Boaters run aground by not paying attention to tides, charts, navigation tools and their GPSes. Investors get swamped with information, media noise, breaking news, politicians, gurus, and derivatives — so much so that they can’t see the oncoming fog banks and tsunamis of cyclical change.
Most investment mistakes are caused by basic misunderstandings of the securities markets and by invalid performance expectations. Losing money on an investment may not be the result of an investment sandbar and not all mistakes in judgment result in broken propellers.
Errors occur most frequently when judgment is rocked out of the boat by emotion, hindsight, and misconceptions about how securities react to waves of varying economic, political, and hysterical circumstances. You are the commander of your investment fleet. Use these ten risk-minimizers as lifeboats:
1. Identify realistic goals that include time, risk-tolerance, and future income requirements — chart your course before you leave the pier. A well thought out plan will minimize tacking maneuvers. A well-captained plan will not need trendy hardware or exotic rigging.
2. Learn to distinguish between asset allocation and diversification. Asset allocation divides the portfolio between equity and income securities. Diversification limits the size of individual holdings in several ways. Both hedge against the risk of loss. Both are done best using a cost based approach.
3. Be patient with your plan and think of it as a long-term voyage to a specific destination — change direction infrequently and gradually. There is no popular index or average that matches your portfolio, and calendar sub-divisions have no relationship to market, interest rate, or economic cycles.
4. Never fall in love with a security. No reasonable profit, in either class of security, should ever go unrealized. Profit targeting must be part of your plan, and keep in mind that three sevens beats two tens — and is much easier to achieve.
5. Prevent “analysis paralysis” from short-circuiting your decision-making powers. Limit the information you allow into your course charting process, and avoid any form of future prediction or bet covering.
6. Burn, delete, toss-out-the-window any short cuts or gimmicks that are supposed to provide instant stock picking success with minimum effort. Consumers’ obsession with products underlines how Wall Street has made it impossible for financial professionals to survive without them. Remember: consumers buy products; investors select securities.
7. Attend a workshop on interest rate expectation (IRE) sensitive securities and learn to deal with changes in their market value — in either direction. Few investors ever realize the full power of their income portfolio. Market value changes must be expected and understood, not reacted to with fear or greed. Fixed income does not mean fixed price.
8. Ignore Mother Nature’s evil twin daughters, speculation and pessimism. They’ll con you into buying at market peaks and panicking when prices fall, ignoring the cyclical opportunities provided by their Momma. Never buy at all time high prices and avoid story stocks religiously. Always buy slowly when prices fall and sell quickly when targets are reached.
9. Step away from calendar year, market value thinking. Most investment errors involve unrealistic time horizon, and/or “apples to oranges” performance comparisons. The get rich slowly path is a more reliable investment road that Wall Street has allowed to become overgrown, if not abandoned.
10. Avoid the cheap, the easy, the confusing, the most popular, the future knowing, and the one-size-fits-all. There are no freebies or sure things on Wall Street, and the further you stray from conventional stocks and bonds, the more risk you are adding to your portfolio.
Compounding the problems that investors face managing their investments is the sensationalism that the media brings to the process. Investing is a personal project where individual/family goals and objectives must dictate portfolio structure, management strategy, and performance evaluation techniques. It is not a competitive event.
Do most individual investors have difficulty minimizing investment risk in an environment that encourages instant gratification, supports all forms of speculation, and gets off on shortsighted reports, reactions, and achievements?
You bet they do!