Okay, so perhaps it wasn’t exactly like that, but you get the picture I’m painting. It was great fun playing shop and many parents would agree that it’s the perfect mix of fun and learning for their little ones. But maybe even we as adults can learn from the simplicity of the lemonade stand, when it comes to how we invest…
So you’ve been saving your money a while now, putting in a little each pay and you’ve worked your way up to a healthy balance that you now want to work a little bit harder for you by investing in shares.
Let's use the lemonade stand as a metaphor.
The forecast for tomorrow says sunny. So you buy more lemons than the day before assuming that if it’s hot out, more people will buy your lemonade and thus your profit will increase. But then tomorrow comes, it’s a little cloudy and you don’t sell quite as much lemonade as you thought and make a loss. Alternatively, it comes out even hotter than you expected, you sell out of your lemonade, and your profit skyrockets.
Sometimes it’s sunny, there are lots of people out in the heat and the lemonade had the perfect balance of sweet and sour. But sometimes, even when we’ve done all the right preparation it can all go wrong. The weather goes from sun to rain or simply not enough people walk by our stand.
This is much the same as the process we go through when we choose to invest. We look at the market updates, we estimate our returns, work out how much we are willing to invest and if we have enough or need to borrow to do so, all based on the reward we think we can achieve. In investing, where there is risk, there is also the opportunity for return.
So what does all this mean?
It is so important that you know where you stand when it comes to your attitude towards risk and return. The way that you invest your money needs to suit you and your personal situation. In fact, sometimes, the most financially sound option is the wrong option for you despite the numbers adding up. That’s because it all depends on you, what you want to achieve and what you are comfortable with.
Let's revisit the lemonade stand to make a comparison.
Take Lily; in her backyard she has a lemon tree. The fruit is always delicious and every season produces so many lemons that she donates baskets full to her neighbours. Summer just started so she has weeks’ worth of beautiful sunny days to set up her lemonade stand. If Lily has a rainy day here or there, or there aren’t as many customers it doesn’t worry her too much. She knows that she has enough time and lemons to recover the loss.
Jake, on the other hand, does not have a lemon tree. His neighbour has one; sometimes the lemons fall into his yard, or his mum buys them from the store. Even though it’s the start of summer, Jake’s parents plan to take him away on holiday so he doesn’t have as much time to sell his lemonade. A rainy day would really put a hole in his pocket and he has to be really careful how much lemonade he makes each day so that he doesn’t make a massive loss if it doesn’t sell. He can’t take as many risks as Lily, because he knows that it will affect him more if things don’t go as planned.
Lily has a high tolerance for risk, she also has a good understanding that her investment in the lemonade stand is long term, and is prepared that some days she might make a loss, but other days she could do really well. Whereas Jake doesn’t have as much time and can’t afford to have his profit and loss fluctuating too much.
So who is wrong?
Neither of them. Lily and Jake both have the right approach to their lemonade stand, because they are investing appropriately for their personal situation. If Jake tried to invest like Lily and he were to suffer a loss, not only would he feel uncomfortable with how much risk he had taken on, but he wouldn’t be able to subsume it in the same way that she could. And if Lily were to invest like Jake, she might miss out on the big returns that she could achieve with her more open attitude towards risk. It’s all about doing what’s right for you.