profitable bank requires a robust credit policy.

How does this relate to investing?

Like the bank situation above, good stock investors require excellent investment policies. Purchasing stocks without reading financial data is comparable to bankers lending to any Tom, Dick, or Harry without conducting background checks. If you buy stocks without reading reports and think you're investing, you're not. What you're actually doing is trading, speculating, or gambling.

This distinction between investing and speculating is crucial. Warren Buffett, one of the world's most successful investors, famously said, "Risk comes from not knowing what you're doing." True investing involves thorough research and a deep understanding of the company's business model, competitive advantages, and financial health. It's about buying a piece of a business with the expectation of holding it for the long term, not just buying a ticker symbol hoping for a quick profit.

So what if you don't know how to interpret financial reports? Can you still buy stock?

Yes, you can. Please keep in mind that you are still not investing strictly speaking. It's okay if you don't know how to interpret financial statements. Everyone has to start somewhere. Fortunately, this is a quick study.

It is possible to learn if you know how to add, subtract, multiply, and divide. No algebra, trigonometry, or Pythagorean theorems are used. There are numerous internet resources that can assist you with this.

Once you master the skill, you will be able to use it for the rest of your life. You gain a genuine skill to recognize and separate investment-worthy stocks from a plethora of unsuitable ones. This is how investors get rich.

How about unit trusts and ETFs?

How can you choose a good unit trust fund or exchange-traded fund (ETF) among the thousands available? Can you rely only on a unit trust agent? How would you know if he or she is reliable?

When it comes to unit trusts and ETFs, it's essential to understand that these investment vehicles offer diversification benefits that individual stock picking might not provide. However, this doesn't mean you can skip due diligence. Key factors to consider include the fund's expense ratio, historical performance, the fund manager's track record, and how well the fund's strategy aligns with your investment goals. While a unit trust agent can provide valuable information, it's crucial to do your own research and not rely solely on their recommendations. Remember, an informed investor is always in a better position to make sound investment decisions.

The plain truth is that if you don't educate yourself on these topics, you won't know what to ask. It is not a question of whether equities outperform unit trusts and ETFs, or vice versa. Instead, a more useful question would be: I'm interested in stocks, unit trusts, and ETFs. How can I become a successful stock, unit trust, or ETF investor?

Becoming good is the essential word here. To become a competent investor, you must first learn to understand financial reports. And once you're good, you can make anything work.

So, where should you start?

Like a competent banker, you can start by learning two key investing skills: fundamental analysis (finding financially stable firms) and valuation (identifying inexpensive stocks). Again, there are numerous helpful resources available online. So, before making any investment decisions, do your study and brush up on your fundamentals.